Money Stuff: SPACs Aren’t Cheaper Than IPOs Yet

Money Stuff


My basic view of special purpose acquisition companies, which we have talked about here and here and here and here, is that they might be a good way for some companies to go public, but they are expensive, far more expensive than a normal initial public offering. In an IPO, you typically pay investment banks a fee of 1% to 7% of the amount of money you raise, and you sell the stock to investors at a price that is probably too low; probably the stock will trade up by 10% or 20% or 100% on the first day that it's public. People complain about both of these things—IPO fees and IPO pops—constantly; venture capitalists are always going around saying that the IPO process is broken and that something needs to replace it. Last  year that something was direct listings; this year SPACs are getting all the attention.

A SPAC, or blank-check company, is an empty shell that raises money from investors in a public offering and uses that money to find a (usually private) target company and merge with that target; the merger results in the target raising money (the money in the SPAC) and becoming public. The SPAC typically pays investment banks a fee of 5.5% of the money it raises, which is effectively passed on to the company that it takes public. It might also pay more investment banking fees for the merger with that company. It typically gives its sponsor—the famous investor or operator who runs the SPAC and finds a target company to take public—20% of its stock virtually for free, which, again, is passed on to that target company. So SPAC fees are about a quarter of the money raised, three or four times as much as you'd pay in an IPO, albeit better disguised. Like an IPO, a SPAC will acquire its target company at a price that is probably too low; the SPAC is in business to get a good deal for its shareholders, so it wants to take the target public at a price that is below fair value. And in fact some of the high-profile recent SPACs have essentially paid $10 a share for companies that immediately traded up to $20 or $30 per share, the sort of embarrassing IPO pop that venture capitalists love to complain about.[1] SPACs also give their investors warrants, which means that if the stock does go up the company has to give away even more of it. So SPACs do not avoid the underpricing effect of IPOs; they probably exacerbate it.

Still you could push back on that accounting. For one thing, SPAC fees might not be quite as big as they sound. Typically the way a SPAC works is that it raises money from public investors, paying a 5.5% investment banking fee and giving sponsors a 20% promote, and then finds a company to merge with. But in the merger the company will typically get a lot more than the cash in the SPAC: Alongside the money in the SPAC, there will generally be a PIPE, a private investment in public equity, where the SPAC's sponsors and their friends will put in a lot of their money too. If the fees on that are lower, then the overall fees could be fine. Here's venture capitalist John Luttig:

PIPE investments typically accompany the de-SPAC transaction, which essentially adds more equity leverage to the SPAC. SPAC sponsors coordinate the PIPE capital raise from hedge funds and PE firms, who are tagging along for the ride. The ratio of PIPE to SPAC money is typically between 2:1 and 3:1. This means that a $400M SPAC could effectively generate a total transaction size of $1.2-1.6B.

There will be fees of around 20% of the size of the original SPAC (excluding the PIPE amount), which goes to the SPAC sponsor in the form of equity – this effectively means a blended fee of 5-6% for the company as a percentage of total capital raised, fairly similar to the 5-7% for a traditional IPO. SPAC fees are mostly equity-based to align the SPAC sponsor and the company, in contrast to the primarily cash-driven fees for IPO bankers. SPAC fees can also be performance-triggered to incentivize fair pricing, such that a portion of the fees will be withheld unless the stock price crosses a certain threshold. Some SPACs use outside bankers to execute the de-SPAC process, which can add some cash fee overhead.

Also the sponsors will sometimes waive or modify some of their economics to make the SPAC deal more attractive to target companies. Also there is nothing fixed about the 20% sponsor promote. Here's Alex Danco:

If we can repeatedly go directly to the retail public and sell these things, what happens if he lowers his 20% fee, to say, 10? Once you really have this process down, could a SPAC start to compete on cost? The conventional answer would say no: you're still paying the blank check fee to go public, M&A fees for the deal itself, not to mention the promoter fee. But you'd be surprised where cost savings can get found in a new, hungry industry that hasn't ossified into its Generally Accepted Margins. 

