Once considered an eleventh hour way to raise and invest capital, blank-check companies are growing in popularity among private equity firms wanting to differentiate their product offerings and make the most of their deal pipelines.
The launch of these companies, also known as special purpose acquisition companies, or SPACs, has grown exponentially in 2020. In the third quarter, SPAC IPOs accounted for 56.3% of normal IPOs in the U.S., the highest quarterly margin across the past two years, up from 26% in the same period in 2019.
Apollo Global Management Inc., TPG Capital LP, CC Capital Management LLC and Neuberger Berman Investment Advisers LLC, and The Gores Group LLC are among the alternative asset managers to have priced blank-check companies this year.
SPACs raise capital through IPOs before searching for an acquisition target. They typically have about 24 months to identify and make an acquisition. If they fail to sign a deal or gain an extension, the company dissolves and returns funds to investors.
Viewed as financing vehicles of the last resort 10 to 15 years ago, the use of these vehicles by private equity firms now is a "self-fulfilling prophecy," Jeremy Swan, the national director of professional services firm CohnReznick LLP's financial sponsors and financial services industry practice said.
"When you get these big names either coming out of big private equity firms or you get the big private equity firms backing the SPACs, it just lends them further validation and has more people thinking about it," he said.
Many private equity firms have sought to diversify their strategies and product offerings beyond traditional buyout funds in recent years, and SPACs offer another path to snap up assets that may not comfortably fit within certain vehicles or limited partner requirements.
They can also offer faster exit horizons. After completing a reverse merger, a sponsor can begin to exit in as little as half a year compared with three to five years for traditional private equity vehicles. "In most cases, it ends up being closer to a year in the sense that they have a lockup period but if that company performs and the stock performs, they can get out of that lockup period much sooner," Swan said.
Sponsors typically received a promotion of 20% of the post-IPO equity model, co-chair of law firm Winston & Strawn LLP's capital markets practice Carol Anne Huff said in an interview. There is pressure on SPAC sponsor economics in the current environment, but SPAC sponsors, including private equity firms, continue to find the economics very attractive.
As markets face headwinds amid the COVID-19 pandemic, SPACs can offer a degree of certainty to those looking to go public.
Target companies are, for all practical purposes, able to lock in a valuation through a SPAC merger, Huff said. "More and more of these deals are being backed with voting agreements, PIPEs [private investment in public equity] and forward purchase agreements, so both the vote and the cash are locked up," she said. "In a traditional IPO, you're more dependent upon trying to time the market. You're not assured of what that valuation will be."
Lockdowns have ruled out in-person meetings, making it "very difficult" to carry out an IPO roadshow, Swan said. "From a SPAC perspective, the roadshow doesn't happen. The financial backers are there, they're launching the process, you have the typical institutional buyers, you have the opportunity for co-investment alongside, and it provides a faster time to market, maybe more certain valuation, and potentially greater liquidity in a shorter period of time."
Longevity of the trend
Advisers to both SPACs and target companies expect their popularity to continue, with the caveat from some that their popularity in recent months is reliant on equity markets holding their high valuations and ongoing economic uncertainty.
A number of permanent capital vehicles that were not common place 20 years ago, like business development companies and commercial mortgage real estate investment trusts, are now part of the current asset under management strategies of a number of private equity firms, Jeff Mortara, head of equity capital markets origination at UBS Group AG said.
Some private equity firms see merit in launching SPACs as part of an expanded assets under management strategy and capability, Mortara added. "This is the year that SPACS get institutionalized."
Demand from non-traditional SPAC investors has in part driven the rise in their number, Huff said. There has been more interest from long-only investors: sector investors who are buying SPAC shares at the IPO stage with the goal of owning the ultimate target company. Continued interest from these investors is key to it becoming a long-term trend. "Traditional SPAC investors will only be able to satisfy so much of the demand for new SPACs."
Increased SPAC activity always coincides with heated markets, Swan said. It's a market opportunity that takes advantage of very active public markets, with strong valuations. "As soon as that starts to fall away, the attractiveness of SPACs will also fall away," he said.
SPAC interest currently "is a little bit different" compared with previous peaks in that there has been such a growth in activity, but if public market valuations drop significantly, the SPAC opportunity "doesn't make as much sense."
An increasing number of large private equity firms will launch SPACs so long as the market is open to them, he said, but added: "I think there should be some caution that the SPAC opportunity is not for everyone, and it's not the right fit for every private equity firm. Anybody who's out there saying, 'this is the next-generation of private equity fundraising' — for some businesses, yes. For others, it won't be."