Advantages of a SPAC

6 min readAug 24, 2020

This article is part 2 of a series (co-authored by Sailesh Patnala) about special purpose acquisition companies (SPACs). If you have missed the first part, here it is for a quick introduction to SPACs: https://medium.com/@saileshpatnala/the-revival-of-spacs-44d7209f4651

Part 2: Advantages of a SPAC

As mentioned in the previous post, SPACs have recently made a comeback as a vehicle to go public in a simple and time-efficient manner. SPACs provide numerous advantages for companies looking to go public when compared to a traditional IPO or direct listing, such as simplicity, faster timeframe, better valuation, and well incentivized long-term partners.

For a quick primer on specific of a traditional IPO: https://www.investopedia.com/terms/i/ipo.asp#underwriters-and-the-ipo-process

Time Frame

The most compelling advantage of a SPAC is the time it takes between intent to go public and actually being traded on an exchange. A company’s executive team would not want to devote 12–18 months of back and forth with the SEC and underwriters followed by a pre-IPO roadshow. SPACs give companies an opportunity to go public in 4–6 months, leaving extra time for the team to focus on building the business and increasing shareholder value.

Since SPACs are able to abstract the IPO process, a private company can simply merge into the already publicly traded (blank shell) company with significantly less work than needed for a traditional IPO. SEC registration documents are short for the SPAC IPO and can be prepared in a matter of weeks. There is no need for historical financial records or assets that need to be disclosed. Furthermore, the sponsors of the SPAC spend the months ahead going on roadshows to raise capital. SPACs take care of all the boilerplate IPO work, leaving the target company to just negotiate terms, conditions, and other standard M&A procedures.

Pricing and Valuation

SPACs provide a better incentive structure with the sponsors (underwriters) for the target company to raise capital in favorable terms. Investment banks that underwrite the traditional IPO don’t share the same incentives as the company. Banks want to maintain their sell-side relationships and sell shares of companies that are going to make their clients the most money. Over-allotment options or greenshoe options are examples of the misalignment of incentives between banks and a pre-IPO company’s long-term success.

It’s not uncommon for a company’s stocks to trade higher than the IPO price on their first day listed on an exchange, also known as the “pop”. Banks disregard complaints from the company and price the IPO unfairly to allow for a pop to compensate early investors (the bank’s clients) who take on more risk. A large pop allows banks to issue more shares to stabilize the price, a process referred to as over-allotment. In this circumstance, the company is leaving money on the table since they raised capital at a much cheaper valuation.

On the other hand, if there is no pop and the stock trades notably lower than the IPO price then underwriters have the option to buy back shares, creating a shortage in supply to drive the price back up. This is the greenshoe option, which is usually written in during the underwriting process. The aforementioned options allow banks to control the IPO process to mitigate downside for themselves and their clients.

Since the underwriters of a SPAC are actually the sponsors, they essentially share the same long term incentives as the company. It can be thought of as an M&A process rather than a transaction. Although negotiations can be difficult, once the merger is completed they are all on the same team. Moreover, sponsors of the SPAC place their reputation on the line when they are confident about a target company. This most often results in a fair and favorable valuation for the company.

Cost Basis

Although expenses for a SPAC are not much different from expenses for a traditional IPO, the structure of underwriter discounts and the overall underwriting process can be more favorable for a company looking to go public. Underwriters of a traditional IPO can be one or more investment banks, who receive an underwriting discount as compensation for marketing and selling the IPO. The discount for underwriters of a traditional IPO is usually around 3.5–7% (according to a PwC approximation based on 705 companies). However, the underwriting discount for a SPAC IPO is 5.5%, with 2% being paid at the time of the IPO and the remaining 3.5% paid at the time of the de-SPAC transaction (i.e. target business acquisition).

Image Source: https://www.pwc.com/us/en/services/deals/library/cost-of-an-ipo.html

Furthermore, the underwriting discount is typically paid to the SPAC sponsors as options on equity in the company. The deferred discount commission is beneficial to the target company and positively incentivizes the sponsors to find a target acquisition to receive their 3.5% commission in the form of equity. In other words, the amount that a company would pay an investment bank to underwrite an IPO is instead paid to the sponsors of the SPAC in the form of equity. While the cost to go public might be more or less the same, incentives of underwriters and the company are more aligned in the SPAC process compared to a traditional IPO.

SPACs vs. Direct Listings

For a quick refresher on direct listings: https://www.investopedia.com/terms/d/directpublicoffering.asp#how-a-direct-public-offering-works

image source: https://www.fastcompany.com/90367018/slacks-non-ipo-is-off-to-an-impressive-start-at-the-nyse

A direct listing is an excellent option if the primary motivation for a company going public is shareholder liquidity without dilution. Direct listings are not meant to raise additional capital. Recently, notable companies such as Slack (NYSE: WORK) and Spotify (NYSE: SPOT) have gone public through a direct listing. A direct listing doesn’t require banks as underwriters, and also doesn’t dilute existing shareholders as there are no new shares created for the public market. Employees benefit by getting immediate liquidity for their promised equity as they are not subject to lock-up periods.

Conclusion

SPACs are one of the best options for companies trying to enter the public market and raise capital quickly. They benefit from a quick turnaround process, more accurate valuation, and most importantly, a well-incentivized long-term partner in the SPAC sponsor. In most cases, the sponsor of the SPAC continues to be a value add for the company by staying on in an executive or chairperson role. For instance, Chamath Palihapitiya continued on as Chairman of Virgin Galactic (NYSE: SPCE) and now works closely with Richard Branson and the team.

In the next part, we’ll look at the capital structure of SPACs and how the SPAC transitions into the target company (De-SPAC).

Special thanks to Sitara Ramesh and Steven Truong for reading the draft of this post, and suggesting edits.

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