Editor’s note: Manuel Gonzalez is a partner at AgFunder and a former managing director at Rabobank. Find out more about him here [Disclosure: AgFunder is the parent company of AFN].
SPACs are all the rage these days, and in agtech, we saw our first high profile SPAC last month when AppHarvest listed on the NASDAQ at a $1 billion valuation.
They stand to shake up the agrifoodtech space and spell positive news for the industry’s investors as a new channel to exit. But what exactly is a SPAC?
A SPAC – from the acronym for ‘special purpose acquisition company’ – is a shell company that has no operations or assets, but is intentionally designed to raise money, through an initial public offering (IPO), to acquire or merge with an extant private venture.
Going public
First, let’s recap on the more familiar options that private companies have to begin selling their stock to the public.
There are several ways in which a private company can go public. Going public means that its shares can be bought and sold on a stock exchange by so-called “retail investors,” and the most common route is through a traditional IPO.
Under this process, the company becomes subject to regulator and investor scrutiny of its audited financial statements.
An investment bank is usually hired as an underwriter, which is typically a four to six-month commitment. This involves roadshows and pitch meetings between company executives and potential investors to drum up interest and demand in its shares. The company then sells a combination of new and existing shares to these investors at the same time as listing on an exchange.
Not all traditional IPOs succeed. Companies such as Spotify and Slack opted to short-circuit that process and went public through an alternative route called a direct listing. This is when the company does not raise any additional funding like with a typical IPO but instead sells existing shares directly to members of the public, saving on fees typically paid to middlemen such as investment banks.
SPACs are already public companies, giving private ventures access to the retail markets by way of a ‘reverse’ merger or acquisition.
Chronologically, SPACs require that investors contribute capital without concrete knowledge of how or where that capital will be deployed. Therefore, they’ve earned the nickname of ‘blank-check companies.’
Here’s how it works:
- A management group, referred to as the sponsor, decides to form a SPAC and raise money through an IPO that sells units in the SPAC.
- These units are typically priced at $10 and made up of one share and a warrant, or a partial warrant. These warrants are contracts that allow investors to buy a certain number of additional shares of common stock at a preferential price sometime in the future.
- SPAC units trade like any other stocks, and therefore investors can buy or sell shares at the current market value anytime after the IPO.
- Once the IPO is complete, all raised funds are transferred to a trust. Over the next 18 to 24 months – which has become the standard SPAC timeline – the sponsor is responsible for identifying and acquiring a company that they believe offers tremendous opportunities in growth and profitability.
In the event that the SPAC fails to acquire or merge with a company within that timeframe, then the SPAC will be liquidated, and investors will receive their money back, net of set up fees.
If, however, a target is identified and approved, then the SPAC and the target business combine, turning the target business into a publicly-traded operating company. This is known as the ‘de-SPAC’ process, during which shareholders can decide whether to remain invested or pull their money out. If investors choose to remain through the acquisition, then their investment will rise and fall with the share price of the post-combination company.
Cost efficiencies
So why would a private company choose to go public through a SPAC?
Many see it as a way to get the cash influx available from the public markets while bypassing some of the regulatory hoops of a traditional IPO.
There’s greater price control for the private company taking the SPAC route compared to the private company going for a traditional IPO. This is because there’s less guesswork and negotiation in determining at which price to offer the shares to the market, since the company only has to agree a price with one investor: the SPAC.
Also, by skipping the investor roadshow process altogether, SPACs streamline the overall IPO timeline considerably.
Some investors like SPACs because they grant them the ability to get in early on an IPO, which may have enormous potential. If the SPAC is successful, the price should appreciate, and investors will make money. Those same investors may also opt to exercise their warrants and buy more shares at a lower price.
Of course, there’s also the possibility that the investment could depreciate. The management expertise of the sponsor group can be key in guiding target companies as they continue to grow.
SPACs can be very lucrative for sponsors, as well.
Sponsors are paid based on the success of the SPAC through share ownership called ‘the promote.’
The promote allows sponsors to buy 20% of the outstanding shares at a heavily discounted price. There can be a major disparity in payouts between sponsors and investors. The high number of sponsor shares at a low price dilutes investor value because sponsors aren’t putting up nearly as much money as the investors, but they’re taking 20% of the gains.
In comparison to the investment cost of a regular IPO, SPAC sponsors don’t get paid unless the SPAC performs well. This means they’re incentivized to maximize the business acquisition, while investment banks that underwrite regular IPOs hang around only until the listing and have no skin in the game.
