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Concepts: SPACs

Gunnar Jaerv
Gunnar Jaerv 15 July 2021

SPACs have become a preferred way for some companies to go public without the difficulties of a traditional IPO, and without the strong market presence that direct listing requires.

For digital assets companies in particular, SPACs seem to allow access to the stock market without requiring extensive filing or long waits.

What is a SPAC, how do they work, and who is using them?

What is a SPAC?

SPACs are Special-purpose Acquisition Companies, publicly-traded companies that carry out no business operations of their own. A SPAC is formed by a group of investors called “sponsors”, who then carry out an IPO offering stock in the SPAC. But SPACs don’t perform any business activity of their own; instead, they exist as an interface between the public and businesses that find it difficult to access funds.

SPACs were first created in the 1900s, but they have undergone a surge of interest in recent years, with many companies seeing them as quicker, lower-cost alternatives to a traditional IPO.

How do SPACs work?

SPACs are sometimes referred to as “blank check companies”, because they don’t perform any commercial operations of their own. They exist solely to raise capital for another company, or to buy another company. In many cases, the company has already been selected and the SPAC is a funding method for the company. In others, SPACs are formed first, then a “target company” is selected for acquisition afterwards.

The basic process is similar in both cases. First, a group of investors decides to form a SPAC. A SPAC consists of common shares merged with a warrant, which is a contract giving the holder the right to buy more shares at a later date. When you buy shares in a PAC, you’re also buying the right to buy more if it does well.

Most SPACs price their shares at around $10 each, and make the warrant exercise price (the cost of buying more shares based on the warrant) about 15% higher than the IPO price.

A SPAC typically has two years to acquire or merge with a private company after it completes its IPO. If it doesn’t, it has to be dissolved and all funds returned to the shareholders who participated in the IPO. Some SPACs reveal which company they intend to acquire or merge with during the IPO process, but some do not. If a SPAC does successfully merge with a private company, its cash reserves, raised during the IPO, become those of its target company and it loses its status as a public company in the process.

What’s the difference between a SPAC, a direct listing, and an IPO?

If you’re a private company seeking investment you have plenty of other options besides a SPAC. Many companies simply list directly to the stock exchange, known as a direct listing. Others carry out an Initial Public Offering. Why choose one over the other, and what’s the difference?

SPAC:

  • Your company goes public by being bought by the SPAC or merging with it
  • It’s easier and faster than an IPO, with a lot less regulatory scrutiny
  • Your company doesn’t have to provide detailed financial information to any authority
  • The fees are higher than direct listings, because the SPAC sponsors seek to profit
  • Investors don’t always know the target company or price

IPO:

  • Supported by major Wall Street companies with extensive experience and know-how, meaning among other things that companies are often valued accurately
  • New shares are created and sold to investors, but these must be underwritten by specialized banks, meaning high fees
  • Companies have to publicize their own IPOs to potential investors
  • Higher regulatory scrutiny, including:
    • Underwriters’ contracts
    • Financial disclosure
  • Typically, there’s a mandated post-IPO lockup period where employees with stock options cannot sell their stock
  • Investors are often extremely well-informed about the value and financial health of the company, thanks to extensive filings

Direct listing:

  • The company sells shares direct to investors, with no other process such as underwriters, roadshows to promote an IPO, or intermediaries
  • Unlike in SPACs and IPOs where new shares are created, companies doing direct listings sell existing shares
  • Direct listings are best suited to well-established businesses whose brand and value is well-known, so they don’t need publicity or assistance from intermediaries
  • Direct listings involve significantly lower fees than IPOs or SPACs
  • There is no mandated “lock-up period” on employee share sales
  • Investors will know more about the company than may be the case with a SPAC, but less than with an IPO

Advantages and drawbacks of SPACS

SPACs come with particular advantages and drawbacks for both investors and companies. Private companies might find a SPAC the best way to get public investment, especially if they have unconventional structures or their business activities are unusual. Investors might see them as a way to gain exposure to promising companies they otherwise might have struggled to work with.

For companies:

Advantages:

SPACs are faster and more convenient than IPOs. If you’re a business that’s up and running and has some assets, an IPO is a long, slow and expensive process. You’ll need to work with investment banks or other underwriters, publicize your IPO and manage paperwork and compliance. An IPO can take six months to a year to complete; a SPAC merger can take three to four months.

