Or, why should Venture Capitalists have all the fun?
The new dawn of SPACs is here. These shell companies, as they are called, first raise money to the tune of hundreds of millions of dollars from institutional investors. The Founders of the SPAC also invest their own money. Then, they IPO the shell company and list the shares at $10/share. Retail investors can now buy shares of the SPAC in the open market. The SPAC keeps its funds in a trust until it can find a company to invest that money in and effect a merge. The SPAC has two years to do the merger. If it fails to merge, money is returned to all investors with interest. The merged company gets a new stock ticker and resumes trading. The original team that created the SPAC has to do some work to identify the target company and consummate the merger. It could get a sizable (median of 2-5%) in the merged entity.
PIPE financing may also be done if the merged company needs to raise more money during the merging process or shortly thereafter. Big funders can provide PIPE financing in return for shares of the merged company.
I am not a SPAC mechanics expert, but that’s a rough picture.
How can this impact the current VC and institutional model of financing of startup companies? A growing and successful startup usually raises a series of rounds from VCs and institutional investors while still remaining private. During this time, the success of the startup is often visible to the general public. Or for the curious, Crunchbase or Pitchbook tells the story. Retail investors, however, can’t buy shares of this startup until it goes public in some fashion.
The SPAC vehicle has the potential to accelerate the stage at which retail investors get to own shares of a startup company. We are talking possibly Series B/C/D stages that a company is suitable to be SPAC’kled allowing retail investors to invest in the majority of growth phase of the company.
This allows retail investors to invest in an index of startup companies, diversifying risk. However, one should be cautious. SPACs are investing in moon shots and the target companies are not making revenue for decades. So, after getting de SPAC’kled (post merger), one could see big drops as investors get clarity on valuation and growth prospects.
The first issue is that retail investors do not know beforehand the target company. They may know the target sector from the SPAC prospectus, but not much else. However, the SPAC gives voting rights and redemption rights to it’s investors once the target is announced. This allows the retail investor to get out if they don’t like the deal. There is a backstop redemption clause of $10/share in theory. As of this writing, I don’t know how well that is going to work
The second issue is the rigor of due diligence conducted by the SPAC. One goal of SPACs is to reduce burden on startup founders and companies and accelerate going public by limiting the need to disclose exhaustive information. As a retail investor in the SPAC, it is likely the case that you will not find details like you do in the S-1. So you have to trust the SPAC promoters that they are doing quality diligence and valuing the company fairly.
By creating a lock up period for SPAC promoters to sell the merged company shares, it’s possible to reduce the motivation for them to flip. Some SPAC promoters are playing nice and adding lock up periods in their prospectus.
If SPACs work with good intent and are regulated efficiently, retail investors can stand to benefit. For VCs, it can act both ways. They could liquidate their “cash suckers” via the SPAC and breathe a sigh of relief. On the other hand, they don’t want to see their strongest performers go public before they can double down. They may still do that, but their control goes away.