The Evolving Landscape of Going Public

The past year has witnessed significant changes to the traditionally structured process of taking a company public. Many of the conventional methods utilized in an initial public offering (IPO) are currently undergoing redefinition.

The rise of direct listings serves as a prime illustration of this shift. Even within more conventional IPO frameworks, we are observing the adoption of novel lock-up agreements, alternative auction methodologies, and the increasing prevalence of virtual, expedited roadshows. Furthermore, a more company-focused approach to investor allocation is becoming standard.

The Emergence of SPACs

However, the most impactful development of the last twelve months has undoubtedly been the widespread use of special purpose acquisition companies, widely known as SPACs. A SPAC is an entity created solely to raise capital through an IPO, with the specific intention of acquiring an existing, privately held company.

Often referred to as “blank check companies,” these organizations generally have a timeframe of 24 months to identify a suitable acquisition target or initiate a merger.

This process effectively results in the acquired company becoming publicly traded. SPACs frequently secure additional funding through a PIPE (private investment in public equity), which serves to validate the SPAC’s valuation and provide supplementary capital alongside the designated target company.

SPAC Growth and Recent Trends

While SPACs have existed for several decades, they experienced a surge in popularity during the 2020 IPO market. To provide context, 2020 saw the formation of over 248 SPACs – exceeding the total number created in the preceding decade.

The momentum continued into 2021, with 298 new blank-check companies formed to date, collectively raising $95 billion (compared to $83 billion in 2020). It is important to acknowledge a subsequent deceleration in new SPAC formations and increased regulatory scrutiny.

We anticipate that these adjustments will persist in the near future.

For a SPAC, the 24-month window for identifying a merger candidate may seem ample, but the due diligence and SEC review processes can readily consume six months or more. Consequently, swift identification of a target company is paramount.

This trend has led to numerous private companies being approached and actively pursued by a growing number of newly established SPACs.

Navigating the SPAC Landscape

At Madrona, our investment strategy focuses on companies in their early stages, providing support throughout their growth, challenges, and financing objectives. As a result, discussions regarding capital raising via SPAC transactions have frequently arisen for many of our portfolio companies.

Evaluating the advantages and disadvantages of SPACs in relation to alternative financing options can be complex and often presents considerable confusion.

Determining the optimal path requires careful consideration of various factors.

Preparing for Public Company Status

A crucial aspect of considering a SPAC (Special Purpose Acquisition Company) is recognizing that the ultimate outcome is a company listed on a public exchange, subject to the regulations of the SEC and the oversight of public investors.

Therefore, when a company is contacted by potential SPAC sponsors, the initial inquiry shouldn't focus on fundraising opportunities. Instead, the primary consideration must be whether the organization is prepared for the demands of public operation.

In the current environment, becoming a public entity can be perceived as a simple achievement. However, this transition introduces significant changes.

Companies must carefully assess if they possess the necessary size, leadership, systems, and reporting mechanisms before exploring any path to going public.

Prematurely entering the public market can generate investor anxiety, which is often reflected in stock performance – even within a SPAC merger. This can negatively impact employee sentiment and hinder future capital acquisition efforts.

Open and candid discussions among executives are vital to determine if operating as a public company aligns with the organization’s long-term objectives.

Key Considerations for Readiness

Before pursuing a public offering, several areas require thorough evaluation.

• Financial Reporting: Are your financial statements prepared in accordance with GAAP (Generally Accepted Accounting Principles) and ready for external audit?
• Internal Controls: Do you have robust internal controls over financial reporting, as mandated by Sarbanes-Oxley?
• Management Team: Does your leadership team have experience navigating the complexities of a public company?
• Investor Relations: Is there a plan for communicating effectively with shareholders and analysts?

Addressing these questions proactively will significantly increase the likelihood of a successful transition and sustained performance in the public market.

A lack of preparedness can lead to costly remediation efforts and damage the company’s reputation.

The Importance of a Realistic Assessment

It’s essential to conduct a realistic self-assessment, acknowledging both strengths and weaknesses.

Don't underestimate the time and resources required to build a public-ready infrastructure.

Seeking advice from experienced advisors – including legal counsel, accountants, and investment bankers – is highly recommended.

Ultimately, the decision to go public should be driven by a strategic vision, not simply by the availability of capital.

