Publications

- May 1, 2021: Vol. 8, Number 5

Pre-SPAC, post-SPAC: Why private markets have supplanted IPOs

by Thomas Powell

In the past, an initial public offering (IPO) was the goal of almost every entrepreneur, as they anticipated an influx of cash, publicity and the prestige of listing on a major securities exchange. However, many business owners have since realized that IPOs come with added burdens of market volatility, significant time requirements and SEC scrutiny. Thus, more organizations today are turning to the private markets — and after the current SPAC trend runs its course, we expect to see this number increase.

PUBLIC MARKETS, PUBLIC PROBLEMS

Former SEC chairman Jay Clayton once said, “I do wish that companies were looking to access our public capital markets earlier in their lifecycle. I like it when growth companies are entering our markets so that our retail investors have an opportunity to participate in the growth.” And with the number of listed companies dropping by 52 percent between the late 1990s and 2016, it is easy to see why he might say that. But there are several reasons why many companies, especially small- to mid-sized organizations, are no longer working toward an IPO.

  • Expensive and time-consuming process. The number of reports and disclosures that a corporation must prepare to meet SEC regulations can take years and involve numerous attorneys, accountants and other specialists, all of which can add up to high costs.
  • Increased oversight. Going public during the early stages of a business puts it under the SEC’s supervision and can significantly alter how a company does business.
  • Extensive public reporting. Public companies lose most of their privacy and are required to report quarterly and annually regarding business operations, financial conditions and other company matters.
  • Possible loss of control. Founders can lose control of their companies. Even as a majority shareholder, founders are incentivized through the company’s share price to keep investors happy.

On the other hand, private markets can offer entrepreneurs the liquidity needed to develop companies without the restrictions that come with an IPO. By staying private, founders avoid the hassle, expense and potential volatility of going public. Plus, private companies do not have to answer to their shareholders. Instead, they are free to focus on their strategy while maintaining greater control of their company.

However, one common complaint about private markets is that they are too restrictive and inaccessible to the average retail investor. An individual has to be an accredited investor to invest. In this regard, what is a retail investor to do? Enter the SPAC.

TAKING UP SPACE IN THE MARKET

Special purpose acquisition companies (SPACs) are, according to the SEC, blank-check companies that “pool funds in order to finance a merger or acquisition within a set timeframe.” Essentially, a SPAC is a type of shell organization that helps a company go public without going through the usual IPO process.

SPACs were created in the ’90s but became popular in 2020 when SPACs raised $83.4 billion, a record-setting number already broken during the first three months of this year, with $87.9 billion raised so far in 2021.

On the surface, the SPAC concept is sound: Put together a solid management team of institutional investors, raise money through an IPO, and then find a private company that wants to go public and acquire that company. Once the acquisition is complete, SPAC investors either exchange their SPAC shares for the merged company’s shares, or they redeem the SPAC shares and receive their original investment, plus interest.

For business owners, SPACs allow a company to go public much faster than the traditional IPO. And for a retail investor, the opportunity to garner public access to the private market can be attractive, especially if your favorite celebrity is endorsing it. Shaquille O’Neal and Alex Rodriguez are legends, but success in their respective sports does not necessarily qualify them to endorse or manage your investment. Celebrity involvement has become so prevalent with SPACs that the SEC recently issued a warning on its website.

It is no secret that a significant portion of the younger generations do not believe Wall Street works for them. According to a Wall Street Journal survey, 37 percent of millennials reported their mistrust of financial institutions, but this does not mean investors should necessarily trust Shaq with their money. SPACs are inherently risky and with retail investors accounting for 40 percent of SPAC trading, they take on a large portion of the risk. Investors in SPACs have no way of knowing what they are investing in, and the due diligence process is not as rigorous as an IPO or the private market.

PRIVATE MARKETS OFFER MORE THAN CAPITAL

An advantage of the private markets is they take their due diligence seriously. Their careers and the success of their firm depend on it. Private equity and venture capitalists must also follow strict guidelines as they manage and guide companies through different market cycles. Some private equity firms may also feature a diverse management team, allowing them to bring expertise and capital to the table.

While there is room for SPACs, IPOs and the private markets to coexist, trends come and go and, ultimately, much of the world’s transactions go through the private markets. In 2017, more than $1.8 trillion was raised in private Reg D offerings, dwarfing SPACs’ record-breaking years. Furthermore, with the recent expansion of the accredited investor definition and larger firms such as Goldman Sachs jumping into the space, the private market will continue to evolve. When the SPAC bubble bursts, companies will once again return to private markets and the advantages they provide.

 

Thomas Powell is the senior managing partner of Resolute Capital Partners LTD.

 

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