Long shunned in Silicon Valley, SPACs are becoming mainstream in technology

Roger Lee of Battery Ventures says “SPAC” used to be a “bad four-letter word” in Silicon Valley.

According to Jeff Crowe of Norwest Venture Partners, the board of every high-profile start-up discusses special purpose companies as a legitimate way to go public.

In the eyes of Peter Hebert, co-founder of Lux Capital, SPACs are “stealing from the 2021 IPO calendar”.

“We’ve encouraged our highest quality companies to seriously consider this,” said Hebert, whose company founded its own health-tech SPAC in October and is looking for a target. “The vast majority of companies looking to make traditional public offerings are dual tracking SPACs.”

Within Lux’s portfolio, 3D printing company Desktop Metal went public via a SPAC in December. Others, such as real estate software companies Latch and Matterport, have announced deals this year with so-called blank check companies.

The sudden burst of SPACs reminds some of the dotcom bubble in the late 1990s. Pre-revenue companies with distant goals go public with astronomical valuations, and famous athletes and other celebrities get into the mix. Name the acronym for a well-known start-up CEO and you will likely hear about the non-stop phone calls they receive from sponsors with hundreds of millions of dollars to spend.

To Wall Street skeptics, it seems like the financial industry’s latest plan to make money off of speculators in a low-interest-rate environment with a spike in the market and investors hungry for all things technology. According to SPACInsider, SPACs have raised more than $ 44 billion for 144 deals so far this year. That equates to more than half of the money raised in all of 2020, which itself was a record year.

While there is undeniable mania in the SPAC boom, another story is playing in parallel. Enterprise-backed technology companies with high growth prospects shun the IPO process, which has its own flaws. Instead, they are starting to feel comfortable with the idea of ​​entering the market in a way that would have been unfathomable a year ago.

In a SPAC, a group of investors collects money for a shell company with no underlying business. The SPAC goes public, usually for $ 10 a share, and then begins to look for a company to acquire. When it finds a target and a deal is struck, the SPAC and the company attract outside investors for what is called a PIPE, or private investment in public assets.

The PIPE money goes into the target company’s balance sheet in exchange for a large share of equity. The SPAC investors will receive shares in the acquired company, which becomes the publicly traded entity through what is known as the de-SPAC.

A big advantage: SPACs allow companies to provide forward-looking projections, which companies typically do not do in IPO prospectuses due to liability risk.

“An IPO is what I would call backwards,” said Betsy Cohen, who led an SPAC that recently disclosed auto insurer Metromile. “Because a SPAC is technically a merger, you have to tell investors what the merged companies will look like after the merger and the project ahead.”

It is also a much faster process than the IPO, which requires you to spend many months with bankers and lawyers drafting a prospectus, educating the market, conducting a roadshow and compiling a book of institutional investors .

Many of the more famous SPAC targets have hitherto been at the intersection of technical and financial services. For these companies, cash burn rates are high and real GAAP gains often won’t come for years, even under the best of circumstances.

Metromile, whose technology allows drivers to pay by the mile instead of a monthly fee, began trading Wednesday following a merger with INSU Acquisition Corp. II, a SPAC led by Cohen and her son Daniel. Chamath Palihapitiya, the venture capitalist turned mega SPAC sponsor, and billionaire Marc Cuban invested in a $ 160 million PIPE.

As of Friday’s close, the stock traded at $ 17.23, giving Metromile a valuation of more than $ 2 billion based on the fully diluted number of shares.

“Metromile is entering the insurance market at a time when telematics is being installed in virtually every car, so there is the opportunity to look at insurance on an individualized, tailor-made basis, which is huge,” Cohen said in an interview. “We felt it was an important company to take to public markets and give them access to capital like insurance companies do.”

Cohen, who founded The Bancorp, said she will have closed seven SPACs later this year, including payment company Payoneer and boutique investment bank Perella Weinberg.

Metromile CEO Dan Preston told CNBC this week that around mid-2020, while his board was evaluating funding options, he expected to raise a big round of private capital and then go public in four to six quarters. The company had been around for a decade and raised hundreds of millions of dollars in funding.

