Why SPACs Are A Solution To The Broken IPO Process

The Solution To Broken IPOs

So, let’s talk about solutions: what is the answer to the IPO pricing problem?

Remember that the core problem with Traditional IPOs is the pricing process, and that the company going public is inherently at a disadvantage

One simple approach is to conduct direct listings, of which both Spotify and Slack have done. In a direct listing, companies going public circumvent the Traditional IPO process entirely and instead allow existing shareholders to sell their shares directly to the public at market-clearing prices (hence the term ‘direct listing’).

The goal is to have better price discovery. It should also allow the company to raise more capital for future business endeavors.

The longer answer is that many companies can actually mitigate the pricing issues by going public sooner or by leveraging reverse takeovers, otherwise known as ‘Blank Check Companies’ or SPAC IPOs. The earlier a company goes public, the less aggregate dollars they miss out on if there is a pricing issue. Mis-pricing the IPO by 25% for a $400 million company is $100 million vs mispricing the IPO by 25% for a $1 billion company is a loss of $250 million for the company.

The reverse takeovers allow a shell company or blank check company to acquire an existing attractive business. The final result is that the private market company is now publicly traded post-merger with the publicly traded smaller organization. We recently saw Chamath Palihapitiya do this with Virgin Galactic and it was quite successful.

In each scenario, we are likely to see a convergence of the reversal of both trends. Companies will start going public sooner and they will avoid the traditional IPO process. Founders will pursue direct listings if they are larger and small-to-medium-sized businesses will pursue reverse takeovers.

The public markets have long been avoided by tech company founders. Those days are numbered though. There are definitely challenges with operating a publicly-traded company, but the benefits drastically outweigh the downside.

After all, I think another real change we’re seeing is a decline in the prestige of the VC firm, which is often used as a signaling factor for investing trends, combined with a rise in the profile of the individual.

That’s important.

All this points to the rise of the SPAC IPO as a solid alternative to the Traditional IPO.

What Are SPACs?

The simplest way to think about SPACs — otherwise known as SPAC IPOs, IPO 2.0, or Blank Check Companies — is just that they’re a way to do an IPO (Initial Public Offering) that is faster, cheaper, and subjectively ‘better’ for retail investors vs. the Traditional IPO.

Essentially, where the Traditional IPO is like the boring and bloated American-style pale lager beer, SPAC IPOs are more like a light beer or a seltzer — refreshing with a clean, crisp taste, and fast finish.

So, whenever SPACs come up, just think of this guy and you’ll have an easier time:

Silly metaphors aside, what’s important about SPACs is that they’re the perfect match for startups looking for public capital.

That makes them perfect for tech companies that aren’t yet profitable, which would prevent them from doing a traditional IPO for years until they had a solid P/E history to demonstrate, but show promise worthy of accelerated backing.

Namely, they’re developing a new product in an industry that is likely to be the “next big thing” in a few years . . . wouldn’t they want every opportunity to get into that market first through expanded access to capital now with a SPAC vs. later with a Traditional IPO, and wouldn’t you want every opportunity to help them get there? . . . and as a reward for that risk, to be able to invest in them first?

Wouldn’t you want to invest in the next Tesla or next Exxon or next Apple now vs. having to wait to buy in with the rest of the investing herd when the NYSE opening bell rings on IPO day? Even if it means taking a risk on a startup that is years away from being production-ready?

I know how I’d answer.

When it comes down to it, we are increasingly compelled to take more risk as the market moves away from fundamentals towards speculation/hype dictating price, as cheap capital from the Fed floods the system, and as the notion of “safe” and “stable” returns becomes less fact and more fantasy.

As solo-capitalists, we need to seek out our own fate, fortunes, and financial freedom . . . because it won’t be given to us. We need to take risks before our opportunity is taken away.

Like I said in my article about How To Discover the Next Big Disruptor:

You don’t get rich by investing at the top of the innovation adoption bell curve; that’s how you stay rich.

Let’s add another adage to that:

If necessity is the mother of invention, then opportunity is the father.

Hence, the SPAC is born.

SPAC IPOs & Solo Capitalism

2020 has obviously been a year of change.

We are living through a time of great transition. These trends will lead to the creation of a new type of investor — the solo-capitalist. These trends include:

1. A transition away from institutions

2. Increased need for individual identity

3. Decreased friction for audience building

4. Greater focus on a decentralized investor base

5. Increasing desire for removal of communication middlemen

6. A rise in solo-capitalist tools & platforms

In effect, this democratization of capital formation (i.e., raising funds for a startup) has been accelerated as companies looking for backing are increasingly tired of the dog-and-pony show required by VC firms for private backing or banks / underwriters for public IPO listing.

Instead, the power of going directly to investors is being put on display more and more.