A young man who asked to be identified only as D. is an entrepreneur in the areas of cybersecurity and network fault identification. His startup has flourished during the pandemic, generating annual revenue of $15 million. A few months ago a large consulting firm made him a surprising proposal: Merge your startup with a special purpose acquisition company, or SPAC.
The idea was simple. The SPAC, a “blank check” shell corporation, would take his company public quickly, without most of the regulatory hurdles of a traditional initial public offering.
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Some would say it’s a tempting offer. Shareholders in the startup can cash out, the startup will likely enjoy a high market valuation and if everything works out, shares can be sold to the public. But D. refused. He understood that his business wasn’t mature enough to be publicly traded. It isn’t enough to get a stock exchange listing.
Behind the offer D. received is a rapidly growing new model for getting companies into the Wall Street action when stock markets are constantly breaking record highs. SPACs have become so popular they are threatening the traditional IPO process, but they also pose a possible threat to shareholders.
A SPAC is a publicly traded company with neither revenue nor commercial operations that is formed by one or more entrepreneurs for the sole purpose of eventually merging with another company that actually has a business. SPACs conduct their own IPOs, after which they have up to two years to find a merger partner. Most SPACs have a so-called sponsor, an executive with experience running a public company, often with mergers and acquisitions experience, who is responsible for finding a deal.
According to the industry website SPAC Insider, last year 248 SPACs went public (most of them in the United States), raising $83 billion – compared to just $14 billion in 2019. The rise of the SPAC tracks the rise of the stock market and IPOs generally.
In the past, SPACs had an image problem. They were seen as companies that had failed to pull off a successful IPO. That has changed in the past two years, and Israeli companies have jumped in. The content-referral company Taboola and the online payments firm Payoneer both decided to go the SPAC route. The app-monetization company IronSource and Outbrain, another content-referral company, are looking into the SPAC option but for now are going with a traditional IPO.
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Omer Keilaf, the CEO of Innoviz, an autonomous-vehicle startup that announced in December it was merging with a SPAC, explained that in his industry there are not many venture capital funds that are prepared to support big companies.
“We saw that one of our big competitors was doing a deal and the market reacted very well,” said Keilaf. “Over the past year there have been more and more SPAC mergers. It seemed like a way to support companies whose revenue sources aren’t yet there. The accepted way of measuring that in a public offering is current and short-term future revenues. A SPAC can better assess future value.”
Innoviz will merge with a SPAC called Collective Growth Corporation in a cash-and-stock transaction that values the Israeli company at $1.4 billion. It’s expected to be listed on the Nasdaq Stock Exchange under the ticker symbol INVZ.
As a rule, companies that merge with SPACs also simultaneously raise capital in a process known as private investment in public equity, or PIPE. The process resembles a private funding round more than it does a public offering. There’s no need for a roadshow, the series of presentations the management team and their underwriters make to potential investors in order to gauge interest and then decide what the company is worth when it goes public. Instead, the company meets with a relatively small number of investors, provides them more information than a roadshow would and gets an estimate of its value more quickly.
But the biggest reason for the rise of the SPAC has been the obvious faults of the IPO model and the investment bankers to arrange them. Companies have repeatedly gone public at low valuations, only to see their stock price soar post-IPO. In effect, the company and inside investors feel they were deprived of the full value of their holdings at the time of the IPO.
“In the end you want a high level of confidence that the deal will be completed at the price you believe is right,” said Oren Bar-On, head of the high-tech practice at the accounting firm Ernst & Young Israel. “In an ordinary offering, you don’t know whether inside the time frame you are planning to do it the window for new offerings will close. You don’t know what the offering price will be. Today, that’s important because there’s a lot of volatility and uncertainty over how the market will accept your numbers.”
By that, Bar-On means how long investors will be willing to accept the valuation that your company enjoys. But that raises the question of whether SPACs are encouraging companies that are not ready to go public to do so.
To that, Raanan Lerner, a partner in the law firm Meitar answers: “I wouldn’t say that good companies only do IPOs and less good companies use SPACs. A company may be excellent but will only be ready for an IPO in another two or three years.” Lerner is advising Innoviz on its SPAC merger.
Bar-On adds that SPAC deals have been enhanced because of the PIPE component and the fact that SPACs increasingly recruit quality sponsors.
However, the SPAC model encourages it to do a deal at almost all costs. The sponsor’s compensation – shares in the merged company – is conditioned on completing a deal.
With time, the sponsor is more willing to consider more adventurous deals,” said Ayal Shenhav, the head of high-tech and venture capital at the law firm Gross, Kleinhendler, Hodak, Halevy, Greenberg & Co.
Shareholders in private companies merging with a SPAC may see their equity diluted more than if they went public via an IPO. It depends on the valuation and conditions of the deal.
Amir Wasserman, general counsel at the Israel Securities Authority, also isn’t so sure that SPAC deals won’t attract lower-quality companies.
“There’s a fear that if there’s a back door, statistically less-good companies will enter through it,” said Wasserman, who is investigating whether the Tel Aviv Stock Exchange should be allowing SPACs to list.
“It definitely raises the question of whether there is too much enthusiasm for the [SPAC] tool. There is a question as to whether the vetting process is being done properly. Investors in SPACs rely heavily on the reputation of the entrepreneur rather than on evaluating existing operations.”