In September 2020, an ambitious EV firm, Nikola, found itself at the epicenter of criticisms and memes after publishing an obscure clip showcasing their new truck prototype. Following this, the CEO and founder resigned after a 20% drop in their stock prices. Even stranger, Nikola had not sold a single car, let alone broke even, and yet was able to list in the NASDAQ. More on this story in a bit. How was Nikola able to pull this off? Through the same financial vehicle that enabled Virgin Galactic’s successful listing in 2019. This phenomenon had set the stage for the debates and questions of the sizzling topic in financial markets today, the rise of Special Purpose Acquisition Companies (SPACs).
The road to being a public company has many routes. The path most often taken is the traditional Initial Public Offering (IPO), which involves more regulatory and investor scrutiny. Companies hire investment banks to underwrite the offering and take on roadshows to pique investor demand before the ringing bell. The average process takes between 4 - 6 months. What if this process can be expedited? Enter the SPAC listing. Across bourses globally, there exists a number of listed blank cheque companies (also known as sponsors) with no commercial operations and are simply there to raise capital for the purpose of acquiring a private company. Money is raised by issuing shares that are often less than $10 and the funds kept until an interesting private company or startup turns up. When the deal is closed, the sponsor takes the private firm public through an acquisition. While firms in a traditional IPO pay fees to investment banks, firms seeking to go public through SPACs also pay a fee with sponsors often taking 20% of founders’ shares, usually at a discounted price. This allows private firms to go public while circumventing the more laborious and time-consuming processes of a conventional IPO. This option has become very popular of late, with many late stage startups opting to go public through SPACs.
SPACs aren’t new. They have been around since the 1980s and interests over the past few years have fluctuated. According to Kolibra Partner, Teezar Firmansyah, SPAC listings of the past had been mainly for capital intensive and greenfield projects. Think of potential oil companies with geological proof of oil sources but no capital to build rigs. Recently, however, the SPACs boom is turning heads globally, a result of companies seeking alternative funding in the public avenue.
What does this mean for VCs? In one perspective SPACs can disrupt the VC sphere, especially pertaining to late-stage funds. Similar to VCs, SPAC sponsors compete in the same sphere to fund hot target companies. According to Mr. Mentiko of Crunchbase News, this competition is happening when companies are trying to figure out the best path for their fundraising method. SPACs have given the option for startups to simply go public earlier as opposed to raising a Series D or E round. This option may be an attractive one given that SPAC deals can potentially provide better valuations and raise nominally more. The SPAC vehicle may indeed be competition in the field of funding. More funding opportunities targeting a small pool of exciting startups would mean competition with VCs would naturally intensify.
However, this phenomenon can also potentially be an opportunity for Venture funds. Companies in the Series B and C rounds are already raising in the region of $10m these days. With fundraising amounts only increasing, it is not unfathomable for rising startups to go public earlier through the SPAC vehicle without needing a private series D or E round. This opens VCs to more potential routes for exit strategies, especially for early-stage funds. Meanwhile, the phenomenon might also change the landscape in later-stage fund markets.
Indeed, this exciting new financial vehicle is gaining traction. However, some pertinent questions still remain. Are SPACs sustainable in the long run? While this method opens up opportunities to promising startups and VCs, they also risk providing an avenue for firms who cannot maintain the fine balance between growth and profitability. The curious case of Uber comes to mind. While Uber is no doubt an exciting startup to dump funding in, public markets may be more averse. Earlier this year, their initial business model of having drivers as contractors in the shared platform came under threat when British courts rectified that Uber drivers are considered employees entitled to benefits and protections. The regulatory change would likely cost Uber an estimated $600m. If Uber were in public markets, such a predicament would likely not convince investors that Uber is a business model that is losing money to gain future returns. Many public investors expect some maturity for companies already listed and are often impatient with firms that are constantly on the red.
Moreover, the sustainability of SPACs came into further question with our old friend, Nikola, from earlier. When Nikola published the clip of its new truck prototype, a short seller identified that the clip had...oddities. The uphill oriented truck was in fact going downhill. The clip was simply reversed and tempered to look like it was going uphill. With a fraud case as absurd as Reddit’s GameStop meme stock spike, Nikola’s stock prices came under speculative attack. This opens the question of whether SPACs provide a funding avenue for companies that are simply not ready for the public market just yet.
Return figures also should also spike a healthy amount of skepticism over this phenomenon. In a 2020 Goldman Sachs study of 56 SPACs that closed an M&A deal, it was found that the companies underperformed the S&P 500 during a 3, 6 and 12-month period. Analysts at Goldman Sachs sees this trend as a “shift in focus from value to growth”.
The growth and popularity of SPACs are likely to grow in the foreseeable future. The opportunities for VCs to ride the waves are still too early to tell. What is certain is that the diversification in funding routes is here to stay. Nonetheless, what must be emphasized in any funding deal is striking the delicate balance of growth and profitability. The emphasis on growth must not neglect foundational stability and the investors’ mandate. Moreover, with changing regulatory frameworks that would undoubtedly seek to establish greater oversight over SPACs, institutional frameworks and good corporate governance is instrumental in achieving long-term sustainability and most importantly, earning the trust of investors.