Could IPOs be replaced by blank check acquisitions (SPAC)? | Hacker News Reader

Could IPOs be replaced by blank check acquisitions (SPAC)?

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77 pointskaboro65 comments

As someone that's raised money for SPACs, been an advisor to SPACs and sold companies to SPACs, the answer is a resounding no. Most VC-backed companies, whether in tech or biotech, don't need the strategic shift that's core to a SPAC thesis. You usually get bought by a SPAC when you need new management to come in and kill darlings for long-term health, not as an option to go public.

The folks that think it's a method to avoid day-one price pops are mostly incorrect. Price pops are intentional as selling 10% of your company at a discount fills up the IPO book much faster and causes 10x+ oversubscriptions. This signals strong demand to the majority of very large asset allocators who come in post-IPO. Those investors psychologically overvalue day-one pops years into the stock's public lifetime. I've had conversations with heads of tech investing at many $100bn+ funds who mention day-one pops when they enter a stock 5 years post-IPO. Doing the math, strong market confidence in your company pays dividends when you're selling the other 90%.

The underpricing pop disappears faster than a fart in the wind. Underpricing in IPOs is direct theft of value from shareholders and employees to investment banks and their clients, and provides zero value for the company.

Why does it persist?

I can think of three non-exclusive possibilities:

* Market power of banks

* Corruption of the stock-compensated managers who benefit from the pop

* Genuine or perceived benefit to the company in further price raising. (Mentioned above)

There's an (also non-exclusive) argument that it's a fair price for the risk that IPO buyers are taking. IPOs do "fail" sometimes, so the pop isn't as great a risk-adjusted return as it looks.

Sorry, this is ludicrous. No analyst is basing their investment view on the 1 day post-IPO movements. Maybe a few months in, as an ancedote about market sentiment, but 5 years in the stock is traded totally differently, by different holders in a basically a different world. When funds make investment decisions we collate a whole bunch of random facts, some relevant, some just general interest. 1 day returns off the IPO can be filed under general interest, just like the gossip magazine articles written about the founders. At best it's attached to the fame of the stock, not the other way around - Facebook's pop is memorable not because of the pop but because of the stock.

Maybe because you're from the sell side you're hearing what you want to, it often puzzles me some of the views that you guys have on the market, the role you have just doesn't actually matter that much to the market. A stock is a business, not an investment banking product. The investment banking actions over the life of the business are out-sized, but they also quickly fade to be indiscernible - Facebook would still be the same company today and worth the same amount today even if it was backdoor listed on the pink sheets at first.

> The folks that think it's a method to avoid day-one price pops are mostly incorrect. Price pops are intentional as selling 10% of your company at a discount fills up the IPO book much faster and causes 10x+ oversubscriptions.

Just because it's intentional doesn't mean companies can't still try to avoid it though, right? I'm still pretty uncertain in my knowledge around this, but isn't this actually still a good reason for a company to seek a SPAC deal?

No. The "pop" is part of the cost of the IPO, but SPACs are more expensive than an IPO.

If your thinking is "IPOs are good, but too expensive; what if there's a big pop I miss out on?", then you would never want to consider a SPAC. If your thinking is "IPOs are good and the pop is fine, but there's too much risk of the deal falling apart", then you might consider a SPAC instead.

But that second part is what’s key these days, right? Reducing uncertainty seems big — as I understand it, with an IPO you don’t know exactly how much money you’ll raise until the literal end of day 1, whereas with a SPAC, the specific dollar amount your company raises is worked out through negotiation well in advance of “going public”.

Thank you for the clarification on that first part, though.

I might be totally misunderstanding the IPO process, but as the company, I sell, say, 100 shares at $10 at 9:00 AM Eastern of the first day. At the end of the trading day at 5:00 pm Eastern, for my balance sheet, it doesn't matter what the share price is, up or down; I've made $1,000 from that initial sale. There are follow-on effects to the company when more shares some time later, but the amount my hypothetical IPO raised is limited to the $1,000 at the start of the day.

Other places on this thread, there are references to "filling up the IPO book," which is referencing the fact that you can offer 100 shares, but you don't know that all of them will sell, or that all of them will sell for the price you offer them at. That's part of the reason they're often underpriced -- to ensure they all sell.

OOC: I'm not familiar with SPACs and reorgs/realigns. I have experience with PE in acquisitions within professional sales. But do you have any insight into how these work top-down with leadership vs. IPO/PE acquisitions? Is there much difference in the usual 2 EOQ expectation for turnaround results?

hi, can I ask, how would I go about learning about all these different financing methods / vehicles if I wanted to read about it by myself? And say for some reason I wanted to do an IPO/finance through a SPAC or something myself, where would I start and what would I need (assuming I don't want to hire some investment bank for me).

