The Recession Factor
Michael Fertik, the founder of Reputation.com and the early-stage venture studio Heroic Ventures, has studied the recent developments in SPAC funding. In September, I had the privilege to have Fertik join my presentation about SPAC at an educational webinar organized by TI Platform Management about the current SPAC boom, its historical antecedents, and what it means for markets, entrepreneurs, and institutional LPs. The Valley’s first flirtation with SPACs, Fertik explained, was in 2008, between the onset of the Great Recession in 2007 and the increased SEC oversight of SPACs that started the next year. The second wave of tech-facing SPACs occurred in 2015-2017. The third is happening now.
In this regard, tech-facing SPACs are not atypical of the overall SPAC market: the three-year period from 2015-2017 includes two of three historic leaps in overall SPAC funding. In 2014, total SPAC IPO funding was $1.8 billion. Total funding doubled the next year, to $3.9 billion, and largely held steady in 2016, at $3.5 billion. Then SPAC funding boomed again, nearly tripling to hit $10 billion in 2017. Thus far in 2020, SPAC dollars are experiencing another multiplication, as year-to-date IPO funding has more than quadrupled 2017’s total.
These historic increases in SPAC funding were not without cause. The first leap occurred at the onset of the Great Recession. And although the 2015-2017 period technically falls within the longest sustained period of economic expansion in American history, it also coincided with a sharp U-shaped miniature recession within the expansion, a contraction that remained restricted to agriculture, energy, and the manufacturers supplying those industries with parts and technologies. This mini-recession was caused in part by a rapid decline in the price of oil, which itself was partially driven by China’s decision, in 2015, to slow economic growth deliberately, and by the Fed’s decision to begin to put an end to the easy-money days of the early years of the recovery by finally raising interest rates in December of that year.
The economic slump of 2015-2016 went largely unnoticed due to the overall expansion, but it was not lost on New York financiers looking for opportunities in afflicted industries. Of the $3.5 billion raised by SPACs in 2016, $450 million (or 12.8%) came from just one of the 13 SPACs to IPO that year: Silver Run Acquisition Corporation, led by energy sector investor Mark Papa. Silver Run didn’t waste time finding a target for a merger: it acquired an 89% controlling interest in Centennial Resource Production, LLP, an oil and natural gas company, in December of the same year. In 2017, Papas was at it again: Silver Run Acquisition II celebrated a $900 million IPO that accounted for approximately 9% of the $10 billion in 2017 SPAC IPO funding; it was the largest SPAC to form in 2017. The blank-check company went on to announce it would acquire Alta Mesa Holdings, another independent energy firm, in 2018.
Another of 2017’s headline SPACs was Vantage Energy, which raised $480 million in its IPO. Although Vantage Energy was forced to dissolve in 2019 after failing to acquire a target, two of the year’s other high-value SPACs successfully completed mergers in industries directly impacted by the mini-recession of 2016: Gores Holdings II ($375 million) and Kayne Anderson Acquisition ($350 million) went on to acquire private companies in commercial transportation and energy, respectively.
These acquisitions demonstrated that SPACs could offer a sensible alternative to a traditional IPO for high-value companies in sluggish sectors of the economy. SPAC sponsors, with the support of their institutional backers, were able to gain controlling stakes in promising private companies that were ready to go public, but wished to avoid the bear markets of their subsectors.
Broken Unicorns and the 2020 Bonanza
The second surge in SPAC funding was also partly led by what Fertik calls “broken unicorns”: high-valuation, venture-backed companies that were attractive but overpriced—and in some cases badly in need of reform. The proliferation of broken unicorns during the 2015-2017 period led East Coast investors and Silicon Valley insiders to take an interest in creating SPACs to merge with broken unicorns at rationalized evaluations, then grow them aggressively. These efforts were epitomized by the successful merger between Chamath Palihapitiya’s Social Capital Hedosophia Holdings Corp., a SPAC that acquired Richard Branson’s unicorn, Virgin Galactic. Although Virgin Galactic was operating at an annual loss of $173 million for the fiscal year ending in June 2019, its stock has gone up 74% since the merger.
The Virgin Galactic–Social Capital deal is often cited as one of the most successful SPAC mergers to date. But it was also a sign of what was to come: the onslaught of super SPACs in 2020, which itself has signaled the maturation of SPACs into something much more disruptive than a simple alternative to private equity, as in the case of earlier SPAC booms. This time, Silicon Valley appears to be leading the trend, rather than following the lead of SPAC sponsors and institutional investors.
