Show Me the Money - SPACs
One of the things I’ve enjoyed the most this year is the time to test and experiment with cutting-edge tech and apps. This issue is part of a six-part series focused on emerging tech and my unique purview into the new and innovative. I hope you enjoy it!
Hi All -
If I had a dollar for every time I saw the word SPAC in a headline, well I wouldn’t be writing this right now! What are SPACS and why are they so popular?
SPAC stands for special-purpose acquisition company or a blank-check company that’s formed for the purpose of merging or acquiring other private companies. Although SPACs have been around since the eighties and nineties, last year SPACs exploded in popularity thanks to mastermind tech-investor Chamath Palihapitiya.
In 2017, Chamath and his team formed the Social Capital Hedosophia SPAC with the sole intent of taking a venture-backed company public. They had two years to find a suitable acquisition and that’s how I first was introduced to Chamath. I spent part of 2018 researching SPACs, understanding the feasibility for a crypto company, and convinced myself that Slack was going to be the target. Little did I know the extent of Chamath’s ambitious plans!
In 2019 he teamed up with Richard Branson to bring Virgin Galactic to the market, signifying the first space company to go public. The market responded positively and four months later the stock price tripled. Not only did this unlock a new use case for SPACs, but it also ushered in a frenzy of investors looking to make hefty returns. In this new gold rush, everyone from space cadets to celebrity basketball players rushed to create SPACs of their own. And yes, there’s actually a Shaq SPAC.
SPACs differ from IPOs in a variety of ways, but at the outset, it’s important to understand the roles of the Sponsor, Investors, and prospective Company. The best way to illustrate this is with a hypothetical. Saddle up, my friends!
We all know that I’m passionate about emerging tech so I decide to raise a $500M SPAC to help take a disruptive startup public. I don’t have a specific company in mind, which is good because that would violate SEC rules. As the sponsor, I put in $5 million of my own money, handle the legal and underwriting costs, and file COS SPAC to go public. Once the paperwork is all set, I go on a roadshow to find investors (aka jump on a bunch of Zoom calls).
I ping my network to see which hedge funds and family offices are interested and Will, Catherine, and David jump on the chance. Why? Well, there’s basically no downside risk for them. Thanks to interest rates being at practically zero, they can essentially provide me with a bridge loan, gain some upside if COS SPAC does well, or get their money back if they don’t like the deal. Also, they believe that the following I’ve built with COS and my reputation means that I’m more likely to find a good deal.
Will, Catherine, and David each invest a couple million at $10 a share and also receive warrants in the IPO. Once I have the initial money raised, I take the COS SPAC public on the New York Stock Exchange under the ticker symbol $COS. The $500 million is then held in a trust account and invested in short-term Treasury Bills. As the sponsor, I get a “promote fee”, which means I keep 20% of the shares and essentially a minority stake in the future company. Now it’s time to go shopping! I have two years to find a private company to merge with $COS, otherwise, the money is returned to the investors (like Will, Catherine, David) and I go back to writing.
Until then Will, Catherine, David, and the rest of the investors have the right to redeem their shares and receive back the cash they invested, plus interest. They also get to keep the share warrants. A few months later, David’s firm decides to change its strategy and go all-in on crypto instead so he gets his money back and I search for a new investor. Eww, David!
After a year of meeting with prospective companies, I discover an awesome flying car startup out of Austin called Giddy Up. They have backing from Softbank, a prototype “Spirit: Stallion of the Cimarron'', and FAA approvals for test flights. They had considered IPOing, but given how nascent their industry is and their questionable ownership structure it was going to be a challenge. Instead, a SPAC seemed like a better route for three reasons. First, the timing to the public markets is quick, only taking a couple of months. Second, there are fewer SEC reporting requirements and compliance obligations. Lastly, the upfront costs are much less since the sponsor (me!) has already handled the underwriting costs.
After some wrangling, we negotiate the acquisition terms and come to an agreement. I take the deal to the shareholders for a vote and it’s approved! We promptly celebrate with Franklin’s BBQ and Ranch Water. Yee Haw!
The news leaks about the potential merger and is the top story in Bloomberg, causing the $COS stock price to jump to $20. /WallStreetsBets is ablaze and I go on Squawk Box wearing my glitter “SPAC THAT” tee to explain the market fundamentals and then tweet the deal memo to my millions of loyal Chief of Stuff followers.
When COS officially merges with Giddy Up that fantasy of Jetson-style flying cars becomes one step closer to becoming a reality. Retail traders couldn’t be happier! Robinhood sees a surge in activity and $COS hits a record high of $50 a share.
Six months later, Biden reveals an ambitious nationwide transportation plan focused on building high-speed rail systems throughout the US. All funding and approvals for flying cars are suddenly grounded indefinitely. In addition, new sanctions against China mean that Giddy Up’s special propeller blades will take twice as long to import. This in addition to other market dynamics causes $COS to quickly slide to $5 a share.
The original investors are long gone, Will sold his $COS position at $20 and Catherine at $50, leaving retail investors with the proverbial saddlebags. I don’t mind either way because I’ve made out like a bandit and I still believe in the business. As Chairman of the Board, I’ve just been briefed about Giddy Up’s new UK expansion plan “Operation Shetland Pony” and that they have secured suppliers out of Germany. I’m thinking of buying an island so I’m toying around with the idea of raising my second SPAC COS II.
Life is good y’all!
Last year SPACs raised $83.4 billion and in the first quarter of 2021 have already raised $88 billion. The influx of capital for SPACs is at an all-time high partially because Investors have almost no downside risk and interest rates are zero. They can happily park their money in a SPAC, make some returns, or if things change, easily get their investment back. With hundreds of SPACs looking for acquisition targets, the challenge is actually finding a viable company to take public. That’s where having a strong, reliable sponsor is critical.
Technology is disintermediating institutions and SPACs are disrupting the public markets in more ways than one. Today established institutions like Goldman Sachs and Morgan Stanley have to compete with the individual star power of sponsors like Chamath, Reid Hoffman (from LinkedIn), and Bill Ackman and from my POV - it’s a losing battle.
Chamath has been dubbed the SPAC King and for good reason - he’s committed to SPACs. He has a solid investing track record from Social Capital, is vocal about taking down the Wall Street establishment, loves crypto and meme stocks, and knows what resonates with his 1.5M Twitter followers. You can often catch him on CNBC commenting about the markets or listen to him “wet his beak” on the podcast “All In” with his besties David Sachs, Jason Calacanis, and David Friedberg. Last year he raised more than $4bn for five more SPACs – known as IPOB, IPOC, IPOD, and so on. Eventually, he’ll do 26 deals, one for every letter of the alphabet.
These savvy sponsors have become their own brands and their external reputation, clout, and social status hinges on making good investment decisions. For Investors, it’s easier to justify investing with a high-profile sponsor as there’s a lower likelihood of getting a bad deal. While the 20% promote fee to sponsors seems high, Founders are willing to make that trade because they get the support of highly successful business leaders and can skip the headache and hassle of the IPO process. Plus with banks consistently underpricing stocks, it’s difficult for a Company to trust that they are getting the most value out of the IPO process.
Whether SPACs are actually a good long-term investment remains to be seen. According to data, in the first three months after merging most of the companies are down by 14.5%. Not great! Also, the SEC is already concerned about bad actors taking advantage of SPACs and has proposed new accounting rules and other regulations to try and curb the frenzy. When the dust settles it will be interesting to see if SPACs succeed or if something new evolves for Wall Street.
In the meantime, don’t be a complete cowboy - please do your research before investing in anything speculative.