And in fact Bill Ackman's giant SPAC, Pershing Square Tontine Holdings, does not have a 20% sponsor promote; Pershing Square, Ackman's hedge fund, is buying shares at their public price and some special warrants at, it says, fair value. The 20% commission that SPAC sponsors historically charged for taking companies public may have been driven in part by the small size and generally dodgy nature of SPACS, which meant that it was hard for a sponsor to find a real home-run trade; for Ackman, having a few extra billion dollars to get him a big stake in a company he likes might be reward enough.

As for the SPAC pop—the fact that a SPAC is going to try to invest in a company at less than its fair market value—there's no guarantee that that will always be true. In fact, historically it often wasn't, though for bad reasons. When SPACs were sort of small and dodgy, they were not always great at sourcing and executing transactions; the stereotype was that their goal was to collect fees for their sponsors, not to make good deals for their investors. Luttig:

SPAC sponsorship used to be a common fee-generating strategy among tier 2 or 3 PE funds. While the SPAC sponsors made money through guaranteed fees, the investments themselves often lost money, which led to adverse selection on the deals. 

That is changing, now that big-name investors are sponsoring big-name SPACs that merge with big-name private companies. Still, I suppose the dynamic could be that the SPAC is trying to rip off the company while the company is trying to rip off the SPAC, and there's enough history of SPACs getting ripped off—certainly it's more common than IPO investors getting ripped off—to make that seem realistic.

If you want to overprice an IPO, you have to convince dozens of big investors to overpay, but if you can find one SPAC sponsor to overpay then you can overprice your SPAC merger. An IPO is effectively a Dutch auction; you get bids from dozens of investors and then price the IPO at the price that clears the market, meaning that the whole deal is priced off the lowest buyer's price. A SPAC merger—any merger—is just a regular auction; you sell your company to whoever will pay the highest price. Of course the universe of merger bidders is smaller than the universe of IPO investors, so the actual clearing price for a SPAC could well be lower, but if you can find one generous outlier it could be higher.

Also, though, as we discussed last week, a SPAC is sort of a merger transaction, which means that it can create value; instead of trying to make money by buying a company cheap, a SPAC sponsor can try to make money by buying a company at a fair price and then increasing its value. There are synergies, perhaps, in the merger. There aren't many, because, after all, a SPAC is just a box full of money; it doesn't actually have a business to combine with the target company that it takes public. But maybe there are some. The SPAC sponsor will be a venture capitalist or an experienced operating executive or a savvy player in the capital markets; perhaps she can help the company she takes public perform better than it would on its own. Danco:

The business and the sponsor, who used to be on opposite sides of the table negotiating against each other, are now on the same team. The sponsor might even become the chairperson of the newly merged public business, like Chamath did with Virgin Galactic. This is very different than the dynamic with banks: it's M&A, rather than consulting. Your negotiation is more brutal, but then once it's done, you merge. 

Unlike the bank, who never really worked for you anyway; the SPAC sponsor doesn't just work for you; they ARE you. 

As I said last week, I suspect a lot of private companies aren't looking for that; they already know who they are, and don't really want to combine their identities with Bill Ackman or Chamath Palihapitiya or Michael Klein. A SPAC is not a neutral tool to take a company public, but a partnership with a sponsor, which may or may not be what you want. But it's what the sponsors want, so maybe they'll pay up for it. One thing that you are selling, when you do a SPAC merger instead of an IPO, is a bit more control, and perhaps the market will pay you for that.

I don't expect SPACs to replace IPOs. I like direct listings well enough because they cut out a lot of the apparatus and structure of traditional IPOs, while SPACs mostly add a lot more apparatus and structure. (And expense.) They feel to me like an interesting tool for weird times, not the future of going public. Merging with one person's company and paying her a huge fee to do so does not feel like a good general substitute for selling shares to the market at the clearing price. But maybe that's wrong; maybe if SPACs are going to be the future of going public, people will start doing them with less structure and less expense.