SPAC funding in 2020 has exceeded $50 billion, shattering the record set in 2019. There are several reasons why. First and foremost is the global recession set off by the COVID-19 pandemic, which brought IPO activity to a near-standstill in a year that many venture-backed behemoths had eyed for an IPO. In this respect, the 2020 SPAC surge’s coincidence with an economic recession resembles booms of years past.
But that’s where comparisons stop: a second reason for the latest SPAC craze is that SPACs have finally begun to shed their bad reputation as a funding mechanism of last resort. Throughout the 1990s and into the new millennium, SPACs were associated with companies that preferred to avoid the transparency requirements of an IPO. SPAC was still a “dirty word” on Wall Street, as well as in Silicon Valley. Things changed quickly owing to the confluence of several factors. The first was the highly publicized success of the Virgin Galactic–Social Capital SPAC merger, which led a diverse array of reputable players to get into the game. Entrepreneurs Kevin Hartz, Peter Thiel, and Reid Hoffman all formed high-profile SPACs, as did former US House Speaker Paul Ryan and Moneyball author and baseball statistician Billy Bean. The emergence of respected sponsors from Silicon Valley and beyond has burnished the SPAC image, and conferred an additional advantage on SPACs as a public market vehicle: by acquiring a board seat through the merger, industry leaders are able to provide additional value to mature unicorns by offering their expertise and guidance.
Another factor behind the 2020 SPAC boom has been long in the making: there has been growing dissatisfaction among tech entrepreneurs about the expenses of the IPO process, which favored Wall Street banks and institutional investors. A proliferation of IPO “pop” events, in which a stock bounces 50% on the first day of trading—or in some cases, more than doubles—led entrepreneurs to believe they were being urged to leave money on the table for the sake of satisfying institutional LPs. When growing discontent with the IPO process paired with the recession that began this spring, entrepreneurs had an extra incentive to avoid the IPO process. The combination of these factors has been sufficient to overcome the bad reputation SPACs earned as shady and unreliable investment vehicles.
What Does It Mean for Institutional Investors?
The 2020 SPAC boom has the most meaningful consequences for late-stage VC. As Silicon Valley–led venture capital has matured, private companies have stayed private longer: Palantir, for example, has been private for 17 years. Airbnb, which rebuffed Bill Ackman’s approach for a SPAC merger, was founded in 2008. Stripe, another company Ackman approached, was founded in 2010 and is at the Series G phase of its startup funding.
VC megafunds, such as the SoftBank Vision Fund, emerged over the past decade to accommodate entrepreneurs who wished to raise corporate-size funding and still remain private, as a way of retaining as much of their companies as they could. As a result, VC became more illiquid over time, with funding rounds stretching a quarter of the way through the alphabet. For LPs, this has meant longer waits for disbursements, erasing one of the distinctions between VC and private equity.
The recent rise of SPACs and direct listings have challenged the relevance of late-stage funds by offering a public funding mechanism that allows venture-backed entrepreneurs to control more of their companies’ destinies while avoiding both the hassle of multi-series rounds of fundraising, on the one hand and the transparency and delays of a traditional IPO on the other. Partly as a defensive reaction, venture capitalists have started to create their own SPACs, and may be competing against other venture funds for LP backers.
Fertik refers to these developments as part of a larger “Wall Street-ification” of the Valley: VC funding and deal structures have also become more complicated as funds grow larger and companies stay private for longer. But perhaps more to the point, the Silicon Valley credo of disruption has led entrepreneurs dissatisfied with the IPO process to believe they can and should disrupt business on Wall Street.
SPACs have also democratized access to potentially high growth startups by enabling retail investors to purchase shares in shell companies whose sole purpose is to acquire a private firm with strong projected future returns—even if those retail investors can’t be sure which tech stock they’ll ultimately end up owning. And as the recent Snowflake IPO demonstrated to resounding effect, retail investors are valuing high-growth tech companies much more highly than even the most optimistic VC investors.
Whereas LPs reap most of the rewards of retail enthusiasm that results in IPO pops, SPACs account for future valuations of high-growth companies in the acquisition price. LP investors aren’t exactly left out in the cold since they’re still the prime funding source for SPAC sponsors. But with any SPAC merger, LPs will split a greater portion of the rewards of retail investor fueled stock bumps with the entrepreneurs whose companies they view as opportunities for growth.
High-profile IPOs aren’t yet a thing of the past. But the $50 billion (and counting) raised by SPACs in 2020 suggests that LPs shouldn’t write off the hype, or continue to dismiss SPACs as inherently sketchy deals. Instead, they should do the diligence necessary to understand a sponsor’s motives and recognize that SPACs offer an opportunity to shift their thinking on venture capital toward a portfolio more balanced in terms of its potential liquidity.