In October 2019, former Facebook executive, and current CEO of Social Capital, Chamath Palihapitiya announced that his Special Purpose Acquisition Company (SPAC) was acquiring Virgin Galactic. The deal – a “reverse merger” – involved Palihapitiya’s publicly traded corporate entity acquiring Virgin Galactic in order to take it public. On the floor of the New York Stock Exchange (NYSE) Palihapitiya declared: “these kinds of transactions and processes are the future. A lot of that traditional oligopoly and monopoly run by Goldman [Sachs] and Morgan [Stanley], those days are numbered.”
With that proclamation Palihapitiya was predicting the decline of the traditional Initial Public Offering (IPO), which is historically the most common way for a private company to raise capital while achieving liquidity through the public markets. Since then, SPACs have become increasingly common vehicles used to take companies public. In 2020 over $36 billion was raised via SPAC, which is more than double the previous record set in 2019. Further, almost half of the public listings in 2020 have been SPACs. It appears these previously obscure investment vehicles are here to stay.
Generally, this is how SPACs work: a SPAC sponsor raises money in the IPO process and uses that capital to search for a private company to acquire and take public. The Wall Street Journal referred to SPACs as “big pools of cash, listed on an exchange, whose sole purpose is to do an acquisition.” That is why SPACs are often called “blank check companies.” Palihapitiya originally raised $600 million in 2017 for the SPAC that ultimately acquired Virgin Galactic in 2019.
SPACs offer several advantages over traditional IPOs, which involve hiring investment banks that spend months raising capital from institutional investors. Alternatively, SPACs provide a quicker and simpler route. According to Bloomberg Law, “the appeal of SPACs lies in their combination of the benefits of an IPO and the flexibility of M&A, all at a reduced cost and in a faster timeframe.” Amid recent volatility and uncertainty, this option has been particularly appealing for many companies.
Palihapitiya isn’t the first investor to seek out alternatives to the traditional IPO process. Benchmark Partner Bill Gurley, one of the best known venture capitalists in Silicon Valley, has called for early stage companies to look for new paths to the public market. “In the past three years it’s gotten worse and I think that’s because the IPO process has devolved,” said Gurley on CNBC in 2019.
Jay Ritter, a professor at the University of Florida, published a paper that Gurley frequently cites. Ritter found that investment banks have “less focus on maximizing IPO proceeds due to an increased emphasis on research coverage.” Ritter also claims that “allocations of hot IPOs to the personal brokerage accounts of issuing firm executives created an incentive to seek rather than avoid underwriters with a reputation of severe underpricing.” In other words, the traditional IPO contains an array of conflicts of interest. As a result, investment banks have often mispriced companies to the benefit of underwriters and to the detriment of the issuers’ long-term shareholders.
In addition to SPACs, companies are also going public via direct listings. Direct listings cut out the middlemen involved in a traditional IPO. They also don’t involve raising capital. In a blog post earlier this year, Gurley wrote that direct listings are “much simpler than a traditional IPO. You just remove the two steps where the shares are intentionally underpriced and then given to the investment bank’s best clients … then you jump straight to the market-based match.” Many prominent companies are choosing direct listings over IPOs, a trend that began with Spotify’s direct listing in 2018. This September the data-mining company Palantir completed a direct listing on the NYSE.
For the first time in decades the traditional IPO has serious competition. There is no longer only one path to the public markets. While the traditional IPO won’t go away overnight, the rise of SPACs and direct listings is creating a new landscape in the capital markets.