Vaccine hedging

Let's say you're the founder and chief executive officer of a small biotech company that is working on developing a coronavirus vaccine. You have done some work, there have been preliminary trials, you have announced the results. The results suggest that you have, say, a 20% chance of making a safe effective vaccine. You believe this. The market believes this. Let's just say it's a true and broadly known fact, you have a 20% chance of winning.

What will this do to your stock? Assume your stock will go up a lot. Before this you were a small biotech with some irons in the fire, no working product, no revenue, of interest only to a few specialized investors. Now you have a 20% chance at untold riches and fame, etc. That chance does not need to be 100% for lots of investors to rush to buy the stock. They are diversified, they have risk tolerance, they'll pay the fair price for a gamble. If you find the vaccine it will be, let's assume (one could quibble!), very lucrative for you, and your company will be worth, say, $20 billion. A 20% chance of that is worth, say, $4 billion now. If your company was worth $200 million before—reflecting a 1% chance of success—then it has gone up 1,900%.

What will you do with your stock? You aren't diversified. Before this you owned, say, 5% of a $200 million company, $10 million on paper of fairly illiquid stock. Now you own 5% of a $4 billion company, $200 million of much more liquid, actively traded, rising stock. If you hold on to the stock and the vaccine works, you'll be worth a billion dollars. If you hold on to the stock and it doesn't, you won't even have the $10 million; when your odds of success go from 20% to 0%, let's say, your company will go out of business and your stock will be worthless.

I think the three options are:

  1. Do nothing, keep all your stock, continue to bet your entire net worth on the success of your efforts. You are a true believer, you are in this because you have faith in yourself and your team, you are a founder-CEO because you take risks and dream big, and you want that billion dollars. 
  2. Sell, like, half your stock, take some risk off the table, ensure that you will be wealthy for the rest of your life, and reward yourself for doing all the good work that got you here. You've earned it! Probabilistically! You haven't actually done any good for anyone yet, but you've done enough to have a 20% chance of doing good for a lot of people, so you deserve a little treat for that. But of course you'll hang on to a lot of your stock because you still have a faith in yourself and team, you still want to be even richer, etc. Also you should probably still have incentives to keep coming to work and making that vaccine because, after all, that was the whole point of starting this business.
  3. Sell all your stock. "Two hundred million is plenty for me, thanks." Maybe you keep coming to work out of intellectual curiosity and public-spiritedness. Maybe you don't.

I think if you choose option 3 you will almost certainly be sued for securities fraud? I mean, if you choose option 3 and keep coming to work and actually find the vaccine and your company goes to $20 billion then everyone will be happy, but remember there was only a 20% chance of that. If you don't find a vaccine, and you sold all of your stock and stopped coming to work the day after announcing positive news, everyone will assume that you were lying, that you announced the positive news to trick people into buying your stock so you could get rich with no product. 

If you choose option 1 no one will complain, but there's an 80% chance you'll be left with nothing for all your hard work. (Oh, fine, you probably collect a salary, "nothing" is an exaggeration.) Perhaps that's how it should be! Perhaps people should be lavishly rewarded for success and get nothing for failure. Or perhaps not, perhaps people should be partially rewarded for partial success, to encourage more people to try.

Or perhaps you do not care at all about these big questions of societal incentives and you just want to make sure you have plenty of money in any scenario. I would choose option 2, of course, but then I have never started a biotech company. It is possible that my risk-aversion and negativity is not what you want in a biotech CEO. In any case if you choose option 2 people will complain a lot. Why are you taking money off the table, now, at this critical time? Do you not believe in your team? Is the positive news that you announced just a lie? 