I used to work as a trader at an investment bank and I've always been curious about the corporate finance side of the business. I have a friend who worked in corp finance at a boutique IB and struck out by himself. He eventually ended up running his own boutique bank in China and deals almost exclusively with SPAC's by helping his Chinese clients list on Nasdaq or whatever. I was always curious how he did it and what one needs to do if he wanted to follow a similar path

At least the way I understand it, SPACs offer a trade off, not an upgrade.

The danger of an IPO (from the perspective of the company going public) is the “IPO Pop”: you offer your stock at $20, by the end of the first day it’s trading at $40, and you realize you left a bunch of money on the table.

This is a benefit to the initial investors, who make a big profit day 1.

The inverse risk is the opposite (see Lyft, Slack IPOs): you offer your stock at $20 and it ends the day trading at $10. This sounds bad for you, the company, but it’s kind of fine — you raised the money you wanted to raise. In the short term, it’s bad for your investors, who just lost a big chunk of change.

My numbers here are made up, but the important thing is the spread: an IPO could pop 5% on first day, or 100%, or -80%. The difference there is volatility, which is what you have to pay a bank for — the risk that they lose money instead of popping.

In times of increased volatility (hello 2020!), you’re gonna have to pay a lot. The bank is going to underprice your stock to try and get a bigger “pop”, which, remember, means you’re probably leaving some money on the table.

A SPAC offers a compromise. “Negotiate with us instead, and avoid the pop (or the drop) entirely!” You reduce volatility in exchange for taking a private deal and potentially leaving some money on the table. It’s trading a bigger payday for a smaller risk, which looks pretty good right now. But in times of more financial normalcy, expect more IPOs.

My understanding of SPACs vs. IPOs is based entirely on Matt Levine’s excellent Money Stuff column, btw — go check that out if you want to read stuff from someone who actually knows this stuff.

The pop of an IPO is by design though. Bankers engineer the opening price lower than market so they can sell the stock pre-IPO to their rich clients and guarantee a quick return for them.

The games bankers like Goldman play with IPO pricing only benefit the bankers. The whole thing is bullshit, which is why more tech companies are looking for ways to cut bankers out of the process.

> The whole thing is bullshit, which is why more tech companies are looking for ways to cut bankers out of the process.

Google IPOed with a dutch auction. I have absolutely no idea why other companies trying to "cut bankers out of the process" don't follow suit.

> Google IPOed with a dutch auction. I have absolutely no idea why other companies trying to "cut bankers out of the process" don't follow suit.

It didn't seem to save them any money. The bids they got all clustered tightly together, the advisory fees they ended up paying were pretty much the same. And economic theory suggests that a Dutch auction gets you worse prices than a conventional auction. All told it didn't go particularly well for Google.

I think it's more likely we'll see more companies doing Spotify/Slack-style direct listings (covid notwithstanding) - those seem to have worked out well enough, and have the potential to cut a bunch of fees out of the process.

Investment Bankers are performing a service for companies that IPO. For this service they get paid. One of the ways that they get paid is buy allocating IPO shares to favored clients. If you change the system so that they cannot get paid this way, then they will end up getting paid another way: higher fees.

Is that worth the tradeoff? Maybe. But it's very unlikely that there is a free lunch to be had here.

> Investment Bankers are performing a service for companies that IPO.

Sure. But that service is largely marketing. They do a roadshow and talk up your company to everyone who will listen.

That's certainly a valuable service. I'm sure it's even worth it to many companies.

I don't really see how it's that useful for well known B2C companies (e.g. Facebook and Tesla).

private investors may know these famous companies like Tesla, but they may not know the details of their business operations. The investment bankers create a prospectus which describes the "story" of how these companies plan to make money, present financials in a way that is understandable (albeit likely an optimistic way), and then sell the investment as an opportunity.

For doing this work, the bankers do get paid handsomely. Whether this work results in a better investment price for said company remains to be determined tbh, but on the whole, i suspect it must be net positive, otherwise this method of IPO won't have continued for a century.

>"The investment bankers create a prospectus which describes the "story" of how these companies plan to make money, present financials in a way that is understandable (albeit likely an optimistic way), and then sell the investment as an opportunity."

How different are these prospectus from the reports that the companies already provide to their investors and boards though? I guess I'm asking isn't that "story" already written for them?

Right, designed by the banks who underwrite the IPO -- not necessarily designed by the companies themselves, hence why a SPAC can look (to those companies) like the better option.

The whole sort-of-conflict-of-interest inherent in IPOs has been fascinating for me to learn about.

