Roger Lee of Battery Ventures says that “SPAC” used to be a “bad four-letter word” in Silicon Valley.
Now, the board of every high-profile start-up is discussing special purpose acquisition companies as a legitimate way to go public, according to Jeff Crowe of Norwest Venture Partners.
In the eyes of Lux Capital co-founder Peter Hebert, SPACs are “stealing from the 2021 IPO calendar.”
“We have encouraged our highest-quality companies to seriously consider this,” said Hebert, whose firm raised its own health-tech SPAC in October and is looking for a target. “The vast majority of companies looking at doing traditional public offerings are dual-tracking SPACs.”
Within Lux’s portfolio, 3D-printing company Desktop Metal went public through a SPAC in December. Others like real estate software companies Latch and Matterport have announced deals this year with so-called blank-check companies.
The sudden burst of SPACs reminds some long-timers of the dot-com bubble in the late 1990s. Pre-revenue businesses with far-out goals are going public at astronomical valuations, and famous athletes and other celebrities are getting in the mix. Mention the acronym to any well-known start-up CEO and you’ll likely hear about the non-stop calls they receive from sponsors with hundreds of millions of dollars to spend.
To Wall Street skeptics, it looks like the finance industry’s latest scheme to make money from speculators in a low interest rate environment with the market at a peak and investors hungry for all things tech. SPACs have raised more than $44 billion so far this year for 144 deals, according to SPACInsider. That’s equal to more than half the money raised in all of 2020, which itself was a record year.
While there’s undeniable mania in the SPAC boom, there’s another story playing out in parallel. Venture-backed tech companies with high-growth prospects are shunning the IPO process, which has its own flaws. Instead they’re getting comfortable with the idea of hitting the market in a way that would have been unfathomable just a year ago.
In a SPAC, a group of investors raise money for a shell company with no underlying business. The SPAC goes public, generally at $10 a share, and then starts hunting for a company to acquire. When it finds a target and a deal is agreed upon, the SPAC and the company pull in outside investors for what’s called a PIPE, or private investment in public equity.
The PIPE money goes onto the target company’s balance sheet in exchange for a big equity stake. The SPAC investors get stock in the acquired company, which becomes the publicly-traded entity through what’s known as the de-SPAC.
One major advantage: SPACs allow companies to provide forward-looking projections, which companies typically don’t do in IPO prospectuses because of liability risk.
“An IPO is what I would call backward-looking,” said Betsy Cohen, who led a SPAC that recently took car insurer Metromile public. “Because a SPAC is technically a merger, you’re required to tell investors what the merged companies will look like after the merger and project forward.”
It’s also a much faster process than the IPO, which involves spending many months with bankers and lawyers to draft a prospectus, educate the market, carry out a roadshow and build a book of institutional investors.
Fin-tech companies have been big SPAC targets
Many of the better-known SPAC targets so far have been at the intersection of tech and financial services. For these companies, cash burn rates are high and real GAAP profits often won’t come for years, even under the best circumstances.
Metromile, whose technology allows drivers to pay by the mile rather than a monthly fee, started trading on Wednesday after merging with INSU Acquisition Corp. II, a SPAC led by Cohen and her son, Daniel. Chamath Palihapitiya, the venture capitalist turned mega SPAC sponsor, and billionaire Marc Cuban invested in a $160 million PIPE.
As of Friday’s close, the stock was trading at $17.23, giving Metromile a valuation of over $2 billion based on the fully diluted share count.
“Metromile enters the insurance market at a time when telematics are installed in virtually every car going forward, so there’s the opportunity to look at insurance on an individualized customized basis, which is huge,” Cohen said in an interview. “We felt it was an important company to bring to the public markets and allow them to have access to capital in way insurance companies do.”
Cohen, who founded The Bancorp, said she will have closed seven SPACs by later this year, including payments company Payoneer and boutique investment bank Perella Weinberg.
Metromile CEO Dan Preston told CNBC this week that around the middle of 2020, as his board was evaluating financing options, he expected to raise a large round of private capital and then go public in four to six quarters. The company had been around for a decade and raised hundreds of millions of dollars in funding.