In the real world this is all complicated by the possibility of inside information, of insiders putting a higher or lower probability on their odds of success than outsiders, of press releases that shade results one way or the other, of sweetheart deals on compensation and stock grants, etc. etc. etc.; I am not saying that my simple model is exactly what is going on here:

The race is on to develop a coronavirus vaccine, and some companies and investors are betting that the winners stand to earn vast profits from selling hundreds of millions — or even billions — of doses to a desperate public.

Across the pharmaceutical and medical industries, senior executives and board members are capitalizing on that dynamic.

They are making millions of dollars after announcing positive developments, including support from the government, in their efforts to fight Covid-19. After such announcements, insiders from at least 11 companies — most of them smaller firms whose fortunes often hinge on the success or failure of a single drug — have sold shares worth well over $1 billion since March, according to figures compiled for The New York Times by Equilar, a data provider.

In some cases, company insiders are profiting from regularly scheduled compensation or automatic stock trades. But in other situations, senior officials appear to be pouncing on opportunities to cash out while their stock prices are sky high. And some companies have awarded stock options to executives shortly before market-moving announcements about their vaccine progress.

I am just saying that (1) in a perfect world of totally transparent accurate information and totally honest loyal but somewhat-risk-averse executives, you would see something like this, and (2) some of these companies are going to get sued for securities fraud no matter what.

Oh Bridgewater

It seems a little incongruous that Bridgewater Associates should have to settle disputes with former employees in regular U.S. courts. Bridgewater's whole thing is about radical transparency and emotional honesty and talking out their problems face to face; if they have disagreements with employees it just feels like they should be settled by couples therapy or, like, going into the wilderness and screaming at each other. Former co-chief executive officer Eileen Murray once said:

"It's kind of a family atmosphere," she said. "I don't know about you, but for me, my family tells me things I don't want to hear. But they do it out of a sense of love and kindness...Some people think [the culture] sounds harsh and stressful. I think it's very kind."

Well that was like a year and a half ago and now she is suing Bridgewater. Her problems with Bridgewater have to do with the circumstances of how she left and how much she will get paid in deferred compensation; she says that she has "substantial claims …  against Bridgewater based on gender discrimination, unequal pay, and breach of contract."

But that's not why she's suing, because nothing connected with Bridgewater can be about the thing itself; everything is about how you talk about the thing. She's suing because, after leaving Bridgewater, she has done other things; she's the chair of the Financial Industry Regulatory Authority, and on the board of a couple of companies. And, being a good Bridgewater alumna, she has of course been radically transparent—or, at least, the regular amount of transparent—with those companies:

Based on Plaintiff's present and potential roles and duties, including without limitation her judgment about what is appropriate and necessary to disclose to current and prospective business partners, Plaintiff has informed Bridgewater that she has disclosed, and plans to disclose, to various third parties the existence of her dispute with Bridgewater.

Consistent with the foregoing, Plaintiff specifically informed Bridgewater that she disclosed to FINRA that she was involved in a dispute with Bridgewater which involves unequal treatment by Bridgewater and significant unpaid compensation due her.

On July 14, 2020, Bridgewater informed Ms. Murray in writing that, based upon the authority granted Bridgewater under the terms of the Plan, her public disclosures about her dispute with Bridgewater will result in a forfeiture of Plaintiff's Deferred Compensation. …

Bridgewater's claim that Ms. Murray stands to forfeit her Deferred Compensation because she has affirmed her right to publicly disclose the existence of her gender discrimination and breach of contract claims against Bridgewater, is both a breach of the terms of the Plan and an improper gambit to silence her voice.

Yeah I have to say, "don't tell your employers anything about your dispute with us" does not seem like a very Bridgewater message! I suppose that Bridgewater is constantly stumbling into ironies like this; that's what you get when you combine a culture of radical transparency with a culture of, um, legally enforced secrecy. Oh well. My recommendation is that they should all come to my living room to talk this out; I will videotape it all and post it online so that anyone who wants to can give both sides credibility scores.

