Going public is a significant milestone for a company, allowing it access to a broader pool of capital and offering the prestige of being listed on a stock exchange.
Traditionally, businesses have pursued this goal through an IPO, a process that, while effective, can be time-consuming and capital-intensive. In recent years, an alternative path has emerged in the form of SPACs.
But are SPACs a good option? In this blog, we'll examine both SPACs and IPOs in detail, highlighting the differences between the two so you can navigate the public sphere with confidence.
IPOs
Since an IPO is the traditional way for a company to go public, let’s start here and explore its definition, pros and cons, and regulatory environment.
What Is an IPO?
An Initial Public Offering (IPO) marks the first time a private company's shares are offered to the public, transitioning the company from private to public ownership. This process is known as "going public” — a major goal for many companies.
Both startups and established companies use IPOs to raise funds for various purposes, such as financing growth, paying off debt, increasing their public profile and enabling insiders to diversify their holdings.
The process benefits existing private investors by potentially offering a premium on their shares, while also opening the door for public investors to participate in the company's growth.
How Long Have IPOs Existed?
The history of IPOs dates back several centuries, with the first instance occurring in the early 1600s when the Dutch East India Company offered shares to the public in the Netherlands.
In the United States, the concept of public trading is nearly as old as the nation itself. The origins of American IPOs can be traced to 1792, with early examples including the Bank of New York and the First Bank of the United States. 2
What Are the Pros and Cons of IPOs?
While IPOs have evolved over time, their core advantages and disadvantages remain consistent:
Pros:
- Capital Gains: Going public generally provides a company with its largest capital infusion, significantly impacting its growth trajectory. In terms of scale, nothing else compares.
- Recognition & Credibility: Publicly listed companies often enjoy greater visibility than private ones, attracting media attention and enhancing their market presence.
- More Flexibility: IPOs can reduce the cost of capital, making it easier for companies, especially younger ones, to secure additional funding at more favorable terms.
Cons:
- Associated Costs: IPOs can be extremely costly, with substantial legal, accounting and marketing expenses, along with fees for underwriters and advisors.
- Pressure From Investors: Public companies face intense pressure to maintain high stock values, which can sometimes force short-term decisions at the expense of long-term strategy.
- Loss of Control: Founders may lose control of a public company, as it is governed by a board of directors accountable to shareholders, who can make major decisions and even remove CEOs.
Who Regulates IPOs in Key Markets?
Regulatory bodies ensure the integrity of IPO processes across different countries:
- United States: The Securities and Exchange Commission (SEC) serves as the primary regulator for securities markets, reviewing company registration statements for IPOs.
- United Kingdom: The London Stock Exchange (LSE) operates under the oversight of the Financial Conduct Authority (FCA), ensuring compliance with market rules.
- Germany: The Federal Financial Supervisory Authority (BaFin) is responsible for approving IPO prospectuses for publication.
- France: The Autorité des marchés financiers (AMF) oversees IPOs, safeguarding investors and ensuring market transparency.
SPACs
In recent years, SPACs have emerged as an alternative route to the public markets. But are they too good to be true? Let’s take a look.
What Is a SPAC?
A Special Purpose Acquisition Company (SPAC), often known as a "blank check company," is a corporation created solely to raise capital through an IPO for the purpose of acquiring or merging with an existing business.
In simpler terms, a SPAC is like an empty vessel that goes public to raise funds, which it then uses to buy a private company, thereby taking it public indirectly.
SPACs surged in popularity in recent years, especially in the US, where 295 SPACs were formed in just the first quarter of 2021, up from 59 in all of 2019. 3 However, this trend has recently slowed, prompting a closer examination of their pros and cons.
Advantages and Drawbacks for the Company
Let's first examine the pros and cons that SPAC mergers present for target companies.
Pros:
- Faster Funding: SPAC mergers typically complete in 3–6 months, compared to the 12–18 months often required for an IPO.
- Premium Sale: Target companies may negotiate a premium sale price with a SPAC due to the limited time window for striking a deal.
- Price Certainty: The acquisition price in a SPAC merger is predetermined in the merger agreement, offering more certainty than the fluctuating price range of an IPO.
Cons
- Poor Returns: Despite enticing initial promises, the vast majority of SPACs have underperformed in recent years, leading to significant investor losses (more on that later).
- Capital Shortfall: If more public shareholders redeem their shares than anticipated, sponsors may need to seek additional financing to cover the shortfall.
- Compressed Timeline: The target company often bears the burden of preparing financials in a tight timeframe, which can lead to less thorough due diligence, restatements, misvaluations or legal issues.
SPACs: What Investors Need to Know
Now, let's shift our focus to the investor perspective, where the numbers paint a less-than-rosy picture.
A study by Goldman Sachs in September 2021 revealed that, while 172 SPACs that closed deals since 2020 initially outperformed the Russell 3000 index up to the deal announcement, their median performance lagged by 42 percentage points six months post-deal. By the end of 2021, around 70% of SPACs launched that year were trading below their $10 offer price. 4
Further analysis by J.P. Morgan showed that of the 431 SPACs completing mergers between 2020 and 2021, 90% had negative net returns, underperforming the S&P small-cap growth index significantly. SPACs that went public in 2020 fared the worst, with a median loss to investors exceeding 80%. 7
In summary, SPACs proved to be poor investments in 2021 and 2022, with the trend continuing into 2023. Unless there are substantial changes, SPACs are unlikely to be a wise investment choice for 2024 and beyond.
Final Thoughts: Weighing SPACs Against IPOs
Whether a company goes public via SPAC or IPO, the importance of regulatory oversight cannot be overstated. It ensures transparency, compliance and fairness in capital markets, safeguarding investor interests.
While IPOs may require more time and capital, the traditional route often proves to be the best. With numerous SPACs failing to find targets in 2023, and with investors facing disappointing returns, the SPAC bubble appears to have definitively burst.
References
[1] https://www.techtarget.com/whatis/definition/initial-public-offering-IPO
[2] https://www.moaf.org/exhibits/americas_first_ipo
[3] https://hbr.org/2021/07/spacs-what-you-need-to-know
[4] https://fortune.com/2021/09/16/spac-returns-ipos-goldman-sachs/
[5] https://www.investopedia.com/terms/s/spac.asp
[6] https://mergersandinquisitions.com/great-spac-scam/
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