SPACs also allow companies to get “assurances from investors early on at an agreed price, not the night before like a normal IPO”, explains Telstra Ventures general partner Yash Patel. And the final sale price can be up to 20% higher than a traditional private equity sale.

Disadvantages:

SPACs can suffer from “shareholder dilution” — sponsors already typically own 20% of a SPAC, and often have clauses triggering automatic payouts of more shares when share prices reach a certain threshold. They’re also less secure for the same reasons they’re faster — fewer filings and less financial diligence. They also give a company less time to prepare for life as a public company, which can be very different. It also involves filing with the SEC, which can be harder to do on a truncated timeline.

For investors:

Advantages:

SPACs offer an attractive risk/reward profile compared to IPOs, especially for institutional investors. In addition, SPAC sponsors usually have both financial experience, and experience in the industry or sector of their target company. So investors in SPACs can essentially outsource target company selection to sponsors. SPAC share prices usually change very fast once a deal is announced, so there’s a limited period for investors to benefit from their low initial share prices.

Disadvantages:

SPACs are far less predictable than traditional IPOs, and while payoffs can be substantial, many SPACs fail to find a deal; many others don’t find a lucrative one.

Tech companies and SPACs

Merging with a SPAC has become a popular way for tech companies to become publicly-listed. SoFi, 23andMe, Desktop Metal and Matterport all announced SPACs this year, and $1.13 billion had been raised by 368 SPACs in 2021 at the time of writing.

Traditional tech companies are embracing SPACs, with Lux Capital’s Peter Hebert saying, “The vast majority of companies looking at doing traditional public offerings are dual-tracking SPACs”.

SPACs and digital assets

Digital assets companies that wish to avoid the rigorous scrutiny of a traditional IPO, and the risks associated with an ICO, are increasingly drawn to SPACs as a way to secure funding.

Cipher Mining merged with Goodworks Acquisition Corp in May, in a $2 billion deal, and Bakt, the Bitcoin futures trading platform, plans to go public by merging with VPC Impact Acquisition Holdings in a deal that values Bakkt at over $ billion.

How to tell if a SPAC is going to perform well

The most reliable predictor of a successful SPAC is experienced leadership, according to Wolfe Research, who found that “the strongest differentiating characteristic of De-SPAC stock performance (i.e., after the merger closed) was the presence / absence of an “experienced operator”. Notably, experienced operator De-SPACs materially outperformed those without an experienced operator”.

Where leadership was highly experienced in the business or sector of the target company, SPACs showed convincing profitability:

SPAC PShare Price Performance

Case study: Circle’s SPAC

Circle, one of the founder members of the Centre consortium that issues the USDC stablecoin, has announced plans to go public “through a combination with Concord Acquisition Corp”, in a deal that values Circle at $4.5 billion.

Circle Investor Overview Video

After starting as a consumer payment app, Circle pivoted to a digital assets trading desk, acquiring an exchange. But it’s mostly known for its stablecoin, USDC, of which there are $25 billion in circulation; the company forecasts a circulation of $190 billion by the end of 2023, and has business plans to build financial services focused on USDC.

Concord Sponsor Group LLC, the owner of Concord Acquisition Corp, is an affiliate of Atlas Merchant Capital LLC, founded in 2014 by Bob Diamond and David Schamis to pursue opportunities in financial services sector investments.

Case study: Bullish’s SPAC

Bullish, the digital assets exchange backed by Peter Thiel and valued at $9 billion to $12 billion, has announced that it is in talks to go public through Far Peak Acquisition Corp, led by CEO Thomas W. Farley and CFO David W. Bonanno.

During the last year, Bullish received an nitial capital injection by Block.one, which settled the class action suit against it for its EOSIO ICO for $27.5 million in June this year. Bullish received $100 million, 164,000 BTC ($5.3 billion), and 20 million EOS ($78.2 million), as well as completing a previously-announced $300 million strategic investment round. Its main product is expected to be a fully-regulated, highly-liquid exchange.

When the SPAC transaction is complete, Thomas W. Farley will become CEO of Bullish, and Block.one CEO Brendan Blumer will be appointed its chairman.

Disclaimer:

Disclaimer: This publication is general in nature and is not intended to constitute any professional advice or an offer or solicitation to buy or sell any financial or investment products. You should seek separate professional advice before taking any action in relation to the matters dealt with in this publication. Please note our full disclaimer here.

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