Private Equity, SPACs & IPOs: A Simplified Explanation

Tech Exits in Early 2021: A Period of High Activity

The initial three months of 2021 witnessed significant activity in the technology sector regarding company exits. Building upon the strong momentum observed in the last quarter of 2020, numerous emerging tech companies actively sought opportunities to realize value as the new year commenced.

Various exit strategies were employed, including initial public offerings (IPOs) and direct listings. Private equity (PE) transactions were also prevalent. Furthermore, a substantial number of special-purpose acquisition companies (SPACs) emerged, making it challenging to track every deal.

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Available Exit Options for Startups

All of these exit routes remain viable options for later-stage startups. The IPO market remained receptive until recently, and private equity firms possess considerable capital reserves, enabling them to offer attractive valuations, particularly in the current economic climate.

Moreover, the abundance of SPACs could potentially facilitate public listings for the entirety of a recent graduating class from Y Combinator.

Selecting the most appropriate exit strategy from this diverse range of possibilities presents a complex decision for startup CEOs and their boards of directors.

Case Studies in Exit Strategies

DigitalOcean opted for a traditional IPO, successfully raising capital through the process. The company, focused on serving small and medium-sized businesses (SMBs), appeared to be a natural candidate for going public based on its financial performance.

The Exchange interviewed DigitalOcean’s CEO, Yancey Spruill, to understand the rationale behind this choice.

Conversely, Latch determined that a SPAC merger was the most suitable path forward. Garth Mitchell, the company’s CFO, discussed the transaction and the factors that influenced their decision with The Exchange.

Finally, The Exchange engaged with Brian Cruver, founder and CEO of AlertMedia, regarding his decision to sell his Texas-based company to a private equity firm.

Summarizing the Decisions

To maintain conciseness, this article will provide a concise overview of each transaction. It will then summarize the perspectives of each company regarding why their chosen liquidity event was the optimal solution.

Each company weighed its options carefully, considering its specific circumstances and long-term goals.

Diverse Avenues to Financial Liquidity

Beginning with DigitalOcean, it’s worth noting a few key points: The company has consistently and openly communicated its growth trajectory over the past several years. Prior to 2020, it reported an annualized run rate of approximately $200 million in 2018, increasing to $250 million in 2019, and reaching $300 million in the first half of 2020. This milestone was officially announced in May of last year.

Consequently, when DigitalOcean initiated the process of becoming a publicly traded entity, it didn’t come as a surprise. The initial public offering was priced at $47 per share, representing the upper limit of the projected range. However, the stock’s performance since then has been somewhat volatile, briefly dipping below $37 before recovering to $43.80 at yesterday’s market close.

The central question is why DigitalOcean opted for a traditional IPO. According to Spruill, the company evaluated both special-purpose acquisition companies (SPACs) and direct listings. The IPO route was ultimately chosen as it aligned with the company’s objectives of cultivating a diverse shareholder base and simultaneously enhancing brand recognition.

He further added that the expenses associated with an IPO are comparable to those of alternative exit strategies. Spruill also highlighted the benefits of the IPO process itself, asserting that its stringent requirements contributed to improvements within the DigitalOcean organization.

During our conversation, I posed a standard question to Spruill, one I ask all CEOs on their IPO day: What are your current feelings? While somewhat conventional, this inquiry often reveals valuable insights from leaders who, after extensive discussions about their companies, are presented with a rare personal question.

Spruill expressed feeling incredibly positive, stating that an IPO is an unparalleled culmination of the extensive effort invested in building a company and its team. He explained that consistently achieving more successes than setbacks, coupled with favorable metrics and market conditions, allows a company to earn the opportunity to be “scrutinized” by leading investors.

These investors contributed approximately $750 million to the company, Spruill noted. These funds will be utilized to reduce debt and increase available cash flow – a decidedly positive outcome.

Shifting focus to Latch, engaging with its CFO, Garth Mitchell, proved insightful. The company has announced its planned combination, disclosed its financial results, and is currently finalizing the necessary documentation for its forthcoming corporate merger.

The rationale behind Latch’s pursuit of a SPAC-led transaction? It presented the ideal timing, with sufficient capital and a suitable partner. The favorable market conditions at the time of the announcement were readily apparent. The capital aspect is clearly defined within the deal’s terms. However, the partner selection warrants further consideration.

Latch isn’t merging with a generic blank-check company. Instead, it’s joining forces with a SPAC sponsored by Tishman Speyer (TS), a privately held commercial real estate firm. Given that Latch primarily serves residential buildings, the potential for synergy is evident.

Mitchell clarified that Latch began receiving inquiries as early as 2019, a significant period ago in the context of the SPAC market. This wasn’t a spontaneous decision.

Without detailing anticipated 2021 revenue growth, Mitchell explained that a SPAC-led debut offered a unique opportunity to secure the capital Latch requires today, as its customers are adopting its products at a faster rate than initially projected. The time lag between hardware sales and new tenant occupancy can create a gap between installation costs and recurring revenue streams, making additional capital beneficial.

Furthermore, the partnership with TS may facilitate Latch’s expansion into the commercial real estate sector.

Finally, consider AlertMedia! According to Fortune, the former startup’s sale of a majority stake to Vista Equity Partners was valued at $400 million. For a company that had previously raised $60 million, this outcome likely represents a substantial return for its investors. (The company’s valuation in its April 2020 funding round was approximately $250 million.)

The same report indicated that AlertMedia’s CEO, Brian Cruver, believes the deal will significantly accelerate the company’s strategic initiatives, compressing a five-to-ten-year timeline into just two or three years.

Given the common perception of private equity firms as entities focused on asset stripping and maximizing short-term profits, The Exchange was keen to understand Cruver’s rationale for selling a thriving company to Vista.

Cruver explained that strategic buyers expressed interest in AlertMedia during the latter half of 2020, recognizing the strong product-market fit in the context of the pandemic.

Increased attention from both strategic and institutional investors ultimately led to the deal, with multiple offers culminating in the agreement with Vista, which Cruver viewed favorably.

Why? Vista is also headquartered in Austin, and Cruver emphasized the firm’s commitment to retaining the company’s leadership team and its shared belief in the importance of employer responsibility towards their workforce. This alignment is particularly relevant given AlertMedia’s business focus.

Cruver added that Vista possesses a proven track record of guiding companies “to the next level.” This includes a favorable exit for employees and shareholders, capital to expand into the remaining 99% of the untapped market, and a shared vision for the company’s future direction, along with guidance for sustained growth.

A compelling proposition, provided the price was acceptable. Throughout the discussion, The Exchange anticipated a potential drawback or hidden condition. However, Vista appears genuinely committed to investing in AlertMedia’s long-term success, rather than solely focusing on short-term financial gains.

This is noteworthy, and suggests that the increased number of options available to tech startups may be forcing private equity firms to adopt a more collaborative approach.

In conclusion: All companies require capital, which can be obtained through an IPO, a SPAC, or a private equity deal, each offering varying degrees of access. Furthermore, every company seeking an exit desires the right partner. For DigitalOcean, it was a broad public shareholder base. For Latch, it meant a partnership with TS. And for AlertMedia, it involved a collaboration with a capital firm based in the same city, offering both financial resources and operational expertise.

There is no universally correct solution; it’s a matter of choosing the most suitable path.