Is SPAC the way to go for IPO aspirants?

Special purpose acquisition companies provide a streamlined path for private firms to go public, but they need to mind potential pitfalls.

In brief

• SPACs offer advantages, such as an accelerated IPO process for companies going public and providing private investment in public equity transactions.
• Pitfalls include misaligned objectives of sponsors and the SPAC’s shareholders, added costs, and challenges in consummating such deals outside of the US.
• Whether a company goes public through a traditional IPO or SPAC, a strong governance structure is crucial.

The use of a special purpose acquisition company (SPAC) by private companies to go public has been around for decades. It was only in recent months that we saw a surge in market interest as the volume of SPACs and capital raised in the US hit a record high. According to the EY quarterly IPO report, Global IPO trends: Q1 2021, SPAC IPOs in the first quarter of 2021 have been breaking records globally, completing more deals and raising more in proceeds than in the whole of 2020.

Closer to home, the Singapore Exchange and the Hong Kong Stock Exchange are considering frameworks to introduce SPACs as an alternative listing structure. Given the recent performance of SPAC IPOs, the prospect of being merged with a SPAC through a process known as a de-SPAC can be enticing for a company aspiring to go public. While any company can be a target, technology and life science companies have been particularly favored for their compelling growth trajectory.

Is SPAC a faster and cheaper way for IPO aspirants to tap into the capital market than the traditional IPO route?

Advantage in speed and valuation

A SPAC framework is similar to a traditional IPO in many fundamental ways. Both enable companies to raise funds and fuel their growth plans, while ensuring that obligations to their investors are met. The main difference is that in an IPO, a company is looking to raise capital; in a SPAC, capital is seeking a suitable company.

The SPAC format in the US offers speed to market and an accelerated IPO process for companies going public through it. Without an actual business function, the “shell” company would complete the IPO process first. Given fewer complex financial statements, the expected period for audit and comment by the Securities and Exchange Commission (SEC) is likely to be shorter. Having said that, when it comes to de-SPAC, the financial information of the proposed acquisition target would still be subject to rigorous SEC review and scrutiny.

The credentials of the sponsors, financial intermediaries and founding investors of the SPAC give the investing public confidence in their ability to spot a high-potential business and accelerate the company’s growth to yield strong returns. A robust executive team can help the SPAC to raise capital faster and at higher amounts. This bodes well for the target company in attracting capital if additional funding is needed for the acquisition.

Private investment in public equity transactions, which often accompanies a SPAC, also provides a long-term investor base for the target company, while reducing the risks of selling to public investors at a road show and being subject to market volatility. By going public through a SPAC, the target company gets early assurance from investors of an agreed price, not just before an IPO.

Potential pitfalls

A SPAC would be an attractive route if the sponsors can identify a suitable acquisition target within the given time frame — usually 12 to 24 months after a SPAC is approved. If acquisitions are not completed in time, the funds are returned to investors.

However, the objectives of the sponsors and the SPAC’s shareholders may not always be aligned. Given that the sponsors will only benefit if a de-SPAC takes place, will the pressure to de-SPAC lead them to execute transactions at higher prices or go for targets with questionable prospects? If so, sponsors may face the possible consequences of not receiving the required vote from shareholders to approve a transaction, a fall in share prices after the de-SPAC, or even legal action brought on by investors.

Moreover, the SPAC process is not cheap. The sponsor typically takes 20% of the merged entity virtually for free, and the costs are then passed on to the target company. Add on the initial investment bankers’ fees to form the SPAC and these costs combined could easily make up a quarter of the gross proceeds — which the target company would have to bear.

While the SPAC may offer a faster route to going public, such transactions are taking longer to consummate outside of the US. Target companies may face challenges in their readiness to operate and report as a public company in the US. Fulfilling the responsibilities of being a US public company with limited resources and knowledge of the SEC’s requirements becomes a hurdle for many.

For a company that has set its sights on an IPO listing, a de-SPAC is a viable option given the certainty of valuation, although the costs involved should be duly considered.

Ultimately, regardless of whether a company goes public through a traditional IPO or SPAC, it must be fully prepared to develop a strong governance structure with robust internal controls and disclosure practices that stand up to regulatory and public scrutiny. After all, going public is just one defining moment in a company’s transformation from private to public — the hard work of being a public company continues right after the IPO.