I believe SPAC targets might also have lower regulatory burdens not entirely sure.

Oooo, that's interesting. I can imagine that's particularly an incentive for startups without robust legal teams.

I always imagined that companies that have their stock price "pop" after IPO would've been better off doing a DPO instead (like Spotify) since they would've gotten more money.

They're engineering it to pop on purpose to play into investor psychology. Getting the IPO oversubscribed and getting headlines about first day performance is a great way to get people to keep talking about and investing in your company.

Not after the stories about how first day buyers got hosed when the stock is flat or down over the next few months.

Matt Levine has been writing about this trend lately:

* https://www.bloomberg.com/news/newsletters/2020-06-23/money-...

* https://www.bloomberg.com/opinion/articles/2020-07-14/everyo...

The gist is that an SPAC is less risky than an IPO for the company (you only have to negotiate with a single entity, and odds of an agreement falling through are much lower) but in return you're going to have to compensate the SPAC for taking on that risk by lowering the price.

That tradeoff is more appealing in uncertain times than in good times.

For those wondering what the heck a SPAC is, this seems to be what it's about: https://en.wikipedia.org/wiki/Special-purpose_acquisition_co...

> A special purpose acquisition company (SPAC), sometimes called blank-check company, is a shell company that has no operations but plans to go public with the intention of acquiring or merging with a company with the proceeds of the SPAC's initial public offering (IPO).

I'm still not entirely clear what the implications are.

It seems like the gist of it is that taking a startup public is a pain in the ass on account of regulatory complexity, so you just create a shell company with a charter that says that if it goes public with enough money it will buy your startup in a private transaction. Then you IPO your shell company, which is easy because it has no operations. If it raises enough money you sell your startup to it, and if not you return the money to the shareholders.

Sounds like another financial innovation to avoid transparency.

It gets even worse when you talk about reverse mergers. For example the way some chinese companies have become listed in the US is just buying out a penny stock company and listing through that.

> Sounds like another financial innovation to avoid transparency.

I guess it depends on whether you think the financial regulations around IPOs are mostly needless friction or necessary for the public good.

The to-be-acquired (aka to-be-brought-public) company only has to negotiate with a single counter-party -- the SPAC -- so it's less likely the deal will fall through. However, the SPAC is taking on more risk -- they are putting literally all of their money into the acquisition in order to effectively become the acquired company -- so the acquired company will probably have to accept a lower price. Would it be higher than the artificially deflated price in an IPO? Maybe, maybe not. In COVID times, maybe it would be higher. Even if it isn't, the risk of an IPO falling through right now is much higher than usual, so a company wanting to go public might be willing to raise less money in exchange for a higher likelihood of the deal working out.

As someone who knows nothing about stocks: why aren't they just auctioned off?

Start by selling the highest bidder the amount of stock they bid for, then continue with the next-highest bidder until the supply is depleted. Wouldn't that guarantee the best value for the company?

That's more or less how a direct listing works. Historically direct listings have been rare, but recently Spotify and Slack have successfully done it.

The main downsides (aside from it just being unusual and therefore a bit risky) is that for regulatory reasons the company can't sell new shares this way, so it's just a means to go public and doesn't raise any money.

However, once the company is public (and has an established price) nothing is stopping them from doing a secondary offering.

> is that for regulatory reasons the company can't sell new shares this way, so it's just a means to go public and doesn't raise any money.

Doesn't the company own shares? I've always assumed that when I get paid stock options or RSUs, they are transferred from "the company". So I would assume that a company could sell shares as part of a direct listing in order to raise money?

Otherwise why direct list?

> regulatory reasons the company can't sell new shares this way

So can only direct list for a followup, not for an initial?

I'd love to issue 1 million shares and just sell them to the pending buy orders on a market.

it'd be easy for the company to commit fraud by doing this. That's why it's disallowed.

An IPO which is underwritten by sophisticated investors will be assumed to have done due diligence and thus, less likely to be an act of defraud.

Hertz tried to sell more shares during their bankruptcy, and needed to ask the SEC for permission (to which the SEC is pretty much denied it).

Google IPO'd with a "dutch auction", which involved all buyers submitting their bid and the opening price was the level in which 100% of stock sold.

Because rational actors won't submit bids at all in a system designed like that. If they do, they'll almost certainly enter a situation in which they end up owning stock that last traded at a price less than they paid.

It's been over a decade since I did auction theory so take what I say with a grain of salt. The bidders would be shaving their bids (ie: paying less than they actually value the stock at) since there's an incentive (ie: profit) to not be the top bidder. Everyone wants to be the last bidder since they get their stock for the lowest price. That probably leads to really unstable dynamics and an inefficient equilibrium. So the company may actually come out with less money than other approaches.

