Forge SPAC Deal: A Bet on Unicorn Illiquidity

The Resurgence of Direct Listings Amidst the SPAC Landscape

With companies like Warby Parker, Freshworks, Amplitude, and Toast preparing for initial public offerings in the near future, the earlier surge in SPAC (Special Purpose Acquisition Company) activity shouldn't be overlooked.

This week, Forge Global (Forge), a tech company facilitating secondary market transactions for private company shares, revealed its plans to become a publicly traded entity through a merger with a blank-check company.

Analyzing the Forge Global Deal

While not every SPAC combination warrants detailed examination, the Forge deal presents a valuable opportunity for analysis.

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Our interest stems from several key areas. We aim to understand the company’s revenue model and the extent of its revenue diversification.

Furthermore, we are keen to assess the potential size of the market for secondary trading of shares in unicorns – late-stage technology startups are frequently traded on these exchanges.

Finally, determining whether the valuation appears justified is crucial, as it can provide insights into the broader SPAC market sentiment.

Transaction Details and Further Investigation

Let's begin with the specifics of the transaction before delving into a more in-depth analysis.

A thorough examination of the deal’s terms and conditions will allow us to evaluate its merits and potential implications.

The goal is to gain a comprehensive understanding of the current market dynamics and the evolving landscape of private company liquidity.

Forge and its SPAC Merger

Forge is set to merge with Motive Capital, a special purpose acquisition company (SPAC) that successfully raised $360 million in December of 2020.

According to the company’s projections, the resulting combined organization is expected to have an approximate $2 billion valuation, calculated on a “fully diluted equity value on a pro forma basis.” The anticipated enterprise value stands at $1.6 billion, factoring in an estimated $435 million in cash reserves following the transaction’s finalization.

While the specifics of the deal – including a private investment in public equity (PIPE) and a 90% equity rollover for current shareholders – are complex, the key takeaway is that Forge will possess a roughly $2 billion equity value and substantial cash holdings post-merger.

This valuation is significant, not merely establishing Forge as a unicorn, but also demonstrating a considerable increase in the company’s worth. Data from PitchBook and Crunchbase indicate Forge’s previous valuation was $700 million (post-money) during its $150 million funding round earlier this year.

Consequently, the merger is poised to deliver substantial returns, not only to early investors but also to those who recently invested capital into the company.

This leads us to an examination of Forge’s core business and its operational model. Forge facilitates trading of shares in pre-IPO companies, allowing transactions to occur before the companies become publicly listed.

It is somewhat paradoxical that the company promotes its platform’s ability to aid in price discovery prior to a public offering, while simultaneously experiencing a private valuation that may soon be surpassed by its public market value.

However, the emergence of a new unicorn is noteworthy.

Addressing the Growing Challenge of Unicorn Liquidity

A persistent issue within the late-stage startup ecosystem is the disparity between value creation and the availability of exit opportunities. Essentially, the market excels at producing highly valued, private companies – often termed “unicorns” – but struggles to facilitate their transition to public markets.

The increasing scrutiny from antitrust regulators, which hinders acquisitions of promising startups by large technology firms, contributes to this problem. However, the core issue remains a shortage of initial public offerings (IPOs) sufficient to accommodate the expanding number of global unicorns.

This situation is a key factor in the appeal of companies like Forge. As the number of unexited unicorns increases, the demand for platforms that enable liquidity for existing shareholders – prior to a traditional IPO – is expected to grow.

Forge itself acknowledges this trend, as illustrated in the following slides from their investor presentation. The first slide highlights the substantial value currently held within private unicorn companies, alongside their increasing numbers:

The second slide demonstrates the pressures that secondary marketplaces, such as Forge, can help to mitigate, showing a lengthening time to IPO and higher valuations at the time of listing:

While these charts are presented in the context of a SPAC transaction, they are relevant because Forge has already achieved significant scale and isn’t solely reliant on projected future performance.

In 2019, Forge reported revenues of $27.7 million, which increased to $51.6 million in 2020. These figures represent gross revenues, and after accounting for transaction-based expenses, the numbers become $24 million and $47.8 million, respectively. Including the full-year revenue contribution from SharesPost, following their merger in November of last year, brings the 2020 figure to approximately $72 million.

The company’s revenue streams are diversified across three areas: transaction-based revenue (a percentage of transaction volume), fees from their “Trust” service, and subscriptions to their data offerings.

Currently, transactions represent the primary driver of revenue for Forge. For instance, the company facilitated $3 billion in transaction volume during the 12 months ending June 30, 2021, a substantial increase from $1.3 billion in the prior year (including SharesPost). Simultaneously, the company’s take rate on these transactions rose from 2.4% to 3.1%.

This translates to an approximate increase from $31.2 million in transaction-based revenue for the year ending June 30, 2020, to $93 million for the year ending June 30, 2021. While transaction expenses are deducted from these figures, the growth underscores the company’s revenue projections:

To understand the future potential of Forge, it’s important to note that revenue from their “Trust” service remained relatively stable between 2019 and 2020, decreasing slightly from $22.5 million to $22.4 million. Furthermore, the Q1 2021 results indicated a modest growth trajectory for this revenue line. Data revenue figures were not specifically detailed.

The core of Forge’s business model centers on increasing trading volume, which directly correlates with the growing number of unexited unicorns and the extended timelines for companies to go public. The addressable market for Forge is expanding rapidly, with a continuous influx of new unicorns and a limited number of IPOs to provide liquidity.

However, Forge’s projections do not anticipate significant operating leverage. The company forecasts continued GAAP operating losses, despite achieving profitability on this metric during the first quarter of the year:

While adjusted EBITDA numbers are improving, reliance on this metric is often viewed with skepticism.

Currently, Forge is valued at slightly over 16 times its projected 2021 revenues after deducting transaction-based expenses. This valuation does not appear unreasonable.

Several details within the documentation did raise some questions. The annualized revenue run rate for Q1 was $124.3 million (excluding transaction-based expenses), which is higher than the company’s full-year revenue projection calculated on a similar basis. This suggests that Forge anticipates lower revenue in subsequent quarters compared to the first quarter.

When discussing the potential for data products to contribute 15% to 20% of their long-term revenue mix, Forge presented the following data:

The first two data points are logical, as other exchanges successfully generate revenue from data sales. Forge is positioned to do the same.

However, the final two data points are noteworthy. The presentation suggests that newsletter subscribers are a strong indicator of future data revenue.

In conclusion, the Forge SPAC deal appears to be a sound investment. The company addresses a real and growing problem within the startup market. With a rising take rate, Forge has the potential for improved financial performance. Ultimately, the decision of how much public market investors are willing to pay for Forge shares remains to be seen.