Advantages of Utilizing the SPAC Route

After a company demonstrates maturity and readiness for public investment alongside regulatory oversight, evaluating the optimal path forward becomes crucial. While the Initial Public Offering (IPO) process was historically standardized, 2020 introduced alternative methods like direct listings, reverse auctions, innovative lock-up agreements, and Special Purpose Acquisition Companies (SPACs). Each of these approaches presents distinct advantages and disadvantages that require careful consideration by companies.

Streamlined Timing and Pricing: The SPAC process offers several benefits concerning timing and pricing. Notably, it generally involves a less complex procedure, potentially leading to a faster transition to becoming a publicly traded entity. Furthermore, companies gain preliminary price insights earlier in the process.

Traditional IPOs and direct listings often experience fluctuating offering prices until the very last moment. In contrast, a SPAC facilitates valuation negotiation during the initial Mergers and Acquisitions (M&A) phase, much earlier in the timeline. This valuation is subsequently validated through the Private Investment in Public Equity (PIPE) raise and again during the “de-SPAC” process.

The early price visibility allows the company to accurately forecast capital raised and formulate plans accordingly. However, it’s essential to acknowledge that both the PIPE and SPAC redemption processes can lead to price adjustments, and in some instances, even cause the SPAC deal to collapse.

Stabilized Pricing: Current data suggests that, alongside the pricing advantages, SPACs exhibit reduced price volatility, or “pop,” on the first day of trading. The M&A and PIPE processes contribute to a more accurate market valuation, typically resulting in equity issuance at a higher price point.

This trend tends to diminish the initial price surge that primarily benefits investors rather than the company itself. CNBC reported an average SPAC pop of 6.5% in February. Comparatively, the average first-day pop for tech IPOs over the past 40 years has exceeded 30%.

These initial findings are encouraging for existing shareholders of companies merging with a SPAC. It’s important to remember that SPAC structures are still evolving, with ongoing considerations regarding SPAC sponsor economics (promote and warrants), lock-up period management, and navigating the three stages of price validation: signing the M&A letter of intent, completing the PIPE, and finalizing the de-SPAC/redemption phase.

Control Over Investor Base: Another significant advantage lies in the ability to strategically manage allocations to Day One public investors. Both direct listings and traditional IPOs involve a complex share allocation process, often granting investment bankers greater control than the company itself.

The SPAC process empowers companies to select their investors by leveraging relationships with sponsors and conducting a targeted PIPE raise, rather than relying on the traditional roadshow approach. This allows for a more curated investor base aligned with the company’s long-term vision.

Variations Among SPAC Structures

When a business opts to become publicly traded through a SPAC (Special Purpose Acquisition Company), selecting the appropriate one is crucial. Essentially, this means identifying the sponsor group best suited to facilitate the public offering. Given the proliferation of SPACs actively seeking target companies, the caliber and advantages offered by their backing sponsors exhibit considerable variation.

Fundamentally, a SPAC represents a collective of individuals pooling their knowledge to identify a company that aligns with their investment philosophy and expertise. Some are formed by experienced operators intending to contribute their skills to the target company, while others prioritize financial aspects. A company considering a SPAC merger should carefully evaluate the following:

• Sponsor Reputation: Do the sponsors possess the necessary standing and trustworthiness to secure a Private Investment in Public Equity (PIPE) and successfully complete the transaction?
• Financial Alignment: The economic structures of SPACs have undergone significant changes. Are the sponsors’ financial incentives geared towards a favorable outcome for the company, or are they primarily focused on maximizing returns for themselves while minimizing their risk? A thorough understanding of the deal’s economics is vital. How is the sponsor promote structured? Are the sponsors investing directly in the offering, or solely in the initial capital? What provisions are in place if the PIPE funding falls short? Is their success tied to a sustained increase in the stock price over time?
• Operational Support: What specific expertise and resources do the sponsors bring to the table, and how dedicated are they to the long-term success of the company? Sponsors should provide value extending beyond the initial public offering—this is a key driver of returns—through their expertise and ongoing support. Is this value genuine, and if so, how substantial is it?

The year 2020 presented numerous novel circumstances—altered lifestyles, new communication methods, emerging challenges, and innovative capital-raising strategies, including increased access to public markets. The disruption of the conventional IPO process is a positive development, given its well-known inefficiencies. However, a company must ultimately determine its readiness for public scrutiny before pursuing a SPAC transaction.

Ultimately, a company must assess its preparedness for the public market before committing to a SPAC route.