You can IPO via an auction. Google did.[1] That's useful when you have confidence the IPO will be oversubscribed, and don't really need underwriters.

[1] https://www.cnet.com/news/google-files-for-unusual-2-7-billi...

If the main dig against traditional IPOs is that they are miss priced I don't see how SPACs fix that. Two SPAC offerings in recent memory that I'm aware of, Virgin Galactic, and Nikola both had huge run ups soon after the mergers happened. This dynamic seems more likely to be a product of hype and limited available shares initially due to lockup periods.

But critically, the misprice is not what matters to the companies raising money. What matters to them is the amount of money they’re able to raise initially, and that can be higher in a SPAC deal. Or it could be lower! But it’s less volatile.

But from first principles, it should basically always be lower.

Yeah, but even if it's lower, the number is certain, decided on over the negotiating table. In an IPO, you don't know till the day of your IPO exactly how much you're going to raise.

When a company does an IPO, they hire an underwriter that guarantees that they'll sell a specific amount of stock at a specific price. So the company knows how much money they'll raise by the time the first day of trading arrives.

Matt Levine has written a number of interesting articles about SPACs recently. In times of high volatility, they become more attractive.

Seems less burdensome to find a large publicly traded company willing to invest with shares of their non-volatile stock. Say megacorp buys a 30% stake, then vested employees get a distribution of 30% of their vest as megacorp stock. You might call this IPO Lite. Benefits of market liquidity for all the shareholders and retain the limited dilution of an IPO.

A SPAC gives more certainty but less money. An IPO gives more money but less certainty.

Most of the criticism of IPOs has been over their cost, and a SPAC is strictly worse.

So...no. SPACs have been (and will continue to be) relatively popular in times of high volatility where their lower risk is worth their higher price, but in general, nobody is clamoring for an IPO replacement that gives even more money to financial intermediaries.

A better question is why this keeps happening? The only thing I can think is that most employees can't sell their stock on IPO day, they're locked in for months to years. So they don't care if the IPO is undervalued, they'll sell at the true value later on.

But what about non employee investors? Why do they sign off on IPOs knowing the stats?

SPACs are a bull frenzy market phenonemom. The winners are the investment banks who collect insane fees between insurance and deal advisory. The other winners are sponsors who get the fattest fee payout in the financial ecosystem dwarfing hedge funds or private equity. Believe me investors are not the winners.

Dont sponsors also take on the highest risk?

They do. If they don’t close a deal they are stuck with all the transaction costs. This leads to adverse selection of deals as a SPAC will always choose to do any deal over dissolving without a deal.

This question has it exactly backwards. SPACs cost the company more money than the IPO pop. With a SPAC you’re buying more certainty than the IPO gives you, and that doesn’t come for free.

I would prefer if companies would stay private much, much longer. The stock market is extremely irrational and believes almost every hype. Which makes a lot of IPOs overpriced in the first place.

Valuations that in hindsight end up being too optimistic aren't unique to public markets. WeWork didn't have to go public to be valued at $47 billion. In fact it was the act of trying to go public that brought the valuation back to reality.

valuations of private companies are even more volatile than for "public" companies. in the case of WeWork it seems to me it was more like a scam of investors who fell for it. I stopped wondering when I read that some of the buildings were owned by the WeWork founders and leased by WeWork.

The problem is that employees of these large private companies are working for somewhat below market wages in exchange for illiquid equity. If these companies stay private for a long time they either have to cash out equity or offer more cash compensation.

Edit: option tender offers are absolutely a thing but I don’t think I’ve ever heard of an RSU tender offer.

I think the issue is, that many don't even have a working business model and are despesrate to find one after they went public. Even though sometimes, there is simply no business model, no way to earn money with a service, no way to make a profit. And in such a situation a company should pay their employees in equity or take money from investors who essentially speculate for a good IPO to get their investment back.

I kind of wish the startups would direct-list on the stock market, and then the early employees have liquidity from the start. This doesn't stop the company raising more money if they're young, they can still issue shares. I'm guessing that theres some downsides to this that I'm not seeing, anyone know?

Once a stock has at least 2,000 acredited shareholders or 500 unacredited shareholders (was 500 shareholders without regard to acreditation before the 2012 Jobs Act), SEC disclosure requirements apply the same as if had IPOd. Allowing/encouraging trading of the stock is going accelerate the time that that happens. Facebook aproaching the shareholder limit was one of the things that pushed them to IPO --- might as well raise some money if you have to prepare all the disclosures and follow all the accounting rules, anyway.

True. Who ever heard of a VC that believed in hype? Hyper rational.

IPO's what?

Exactly!

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