How SPACs are changing the startup landscape

If 2020 wasn't dominated by a global pandemic, it might have been considered the year of the shell company.

Indeed, so-called special purpose acquisition companies, or SPACs, accounted for half of all U.S. initial public offerings last year, solidifying their role as a viable alternative for private, early-stage startups to access capital faster and with less regulatory hurdles than traditional IPOs.

“You're seeing more and more private companies that would otherwise stay private longer now having an avenue to tap into the public market," says Patrick Healey, founder, and president of Caliber Financial Partners, a financial planning and investment firm in Jersey City, N.J. “Historically, private companies would be more inclined to raise capital through venture capital investments."

What are SPACs?

SPACs, often referred to as blank check companies, are created to pull funds from investors to finance mergers or acquisitions within a set time frame, typically 24 to 36 months. These companies, which lack operations or business plans, primarily target startups in specific industries for takeover via an IPO.

When the IPO is completed, typically through a reverse merger, the SPAC is dissolved, and its shares are converted in the acquired, publicly-traded company.

Noted investors Bill Ackman and Michael Klein last year raised billions through SPACs, which have attracted celebrities and sports stars as ambassadors, executives, and board members. The list includes hoops icon Shaquille O'Neal, tennis great Serena Williams, and singer/songwriter Ciara.

Business is booming

SPACs filed a record 247 IPOs last year, up from 59 in 2019, a whopping 319% jump, according to Norwalk, Conn.-based market tracker FactSet Research Systems Inc.

Buoyed by sheer volume and the Wall Street debuts of Airbnb, luxury electric vehicle maker Fisker, and online sports betting and casino gaming operator DraftKings, SPAC IPO proceeds ballooned to $75 billion, morphing 2019's total of $12 billion, according to Deal Point Data in Newark, N.J.

Questionable valuations, quantitative easing, and an ongoing recovery hasn't disrupted the boom, as SPACinsider counts 223 filed IPOs this year and nearly 300 more in search mode.

Business attorney Roger Royse, who's fielding several weekly SPAC inquiries, recently started marketing the option to Silicon Valley tech startups and other hopefuls.

“There is a tremendous amount of SPAC money looking for targets," says Royse, a partner in the Palo Alto, Calif., office of Dallas-based Haynes & Boone LLP. “It's pretty attractive to consider that a company may not have to deal with the distraction of dealing with multiple rounds."

Drawbacks, other concerns

A premature SPAC exit, however, could limit proceeds for founders and other early investors, Royse warns, since staged financing rounds are ultimately tied to valuations, potentially leaving less money on the table. Most SPAC targets are unprofitable with unproven business models, escalating risk tolerance for investors, and likely most SPACs won't find a partner within their investment window.

Others aren't projecting real revenue for years.

“The SPAC boom may end up bringing a lot of earlier stage, much riskier companies to market," Michael Cembalest, J.P. Morgan Asset Management's chairman of Investment Strategy, wrote in a recent note to investors.

Tips and recommendations

Thomvest Ventures, a $500 million evergreen venture firm based in San Francisco, has backed one SPAC IPO—Figure Acquisition 1 raised $250 million in February—and has another in the pipeline with SoFi, another fintech company.

The VC places high importance on SPAC sponsors, the IPO underwriters, and organizers; the significance of the cash infusion, which can be transformative; and managing and meeting investor expectations as the acquired company transitions to the public markets, including providing regular guidance to analysts and investors.

Managing Director Don Butler recommends portfolio companies consider the SPAC route, with a few caveats.

“I would also recommend they focus heavily on their preparedness for being a public company and also on their selection of the financial sponsor/partner going forward, as we expect a correlation between the quality of the financial sponsor and their success in the public markets" he contends.

Finding a suitor

PureVita Medical, which launched amid the summer peak of coronavirus outbreaks, is looking to potentially merge with a SPAC later this year. The Utah-based medical mask manufacturer has been self-funded since its July inception, investing about $5 million into the business.

Co-founder and President Paul Hickey understands the challenges of raising funds in the private markets. He's raised 22 rounds for previous startups, Chinese manufacturers, and boutique investment banks.

SPACs, he argues, provide a better valuation, quicker funding, the potential to raise additional capital more easily, and include benefits enjoyed by most public companies, such as stock options, which help attract top talent.

“It's by far the better way to raise capital verse private equity or venture capital," Hickey says. “Every round of financing as a private company is extremely painful."