Among key phrases such as “Covid” and “quarantine”, one word became significantly more popular in all of our vocabularies this year, SPACs. From your daily financial news to your monthly podcast catch-up, SPACs became an increasingly hotter topic as the year progressed. The 206 SPAC IPOs have accounted for more than half of the record $124b IPO proceeds in the US this year. These numbers are even more significant once we take into account that, this year’s SPAC IPOs, have raised 5x more capital than 2019, or just under twice more than all IPO proceeds that SPACs have raised between 2010-2019, combined.[PitchBook Analysis]
This article will explore the reasons behind this surge in interest, and the impact it may have on the Venture Capital ecosystem.
What is it and how it works
A SPAC (Special Purpose Acquisition Company) is a holding company that goes public with the sole purpose to raise money through an IPO, in order to find a private company, and take that public via a merger/acquisition (or de-SPACing).
SPACs are commonly formed by an experienced sponsor, which invests around 20% in the SPAC, and the remaining 80% is held by public shareholders through “units”. Each unit consists of a share of common stock, and a fraction of a warrant. The SPAC IPO normally consists of an investment thesis focused.
Once the procedure is concluded, the SPAC usually has 18-24 months to identify and complete the de-SPACing. Should this not happen within the timeframe, the IPO proceeds are returned to the public shareholders. During this search timeframe, the SPAC announces the merger, and the public shareholders may either accept, or vote against it, and elect to redeem their shares.
Goldman Sachs looked at 56 SPACs that have announced mergers with target companies since 2018. From their result, they note that SPACs do indeed outperform the market, but only up to the quarter following the de-SPACing. The stocks then tend to lag behind. On average, the 56 SPACs beat the S&P 500 and Russell 2000 by 1% and 6% respectively in the first month after the deal, and 11 points and 15 points positively after three months. From thereafter, the numbers turn negative.
A similar story can be seen by a Harvard study, in which they looked at 47 SPACs that merged between January 2019 and June 2020. The study also separates what they consider high-quality sponsors (HQ) vs non-HQ. The results do show that, after three months, only the HQ sponsors beat the market (25.1% above IPO Index and 37.5% over Russell 2000), whereas the non-HQs are on average below market by -53% (IPO Index) and -42% (Russell 2000). The spread between HQ to the market, however, diminishes with time. After 12 months, HQ sponsors perform -12% against the IPO Index and +10% against Russell 2000. 
Moreover, we note that the distributions presented by the SPACs are very diverse. Within three months, HQ sponsors return 31.5% vs -38.8% from non-HQ. This too was noted in the Goldman Sachs analysis, where the 75th percentile of SPAC outperform S&P by 22%, while the 25th percentile lagged by 69%. The Russell comparison was +37% & -63%.
So, why is it so popular?
If the performance of the SPAC is short lived, and with returns being so disperse, why, then, have we seen such a tremendous growth in the use of SPACs?
There have been a few reasons proposed as to the 5x increase from 2019, and behind all the incredible numbers highlighting the SPAC growth this year. Some argue that SPACs provided a safer form of investment for market investors, who were averse to the volatility of the markets experienced this year. A SPAC investor has protections, such as warrants, that allows the investor to withdraw capital, with interest (which are usually struck 15%),  at the time of a proposed business combination. On top of this, SPACs have become gradually better at finding targets, leading to less liquidation. According to a McKinsey study, more than 90% of recent SPACs have successfully consummated mergers, whereas at least 20% were liquidated prior to 2015.
The combination of the optionality for the investor to choose whether to opt-out of the proposed deal, together with the guaranteed warrants, are appealing factors to invest in SPACs instead of a highly volatile market, which has been the case this year. The security provided with these tools, are enough premium to justify the lower average return. Furthermore, on top of the security and optionality provided by a SPAC, it also comes with the potential for impressive returns for those who opt-in the de-SPACing deal, as we have seen by the fantastic outperformers mentioned above.
On the other side of the equation, we look at the target companies. Another possible explanation for the growth in SPACs is the increase in available target companies interested in pursuing this route. SPACs offer a simples IPO process that saves time and energy for all parties. Since a SPAC is just a blank check company, it is significantly easier to go through an IPO. Similarly, the path to IPO for a company can be lengthy, costly and involves interactions with multiple investors through a road show. The SPAC transaction functions more like an acquisition, which means a negotiation with a single party (the sponsor) and requires a lot less due diligence from the regulators, which speeds up the process to public markets. Of course, once the company goes public, it is then subjected to the same level of financial scrutiny as any other public company.
The Venture Capital growth story and its impact on SPACs
The SPAC industry has turned to bringing private companies, which are high growth cash-intensive companies, to the public market. These are precisely the companies which prefer to forego the lengthy IPO process, and let their valuation be confirmed in the acquisition process. Such target companies have been traditionally within value investments, but the public market investor is eager to participate in deferred listings in the hopes of backing the next great growth story.
Between 2010-2019, 25% of SPACs have targeted Energy companies, 18% in IT, and 9% in Consumer. In 2020, IT and Consumer have represented 40% and 25% of targets, respectively, whereas Energy’s representation fell to 2%. Furthermore, regarding actual de-SPACing, 68% of SPAC mergers this year were in tech, consumer discretionary, or biopharma. Only 24% of SPAC mergers were in industrials, financials, or energy.
This is best highlighted with the biggest SPAC IPO was also finalized this year, with Pershing Square raising an astonishing $4b in an IPO, having an investment thesis to bring a Unicorn to the public market. Other tech focused SPACs include Social Capital (Fund II for $360m, III for $720m, IV for $400m, V for $700m, and VI for $1.0b), and Dragoneer Growth Opportunities Fund I for $600m and Fund II for $240m. [PitchBook Analysis]
Moreover, much like the appeal of fast-growing capital-intensive tech companies, the biopharma sector is also gaining momentum, as previously mentioned, within the SPAC Universe. These companies typically view public listing process as another fundraising event, rather than full exit, and many require backing from crossover specialist investors prior to the IPO as a signaling to the market of the quality of their technology and research. These companies need access to capital to conduct bigger trials, fund R&D programs, and receive approvals from regulatory bodies. The access to quality crossover investors, like Sofinnova or Forbion (both of which are examples of successful commitments done in 2020 by Aurora I, Axon’s Fund of VC Funds), is extremely limited, which is why many biopharma companies are seeking this route.
Appetite for healthcare is best shown with MultiPlan’s reverse merger with Churchill Capital Corp III for $11b in July 2020. The deal is the largest de-SPACing ever, to date, and will serve to bring the US healthcare services to the public market. Furthermore, on healthcare, the best first-day pop for a SPAC this year was with Therapeutics Acquisition, which saw a jump of over 20% in a day.
As a result, we also see the creation of healthcare focused SPACs, like Chardan Healthcare Acquisition 2 ($85m), Deerfield Healthcare Technology Acquisitions $125m, and LifeSci Acquisition Fund I ($60m) and Fund II ($75m).[PitchBook Analysis]
Conclusion for SPACs
As the public grows ever more interested in getting access to these fast-growing companies, both in tech and in biopharma, it will be in the interest of SPACs to keep raising IPOs and looking for a target that will match public interest.
Those who can invest in mature private companies pre-IPO, such as Axon’s fund ICT IV, will have a great advantage being able to select and closely follow industry leaders before they go public. These new funds are entering into a market that provides a plentitude of exit options never seen before, while being able to capitalize on the public’s appetite for growth stories.
The rise in tech and healthcare SPACs will, therefore, most probably result in a rise in liquidity and exits for Venture Capitals.