Other underwriting companies such as Lemonade and Root held traditional IPOs last year. But Preston says the more he learned about SPACs, the more he realized that it was the better approach for his business, which had to do with the high costs of operating in the heavily regulated insurance industry. – and a pandemic that reduced the number of kilometers driven.

“The sweet spot is companies that are quite close to the stock market, but need a little more historical data to prepare,” Preston said.

Metromile said in its merger statement that it expects insurance revenues to increase 39% to $ 142.1 million in 2021, then increase 81% in 2022 and more than 100% in 2023. Adjusted gross profit will increase from $ 11. 1 million last year to $ 144 million by 2023, the filing says.

Online lender SoFi said in January that it went public through a Palihapitiya-run SPAC in a deal valuing the company at $ 8.65 billion. In the merger agreement, SoFi expects annual revenues of $ 980 million this year, increasing to $ 3.7 billion annually by 2025, while contribution gains over that trajectory will more than quintuple to $ 1.5 billion.

In other financial SPACs, Palihapitiya led the reverse merger of digital real estate company Opendoor, which went public last year and is now worth more than $ 20 billion. He did the same with health insurance company Clover Health (which said this month it is under investigation by the SEC) and leads the PIPE for solar finance company Sunlight Financial.

He also does software deals. In January, Palihapitiya was a PIPE investor in Latch, a developer of smart locking systems sold to real estate companies. Latch is generating recurring software sales and said its revenue booked in 2020 was up 49% from the previous year to $ 167 million.

Blackrock, Fidelity and Wellington are also part of the PIPE which means they will be shareholders when Latch goes public. Those names, considered leading investors in the public market, are starting to hit the SPACs, at least one of which is showing up in the PIPE for SoFi, Matterport, Opendoor and the consumer genetics company 23andMe.

For companies that can attract investors of that caliber and have sponsors they trust to keep up with the ups and downs of the journey, an SPAC can be the most efficient way to raise money. Large private rounds typically require a hefty dilution, while IPOs often provide a 50% to 100% discount for new investors.

In a SPAC, the target ultimately gives up to 20% of the shares to the sponsors and additional shares to PIPE investors. The rest remains mainly with insiders. When the company is public, it can raise follow-on capital at market rates. For example, Opendoor has just announced it will raise $ 770 million at $ 27 a share, representing a value increase of approximately 200% from the time of the investment in PIPE.

Norwest’s Crowe, whose company was a venture investor in Opendoor and online therapy provider Talkspace, another SPAC target, said the pricing is favorable for the best companies because so many SPACs are after them.

“The price is crazy,” Crowe said. “There is a huge pent-up demand for all these companies. Many companies that would have gone public in a relatively even manner in 2021 and ’22, if the markets held up, are now all going wild.”

Venture investors are also stepping in. In addition to Lux, companies such as FirstMark Capital, Ribbit Capital, Khosla Ventures and SoftBank have established their own SPACs. Separately from their firms, venture capitalists have followed Steve Case, Reid Hoffman and Bradley Tusk Palihapitiya to the SPAC sponsor arena.

Growth-phase company G Squared this week announced the closure of a $ 345 million SPAC. Founder Larry Aschebrook called it “just another tool in our toolbox” in an interview to help companies access capital. He said it could be a good option for a CEO who is ready to run a publicly traded company and a company that has raised a lot of money in the past and can benefit from easy access to the capital markets.

“There are only a handful that we think are super high quality companies,” Aschebrook said of the technical SPAC deals already announced. “Companies we are interested in are either faltering in profitability or profitable and are logos that everyone knows.”

Although Lee of Battery’s no longer considers SPACs to be equivalent to a curse word, he said none has yet come out of his firm’s portfolio. However, Battery is an investor in Coinbase, which is being disclosed via direct listing, following on from Slack, Spotify and Palantir by allowing existing stakeholders to sell in the debut rather than issue new shares as a company.

Lee said he would not be at all surprised to see an SPAC from one or more of his companies this year, acknowledging that it has become a third viable mechanism to go public.

“Direct listing was the first thing new to the capital markets in 50 years – and the rebranding of SPACs is the second,” said Lee. “Ultimately, you’re still a public company and you have to be able to endure rigor and scrutiny.”

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