Special Purpose Acquisition Companies (SPACs) are all the rage on Wall Street right now. SPACs are publicly traded “shell companies” that raise capital through an IPO process and then use that capital to merge with a privately held business through a business combination. For a more detailed discussion of the SPAC structure, click here. In 2020, SPACs accounted for 248 initial public offerings (IPOs) and raised approximately $83 billion dollars, which was about half of the overall IPO activity on Wall Street. Of this number, about 40% of all 2020 SPACs were focused on the tech industry. SPACs are off to an equally impressive start in 2021. The SPAC phenomenon is reshaping the role of high-growth, venture-backed companies in the public markets in profound ways as SPACs provide a path to listing for many pre-revenue companies with high valuations, especially in the tech sector.

When compared to a traditional IPO, SPACs provide private companies that are looking to be publicly traded, especially tech companies, with a number of key advantages:

• When it comes to timing, SPACs are fast. After a SPAC has completed its IPO, it is generally able to complete the business combination in only a few months. This is far quicker than companies pursuing a traditional IPO, which will generally take 12-18 months to get ready to go public.
• SPACs also provide sponsors and management teams with a greater ability to position the company with investors since they are able to start marketing the business combination once a merger target is identified since the SPAC is already public. In addition, SPACs are able to market off of forward-looking projections and have a potentially much longer marketing period. This is key for tech companies, many of which do not have mature businesses with historical profits.
• From a valuation standpoint, the extensive pre-marketing opportunity in a confidential setting allows a SPAC to educate its investors so that they can understand whether the valuation of its potential merger partner is appropriate and provides for better pricing insight.
• Finally, because a SPAC transaction is effectively a merger, there is considerable flexibility regarding deal structure compared to a traditional IPO. Companies have the ability to incorporate different earn-out structures and other features to the deal that may not work in a traditional IPO setting. In addition, many sponsor and management teams will secure additional funding, through private investment in public equity (PIPE) transactions, in connection with the business combination to provide even more flexibility in deal structuring. This also enables a SPAC to complete a transaction with a value far in excess of the proceeds raised in the IPO, provides important investors with the opportunity to build a meaningful position, allows the SPAC to curate its cap table and shareholders, and de-risks whether the business combination will be completed.

Notwithstanding the foregoing, SPACs are not for everyone, and sponsors must consider whether the structure will appeal to public shareholders, taking into account factors such as costs, liquidity and potential growth.

Based on our understanding of the market, we believe that SPACs are here to stay but will continue to evolve in order to reflect the growing competition, which will eventually weed out underperforming SPACs, leaving behind only the higher quality SPACs for investor participation. With founder remuneration becoming less generous over time, the well-known, overperforming sponsors will continue to attract attention and will be able to raise bigger sums of money while the weaker players will eventually fade away.