Other insurance-tech businesses like Lemonade and Root held traditional IPOs last year. But Preston says the more he learned about SPACs, the more he realized it was the better approach for his company, which faced the high costs of operating in the heavily regulated insurance industry — and a pandemic that slashed the amount of miles driven.
“The sweet spot are companies that are pretty close to being public but need a little more historical data to get ready,” said Preston.
Metromile said in its merger filing that it expects insurance revenue to increase 39% to $142.1 million in 2021, and then jump 81% in 2022 and more than 100% in 2023. Adjusted gross profit will increase from $11.1 million last year to $144 million in 2023, the filing says.
Online lender SoFi said in January that it was going public through a SPAC run by Palihapitiya in a deal valuing the company at $8.65 billion. In the merger agreement, SoFi projects annual revenue of $980 million this year, increasing annually to $3.7 billion in 2025, while contribution profit will more than quintuple over that stretch to $1.5 billion.
In other finance SPACs, Palihapitiya led the reverse-merger of digital real estate company Opendoor, which went public last year and is now worth over $20 billion. He did the same with health insurer Clover Health (which said this month that it’s under investigation by the SEC) and is leading the PIPE for solar financing provider Sunlight Financial.
Top-tier investors joining the fray
He’s also doing software deals. In January, Palihapitiya was a PIPE investor in Latch, a developer of smart lock systems sold to real estate companies. Latch generates recurring software sales and said 2020 booked revenue jumped 49% from the prior year to $167 million.
Blackrock, Fidelity and Wellington are also part of the PIPE, meaning they’ll be equity holders when Latch goes public. Those names, viewed as top-tier public market investors, are becoming familiar to SPACs, with at least one of them showing up in the PIPE for SoFi, Matterport, Opendoor and consumer genetics company 23andMe.
For companies that can attract investors of that caliber, and have sponsors they trust to stick with them through the ups and downs of the journey, a SPAC can be the most efficient way to raise money. Large private rounds typically require hefty dilution, while IPOs often come with a discount of 50% to 100% for new investors.
In a SPAC, the target ends up handing up to 20% of shares to the sponsors and additional stock to PIPE investors. The rest primarily remains with insiders. When public, the company has the ability to raise follow-on capital at market rates. For example, Opendoor just announced it’s raising $770 million at $27 a share, marking an increase in valuation of about 200% from the time of the PIPE investment.
Norwest’s Crowe, whose firm was a venture investor in Opendoor and online therapy provider Talkspace, another SPAC target, said that pricing is favorable for the best companies because there are so many SPACs going after them.
“Pricing is nuts,” Crowe said. “There’s enormous pent-up demand for all these companies. A lot of companies that would’ve gone public in a relatively even fashion over 2021 and ’22, if markets hold, now are all going out in a mad rush.”
Venture investors are jumping in as well. In addition to Lux, firms including FirstMark Capital, Ribbit Capital, Khosla Ventures and SoftBank have raised their own SPACs. Separate from their firms, venture capitalists Steve Case, Reid Hoffman and Bradley Tusk have followed Palihapitiya into the SPAC sponsor arena.
Growth stage venture firm G Squared announced this week the close of a $345 million SPAC. Founder Larry Aschebrook, in an interview, called it “just another tool in our toolbox” to help companies access capital. He said it can be a good option for a CEO who’s ready to run a public company and a business that’s raised a lot of money in the past and can benefit from ready access to the capital markets.
“There are only a handful we think are super high-quality companies,” Aschebrook said about the tech SPAC deals that have already been announced. “Companies we’re interested in are teetering on profitability or are profitable and are logos that everyone knows.”
While Battery’s Lee no longer views SPACs as equivalent to a curse word, he said there hasn’t yet been one out of his firm’s portfolio. However, Battery is an investor in Coinbase, which is going public through a direct listing, following the lead of Slack, Spotify and Palantir in allowing existing stakeholders to sell in the debut rather than issuing new shares as a company.
Lee said he wouldn’t at all be surprised to see a SPAC from one or more of his companies this year, acknowledging that it’s become a third viable mechanism to go public.
“The direct listing was the first thing new thing to happen in the capital markets in 50 years — and the rebranding of SPACs is the second thing,” Lee said. “At the end of the day, you’re still running a public business and you have to be capable of withstanding the rigor and scrutiny.”
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