What Is the Difference between SPAC & IPO? | Executive Recruiters

      What is the difference between SPAC and IPO?

      Apart from the inescapable specter of a global pandemic, 2020 will be remembered as the year when SPACs emerged as a true contender to the tried and tested IPO.

      With more than $70 billion in gross proceeds by December, SPACs accounted for 97% of the total money raised in IPOs in 2020, according to the Securities Industry and Financial Markets Association (SIFMA). Compared to a performance of just 9.9% in the decade up till 2019, it’s clear how much momentum this deal structure is enjoying currently.

      While SPACs are undeniably hot at the moment, intrepid founders and CEOs might be wondering how much of that is due to herd instinct and whether SPACs are a better alternative to IPO. We’re looking at these two types of deal structure and how they compare in this post.

      What Is an IPO?

      An Initial Public Offering (IPO) is the process through which a private company offers its shares for sale to the public. Usually, the IPO will be the first time ever that the company is offering its shares to the public. The company’s shares will be listed on a stock exchange, where investors can then purchase a stake in the company. Through the process, the private company converts from private to public and becomes known as a PLC.

      The process begins by hiring an investment bank that advises the company, in a role called “underwriting”, and helps file its S-1 prospectus with the Securities and Exchange Commission (SEC). The prospectus will include financial projections, potential risks of the IPO, and how the proceeds of the IPO will be used. If approved, the underwriters will hold “investor roadshows” where they promote the company’s stock to potential institutional investors. The underwriter will allocate shares to willing institutional investors, and then buy shares from the company before listing day. Listing day is when the company’s shares will be available for trading on the stock exchange.

      An IPO is a momentous occasion for a company, usually taken as a validation of the company’s growth and maturity. IPOs bring their own concerns though, as they expose the company to greater scrutiny from regulators and investors regarding their financials and performance. In addition, they are typically expensive and time-consuming, taking anywhere from 6 months to well over a year before completion.

      What Is a SPAC?

      A Special Purpose Acquisition Company (SPAC) is a publicly-held shell company created with the sole purpose to acquire a private company. A SPAC might be created by a team of sponsors looking to acquire portfolio companies or it could be created by a private company intending to go public by this route.

      SPACs typically hold no assets and have no operating business. They can however raise money to finance an acquisition by listing their shares on a stock exchange. This arrangement is called private investment in public equity (PIPE), and is the equivalent of an IPO. Only, in this case, the process is very fast and efficient for the SPAC since it holds no assets and must fulfil minimal disclosure requirements.

      A SPAC must usually carry out its intent of merging with a private company within 24 months or return the money it has raised back to investors. After acquiring a private company, the SPAC takes over all of its operations, assets, and customers, essentially becoming that company – with the difference that the private company is now publicly-held. This process is often regarded as an example of a reverse merger.

      At the end of the process, the SPAC’s sponsors will have functionally taken both companies public, but at less cost and with far less stress than an IPO.

      How Do They Compare?

      At their core, SPACs invert the traditional approach to raising capital with an IPO. As Don Butler, MD at Thomvest Ventures puts it in an interview with Crunchbase, “an IPO is basically a company looking for money, while a SPAC is money looking for a company”. Beyond this, however, SPACs and IPOs produce deeply different outcomes especially in the areas of regulatory procedure, cost, speed, and efficiency.

      • Efficiency: SPACs are far more efficient than IPOs. Using a SPAC provides companies wishing to go public with a streamlined process that saves time, resources, and frees up the company to focus on its business. Compared to this, an IPO will involve an army of experts, consultants, and professionals including lawyers, investment bankers, accountants, and regulators.
      • Speed: A SPAC can be incorporated and taken public in mere weeks, far less time than the several months, or even years, that will often be needed to take a private company through the IPO process. Without the added burden of extensive regulatory processes and investor roadshows, companies can quickly go public in no time at all using a SPAC.
      • Cost: IPOs are typically resource-intensive. According to a study by PwC, investment banks involved in the IPO process can take up to 7% of gross IPO proceeds as fees, and that’s just for the underwriters. Fees paid to lawyers, accountants, valuers, and other experts will likely add up over the lengthy period of an IPO. In contrast, SPACs are much cheaper since they take much less time to proceed through the regulatory process of an IPO.
      • Regulatory: Arguably the most significant advantage that a SPAC brings is its lighter regulatory burden. IPOs bring extensive, and sometimes unflattering, scrutiny to a company and its operations. Even for the best performing companies, the spotlight can raise questions about their business model or add uncertainty around their valuation. Since a SPAC has no operations or assets to speak of, it can go through these regulatory processes much faster, thus shielding the acquired private company from harsh scrutiny.

      Choosing a SPAC over IPO: Pros & Cons

      As the foregoing already shows, choosing a SPAC will bring several clear advantages to companies looking to go public. They can execute much faster than an IPO, enjoy fewer regulatory hassles, and spend less overall on the process. Added to this, SPACs also hold the following advantages over IPOs.

      • Lower marketing costs: Without the need for extensive investor roadshows or reams of prospectus pages, SPACs allow companies to save on marketing costs throughout the process.
      • Room for additional capital raises: SPACs can raise PIPE or debt funding to not only fund the acquisition but also fuel the operations and growth of the resulting company.
      • Clear price discovery: The price of the private company’s shares is typically negotiated and agreed upon with the SPAC before the merger is complete. In contrast, an IPO brings the uncertainty of a volatile market as the price of the shares will depend on market conditions at listing time.
      • Operational expertise: Using a SPAC arrangement can afford the private company access to experienced industry professionals, who fall into the typical profile of SPAC sponsors. The company can tap into their expertise or even invite them to take a seat at the board.

      While a SPAC can mean faster time to a public offering for private companies, it does come with its disadvantages when compared to an IPO. These include the following:

      • Potential capital shortfall: SPAC investors are allowed to redeem their shares at or before acquisition. Where too many investors take this option, it can leave the SPAC with a funding shortfall.
      • IPOs might produce more confidence: The rigorous due diligence involved in the IPO process plays an important role in exposing weak or fraudulent companies. Because a SPAC allows private companies avoid this stringent scrutiny, it might let them hide important details that become problematic later on.
      • Dilution of shareholding: SPAC sponsors are typically guaranteed a “promote” consisting of a 20% stake in the target company, in addition to warrants that let them buy more shares in the company. They might also enjoy earnouts that entitle them to even more shares if the stock price meets a specified target, leading to dilution of the original founders’ and shareholders’ holding in the company.

      Summing up

      Overall, while a SPAC and IPO leverage uniquely different routes towards a public offering, they eventually achieve the same goal – letting a private company earn the market validation and financial rewards that an IPO brings.

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