Maureen Dowd x Elon Musk

I try to say amusing things about financial news around here, but I have nothing amusing to add to Maureen Dowd's incredible interview with Elon Musk (and his girlfriend Grimes, "otherwise known as Claire Boucher, otherwise known as 'c,'" and, briefly, their baby, who is allegedly named "X Æ A-Xii") from this weekend, it is perfect on its own, perhaps the greatest entertainment experience I have had in this pandemic, you should just go drop a lot of acid and read it. It is futile to quote, since each sentence is amazing and not one of them has anything to do with any of the other sentences; nonetheless I will excerpt a few passages at random:

Mr. Musk said that "c has gotten quite worried about A.I. in the last few weeks. I think GPT-3" — the latest A.I. tool that has Silicon Valley buzzing — "has caused her to become quite concerned. And I'm like, 'Welcome to me circa 10 years ago.'"


Chortling, he said. "I'm not that concerned about my DMs being made public. I mean, we can probably cherry pick some section of my DMs that sound bad out of context but overall my DMs mostly consist of swapping memes."

And there's this, about Musk, Amber Heard and Johnny Depp:

"I definitely was not having an affair with Amber while she was married to Johnny, this is totally false," Mr. Musk said, disputing Mr. Depp's claim. … 

I noted that the actor employed some smack talk worthy of a pirate in a text message to Ms. Heard that was read in court, threatening to slice off a sensitive part of Mr. Musk's anatomy.

"If Johnny wants a cage fight, just let me know," Mr. Musk said mischievously, breaking into his famous giggle.

I'm sure Tesla Inc.'s board of directors will be absolutely delighted if Musk has a public cage fight with Johnny Depp, why not, it'll probably sell cars.

Elsewhere, Musk is apparently commuting to work in a prototype self-driving Tesla; "it's almost getting to the point where I can go from my house to work with no interventions, despite going through construction and widely varying situations," he said on the earnings call. Someone tweeted about this, "show me the risk factor," and while Tesla's 10-K does say "we are highly dependent on the services of Elon Musk, our Chief Executive Officer," it does not describe in detail all the possible ways that Musk could, uh, leave their service. My own view is that Musk is going to live forever, that Peter Thiel is going to discover the secret of eternal youth and share it with him, but I also think that if he ever does die it will be (1) while serving as the CEO of multiple companies and (2) in some sort of cartoon crash involving some or all of their products. "Elon Musk died today when a spaceship piloted by Johnny Depp crashed into his self-driving car in a tunnel," Tesla will announce, and the stock will plummet. Will it be securities fraud? Oh you'd better believe it.

Things happen

Dumb Money Making Smart Stock Picks in Yearlong Robinhood Rally. Everyone's a Day Trader Now. U.S. SEC chief 'worries' about retail investors trying to get rich quick. Hedge Fund Fees in Free Fall Is the New Reality For a Humbled Industry. How the Child Care Crisis Will Distort the Economy for a Generation. Covid's Next Economic Crisis: Developing-Nation DebtJumbo Mortgages Are No Longer the Cheapest Mortgages Around. Desperate hunt for yield forces investors to take 'extreme risk'. Gold hits a record and dollar falls as economic outlook darkens. Coronavirus turns the City into a ghost town. Hedge-funder gambles on coronavirus to build casino empire. "Goldman Sans": Use Our Font, Disparage Us Not. 

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[1] The highest-profile 2020 SPAC deals might be DraftKings Inc., whose stock closed at $19.35 the day its SPAC merger closed, and Nikola Corp., whose stock closed at $33.97 the day its SPAC merger closed. Both of those deals involved the SPAC paying $10 per share, the typical SPAC price, so they are 93.5% and 240% "IPO pops," though they don't quite look like that. (The SPACs themselves traded for months before the mergers, and the mergers had been announced well before the closing date, so these were not one-day pops.) 


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