Nothing new; recent growth
SPACs have been around for decades, and in the past have garnered a bad reputation for scamming investors. The US Securities and Exchange Commission (SEC) started regulating SPACs in an attempt to reduce fraud. The regulation granted investors the right to redeem units before an acquisition.
While SPACs remained relatively unpopular for years, more recently they have experienced tremendous growth with SPAC IPO counts moving from one in 2009 to 248 in 2020, according to spacinsider.com. More than $83 billion was invested in SPACs in 2020, dwarfing the $13.6 billion invested in 2019, according to Dealogic, and just in February of this year, blank-check companies signed a record $109 billion across 50 transactions globally, according to new data cited in the Financial Times.
As reported in the FT, “February’s dealmaking frenzy was capped by the largest SPAC merger to date when the electric vehicle developer Lucid agreed to go public last week in a $24 billion deal with a blank-cheque company set up by ex-Citigroup banker Michael Klein.”
Examples of other high-profile SPAC companies include DraftKings, Nikola, and Virgin Galactic. In the food space we can count several as well:
- Natural Order Acquisition, pursuing target companies that use plant-based, cell-based, or precise fermentation technologies to develop food products that eliminate animals from the food supply chain.
- HumanCo Acquisition, with a health and wellness focus, including food, beverage, and nutrition.
- Aspirational Consumer Lifestyle Corp, targeting premium consumer brands that have a focus on Millennials and Gen Z, with a focus that includes wellness, plant-based proteins, and milk alternatives.
- Novus Capital Corporation, with a tech focus, including agtech. (Of note, their first SPAC conducted the reverse merger of AppHarvest earlier this year.)
- GreenVision Acquisition Corp, which recently invested in micro-mobility startup Helbiz, aspiring expansion into food delivery. (TechCrunch)
- Sustainable Development Acquisition I Corp (SDAC), intends to focus on businesses in the water, food & agriculture, and renewable energy sectors that are addressing the global challenges identified by the United Nations Sustainable Development Goals.
Inherent risk
As with any investment, there is inherent risk, so how can an investor determine whether to invest in a SPAC? Here are three things investors should consider:
- First, the sponsor. By design, SPACs have no assets and no track record, so investors are betting on the management team. In recent years SPACs have used high-profile sponsors like Chamath Palihapitiya, a former Facebook executive, and Bill Ackman, a famous hedge fund manager, to signal their potential. Investors are wagering that these executives will strike gold once again and take their investors with them. Investors who are interested in SPACs should spend time researching the terms of the investment. A good place to start would be to carefully read the SPAC’s IPO prospectus, as well as its periodic SEC filings. Investors may also find it beneficial to research and evaluate the management team in order to better understand their expertise, experience, and personal track records.
- Second, if a target company is identified, investors need to decide if it is a good investment. One benefit of the traditional IPO route is that companies and management teams undergo scrutiny from investors, underwriters, and regulators. This scrutiny can be helpful in weeding out some prospects. For example, WeWork failed to go public because the scrutiny revealed numerous irregularities with the company and its management. SPAC shareholders should carefully evaluate the target company when an acquisition is announced. This is when they have to determine if they want to stick with the SPAC or redeem their funds.
- Finally, as with any investment, investors should weigh the opportunity cost of giving a blank check to a sponsor team or investing in other assets. While some SPACs have been very successful, one study from 2010 to 2017 followed 92 SPACs (Wall Street Journal, 2017) and found that they underperformed the broad market index by 3%. Another study (Financial Times, 2020) found that between 2015 and 2019:
- The majority of SPACs were trading below the $10 IPO price;
- A little more than half the companies had actually made an acquisition;
- 15% were in the process of making an acquisition;
- 29% were still searching for a deal; and
- 4.8% had dissolved the SPAC and returned money to their investors
Like most investments the results are mixed. In the end, SPACs can offer an opportunity to invest in something new, young, and exciting that relies more on product iteration and R&D versus current cash flow.
SPACs could be the IPO 2.0 wave that will transcend the obsession with current cash flow that has driven the private equity boom and driven the debt boom of the past. We could see more of these earlier-stage businesses becoming less afraid of going public sooner, and we could see a change in capital markets momentum in favor of long-term growth and R&D.
This could also shorten the feedback loop of venture capital investments and drive more capital to invest in early-stage companies way before the IPO. Nevertheless, investors must always weigh the risks and determine how a SPAC fits into their overall portfolio strategy.
