SPAC – Complimenting the VC Universe

SPAC IPO wave seems to be unstoppable. IPOs of blank check companies have surged from 28% of total IPOs in 2019 to 55% in 2020, and 76% in 2021 YTD, per SPAC Analytics data. Funds raised have matched the deal count. Gross proceeds rose steeply from 19% in 2019 to 46% in 2020 and 64% in 2021 till date. While SPACs as a way to public markets have a number of undeniable merits, however, the underlying motive is a wild rush of a wide investor group including PEs, hedge funds, and an increasing number of VCs to benefit from the lucrative low-risk high reward inherent to SPAC sponsorship construct.  

In addition to an intriguing interplay of factors including (1) speed to market, (2) widening gap between the public-private valuation, (3) exits based on future projections, (3) and younger and riskier firms going public amid seemingly unbridled retail investor enthusiasm, the SPAC’s sponsor economies is motivating institutional investors of all kinds to come out with their own SPACs.

Low-Risk High Returns

As per the current SPAC arrangement, while a SPAC’s sponsor is required to furnish a mere 2-3% of the IPO value as risk capital, he disproportionately gets up to 20% of target equity in return. For instance, Tusk Ventures provided $8 million as risk capital for its $300 million gaming-focused SPAC. Similarly, Chamath Palihapitiya’s Social Capital, which acquired Richard Branson’s Virgin Galactic and triggered the SPAC wave, invested $10 million in risk capital. This turned into an almost $200 million stake in Virgin Galactic.

“A SPAC manager doesn’t need to put up a lot of capital to turn it into something very valuable.” David York, MD, Top Tier Capital Partners.

Moreover, while sponsors can mint average returns of 10x on investment, as per a Feb 2021 JPMorgan’s study, the risk of losing the small risk capital invested is extremely low. In case of no merger and resultant SPAC liquidation, the sponsors don’t get the risk capital back. This amounts to visible lower risks given that for a typical VC firm there is a high risk of 35% of all venture deals turning to zero.

As an exception, Bill Ackman’s Pershing Square Tontine Holdings forego its 20% sponsor promote and paid $67.8 million for warrants to acquire 6.21% of the company. This is in sharp contrast to usual SPAC deals such as those executed by Goldman Sachs and Third Point Management.

Figure 1: High Returns with Low Risk Capital and Negligible Risk for SPAC Sponsors

Source: CNBC

Vertical Integrated VCs – Dawn of New Era

SPAC sponsors have netted outsized returns between Jan 2019 to Jan 22, 2021, per JPMorgan data. While SPACs have always been popular with PE firms as a way of taking their portfolio companies public, VC firms are rapidly adapting to integrating SPAC exits into the VC funding lifecycle. Accordingly, a swath of marquee VCs including SoftBank, Altimeter Growth, Foundry Group, General Catalyst, Fifth Wall, and Khosla Ventures are sponsoring SPACs.

Figure 2: Return Analysis for Investors in IPOed or Liquidated SPACs

Source: JPMorgan

Moreover, increasingly VCs such as G Squared are realizing that being SPAC sponsors can also enable them to better control the exit timing of their portfolio companies, positioning them to gain from any upside in the target’s stock, in addition to the returns from sponsors promote.

“If other people are ‘SPAC-ing’ my companies, then I should do it myself and get the sponsor upside.”—Amy Wu, Partner Lightspeed Venture Partners

While SEC doesn’t allow a SPAC to be formed for a predetermined target due to the obvious conflict of interest, as long as VCs are can show that no prior substantive discussions were held, they can take their portfolio companies public at a time of their choosing. While shortening the time to exit a VC firm could ensure better returns and increased liquidity. 

“If we are a trusted partner to these companies while they are private, it’s logical that we could be a preferred partner to them as they access the public markets,” —Larry Aschebrook, Managing Partner, G Squared.

Furthermore, VCs are also using SPACs to shorten the time from raising funds to liquidating their investment. VCs time to raise funds comes down drastically with SPACs shorter route to the public market compared to the traditional funding to IPO/DL exit process. For instance, it took Bradley Tusk, CEO and co-founder of Tusk Ventures, three months to raise $300 million for his SPAC compared to roughly two years to raise his first $37 million.

Some LPs are understandably wary of the VCs SPACing their portfolio companies. However, others take it as an additional arrow in the quiver.  Against this backdrop, many VCs are increasingly raising SPACs as part of their respective venture funds and allowing LPs to benefit from potentially higher returns and increased liquidity. 

“We wanted to make sure that we were aligned with our LPs. From our LPs’ perspective, a SPAC should be a significant enhancement to the outcome and not a drain.”—Larry Aschebrook, Managing Partner, G Squared.

SPAC – Fast Tracking VC Exits in Clean Tech

With ESG investments gaining traction and President Biden’s focus on boosting cleantech – including $174 billion spendings to boost the EV market – SPACs could enable VCs to increase investment flow into the cleantech sector.

Due to the capital-intensive nature and longer time to market for cleantech companies – companies into EVs, renewables, energy storage, and nuclear power – often find it hard to raise early-stage capital. For VCs, investment into cleantech has brought on average -15% IRR since 2000, as per Cambridge Associates data as of Jan 2021. However, in 2020 $4 billion flowed into the cleantech sector via the SPAC route. Looking ahead, with 43 active SPACs looking to or in the process of finalizing merger targets in the cleantech space, the VC investment is expected to surge in the sector.