# Understanding SPACs: A Founder's Essential Guide for Going Public
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Chapter 1: Introduction to Capital Raising and SPACs
Navigating the capital-raising landscape can be quite intricate for any business, particularly when comparing early-stage startups, often negotiating terms informally, with more mature companies that must adhere to extensive regulatory standards to go public. Founders and investors of late-stage firms, who are keenly focused on growth, frequently contemplate going public as a means to access additional funding for expansion. This endeavor typically requires an initial public offering (IPO), which is no small feat. The process involves satisfying regulatory obligations, engaging in roadshows to entice institutional investors, and covering underwriting fees owed to investment banks facilitating the transition.
But is there a simpler alternative for founders?
This is where Special Purpose Acquisition Companies (SPACs) come into play.
Chapter 2: What Are SPACs?
SPACs are essentially shell companies established by sponsors with the sole aim of raising capital through an IPO. These sponsors then seek out private companies to merge with, effectively allowing these firms to go public without the traditional hurdles of an IPO. Unlike venture capital funds that invest in multiple companies, each SPAC is created with the intent to make a single investment — the merger with a private company.
The credibility of a SPAC heavily relies on its sponsor. SPACs backed by well-known sponsors like Chamath Palihapitiya, Reid Hoffman, or Bill Ackman tend to attract considerable interest from investors. This phenomenon is rooted in the concept of validation; similar to how investors favor hedge fund managers with strong track records, SPAC investors are drawn to reputable sponsors.
Chapter 3: The SPAC Process
Understanding how SPACs function is crucial for founders. The process typically unfolds in the following steps:
- Formation: The journey begins with establishing a shell company, the SPAC, which has no operational activities or assets.
- Finding Investors: The sponsor seeks institutional investors to contribute to the SPAC, much like a standard IPO. Investors are informed that the SPAC is merely a shell company, and they are not privy to the identity of the target company.
- SPAC IPO: If investor interest is sufficient, the SPAC conducts an IPO on a stock exchange, selling units at a standard price of $10.00 each. These units include shares and warrants, which allow investors to purchase additional shares at an exercise price of $11.50. Funds raised are initially held in trust and invested in Treasury Notes until a target company is secured.
- Identifying Target Companies: The sponsor typically has 18 to 24 months to find a suitable target company. Failure to do so results in liquidation, returning funds to investors. Once a target is identified, the sponsor makes an acquisition offer using the IPO-raised funds.
- PIPE Funding: To supplement the SPAC IPO proceeds, sponsors may arrange for additional private investments in public equity (PIPE), often sourced from private equity or hedge funds.
- Merger Approval: After securing a target company and PIPE commitments, SPAC investors must approve the merger.
- De-SPACed Company: Upon successful merger completion, the target company becomes publicly listed, bypassing the traditional IPO route.
Chapter 4: Incentives of Stakeholders
While the SPAC route presents apparent advantages for founders, understanding the motivations of each participant is essential.
SPAC Sponsor Incentives
The sponsor provides crucial sector expertise and has a vested interest in completing a successful merger. They receive a special class of shares, known as the sponsor promote, amounting to 20% of the SPAC’s post-IPO equity. This incentive could lead sponsors to push for a deal, potentially disregarding other important factors.
Institutional Investors
The recent growth in SPACs is closely connected to the capital influx from institutional investors participating in SPAC IPOs. Though there’s inherent risk in the timing of returns, investors gain access to innovative opportunities that may not be available via traditional IPOs. Additionally, SPAC investors have the option to redeem shares if they disapprove of the proposed merger.
Target Companies
For private companies, opting for a SPAC means circumventing the lengthy and costly IPO process. The SPAC route can reduce the timeline to going public to approximately 4–6 months, compared to the 18 months associated with a traditional IPO.
Chapter 5: The Financial Implications of SPAC Fees
While SPAC fees may initially seem more favorable than those associated with IPOs, founders should evaluate the overall costs involved, including underwriting fees, pricing, warrants, and the sponsor promote.
Traditional IPO Fees: In a typical IPO, the underwriting fee is around 7% of the total capital raised. This fee compensates the investment bank for pricing the IPO and securing institutional investors. Unfortunately, underpricing can lead to a significant "IPO pop," shortchanging the company and its founders.
SPAC Fees: Although SPAC underwriting fees range from 5% to 5.5%, founders should consider hidden costs that could ultimately surpass 25% of the total capital raised during the SPAC IPO. Notably, the sponsor promote can significantly diminish funds available to the company.
A Note on Fees
Despite the costs, PIPE commitments from private equity or strategic investors can alleviate some financial burdens since these funds are not affected by the aforementioned SPAC fees. With rising competition among SPAC sponsors, the sponsor promote may decrease, creating a more balanced playing field.
In summary, while SPACs offer a streamlined approach for going public, founders must carefully assess both the advantages and potential pitfalls, including the incentives of all parties involved.
Description: This video explains what a Special Purpose Acquisition Company (SPAC) is and how it operates, providing insights for founders considering this route.
Description: This video discusses the intricacies of SPACs, including potential pitfalls and why some investors might want to steer clear of them.
Disclaimer: The information provided here does not constitute legal or financial advice. For more insights on venture capital, startups, and technology, feel free to connect on Twitter and LinkedIn.