The question on many software founders’ minds these days echoes Hamlet’s famous soliloquy: To SPAC or not to SPAC? Special purpose acquisition companies (SPACs) are also known as “blank check” companies because they involve individual investors giving a big-name investor — the “sponsor” — a blank check to buy an unidentified company (the “target company”) and execute an unspecified plan.
The growth in SPACs, at least before the recent regulatory pushback, is astounding. U.S.-based SPACs raised $87.9 billion in the first quarter of 2021, beating the total amount raised in 2020 in just 3 months. In 2020, funds raised via SPACs grew 462%, raising over $79 billion. That’s more than the $67 billion raised over the same period in traditional IPOs.
SPACs are popular with retail investors who want in on growing companies that aren’t otherwise publicly available. They appeal to founders of late-stage software companies, too. SPACs offer an attractive exit for companies looking for an option that values future growth.
With SPACs facing heightened regulatory scrutiny, deal flow has slowed. This should prompt founders to take the time to assess all their funding options: IPOs, SPACs and PE investments. This post walks founders through these pros and cons.
Differences Between SPACs And Traditional IPOs
A SPAC offers a simple, streamlined way to take a company public. The SPAC sponsor handles all the paperwork. There’s no roadshow. “Safe harbor” provisions of SPACs allow founders to talk up their company’s value based on projected earnings, unlike a traditional initial public offering. And when it’s time for the sponsor to buy the target company, that transaction is a simple merger between founder and acquirer.
SPACs also provide speedier investment returns than traditional IPOs. In an IPO, investors must accept a six-month “lockup” before they can sell shares. With SPACs, investors can sell their positions immediately to other institutional holders, so they can capture more of that IPO-style bump if the SPAC is successful. In a SPAC, founders can also purchase up to 20% of the business on favorable terms prior to the target company’s acquisition. This sweetens returns more for founders.
Why Founders Might Choose SPACs
Companies that lack the scale, profits and/or predictability required for a traditional IPO may be interested in SPACs. The way I see it, three factors play a role when company leaders pick a SPAC: ego, valuation and control. Ego is a simple factor but a profound one. Many founders dream of taking their company public, and a SPAC enables them to fulfill that dream.
Valuations are the second factor that draws founders toward SPACs. It’s widely believed that public markets value companies more highly than private markets — and that’s probably true now. There’s lots of SPAC money chasing acquisition targets, which drives valuations up. Founders may also face pressure from their venture investors to extract liquidity at this moment of high valuation, and SPACs offer a speedy way to do that.
The third factor is control. A SPAC enables the founder to retain more control versus the degree of control they’d retain with PE investors in the mix, as one point of comparison. However, many SPACs don’t find their acquisition target. As of this writing, 92 of the 252 SPACs announced in 2020 are still searching for a target company according to SPACInsider. This is well over the usual 24 months sponsors are supposed to take to find that target company. So, keep in mind that SPACs don’t work out for every company.
Why Founders Might Choose PE Investments
A private equity investor has more “skin in the game” in these situations, potentially aligning their interests with a target company. The investor contributes a hefty amount of capital and then works hand in hand with the company to try to scale the business and increase its value before any exit. (Full disclosure, my company offers this service as do others.) In a SPAC, by contrast, the big-name sponsor puts up a few million and turns to the public market to raise hundreds of millions more. The sponsor retains about 20% of the profits, even though it contributed only a sliver of the capital.
A PE investor generally sticks with a company for the long term. Good growth PE teams help founders build and professionalize their teams and infrastructure, improve operational metrics, develop new products, expand into adjacent markets, engage in M&A and drive organic growth. Many firms specialize in specific markets such as vertical software or industrial technology. Finally, growth PE deals, as opposed to very large buyouts, typically don’t employ large amounts of debt, making the deals less risky.
But a growth-oriented, private-equity investment is not right for everyone. These deals often entail a lot of work for company founders: Growth investors can push you hard to improve your business and operating metrics, and if you and your PE investor don’t share the same vision, the partnership can fail. As a founder, your ownership stake gets diluted, so you have to believe the overall value of the business can grow exponentially by involving a PE partner. Finally, many private equity investors can be quite prescriptive, recommending certain strategies and operational moves they’ve seen work before, which might not be right for your company. Traditional PE investors can sometimes be more focused on profits at the expense of growth.
The Bottom Line
SPACs often appeal to founders of promising young companies that lack the scale, profits and/or predictability required for a traditional IPO. These companies might also be a great match with a growth-oriented PE firm that understands their verticals and can help them make a quantum leap in operations and profitability. Even if an initial investment decision falls through, founders have other opportunities.
Battery Ventures provides investment advisory services solely to privately offered funds and neither solicits nor makes its services available to the public or other advisory clients. Nothing herein should be construed as investment advice. Content obtained from third-party sources, although believed to be reliable, has not been independently verified as to its accuracy or completeness and cannot be guaranteed.