SPAC Sponsor Shakeout
The success of a SPAC, as defined by investing in a good company that offers strong long-term returns on capital, depends entirely on the sponsor.
In our current market, it seems like any sponsor can raise a few hundred million dollars. While some may question the sustainability of that trend, we think capital available to SPACs will stay high over the foreseeable future. SPACs are essentially a risk-free trade with a near-term arbitrage opportunity dependent on market excitement about the sponsor and a longer-term opportunity for dynamic upside depending on the target acquisition. In a choppy market where investors are concerned about a bubble, it’s arguable that such a risk-free trade would only become more desirable.
When the fervor around any and all pre- and post-transaction SPACs eventually calms and premiums offered to those issues become more rational, we expect the market to embrace the necessity of quality sponsors to capture the dynamic upside potential of a SPAC investment. Capital will remain available to SPACs in the future, but it will accrue to the best sponsors just as capital always accrues to the best investors.
So, what makes a good sponsor?
We think good SPAC sponsors have four qualities, particularly as it relates to bringing venture-style tech companies into the public market:
- An understanding of investing in companies early in their lifecycles.
- An ability to help public investors understand the potential of the company and its technology.
- An ability to raise the profile of a small cap company, grounded in near-term realism and long-term possibility.
- An ability to attract good companies. It is the first three that enable this last one.
Good sponsors understand early lifecycle companies
Since SPACs offer the unique advantage of talking about forward projections where traditional IPOs can only talk about past performance, SPACs are well suited to bringing venture-stage companies into the public markets, and we’ve previously described SPACs as public venture capital. As such, we expect the majority of SPACs to be used for companies earlier in their lifecycle than traditional IPOs. Good sponsors need to possess the skillset to assess early-stage companies where intangibles are often more instructive than tangibles.
While all investors public and private look at team as a factor for investment, team is particularly important in venture investing. Public investors often define good management teams by past execution and delivery on financial performance, something not readily available for earlier-stage companies. Good sponsors must know how to assess emerging managers as part of deploying SPAC capital, particularly the ability of management to convey vision, develop technology, hire a strong team, and deal with greater volatility in the business than might happen in a more mature company.
Beyond management, good sponsors also need to be able to assess the company’s technology on two major planes: feasibility and market desirability. This can be a challenging equation. If auto experts were to offer a feasibility assessment of Tesla in its early days, they would likely have been fairly negative on Tesla’s ability to bring down battery costs, improve range, and build cars at scale. Of course, they would have been terribly wrong. Good sponsors need to avoid backing companies with obviously weak or flawed technology, but the best investments often come from places where experts believe something impossible. Extraordinary results always come from the consensus impossible becoming possible.
On market desirability, good sponsors need to have a strong view of how the target acquisition’s technology can help create a future to which we’re already moving or to blaze a trail to a future that no one even sees yet. The latter case is always the rarest find in investing, whether public or private.
Good sponsors help public investors understand the long-term opportunity
Investing in the public markets is a different game than investing in the private markets. Public marks can create wild swings in asset valuations that private markets don’t suffer from (at least visibly), and liquidity gives public investors the ability to exit positions at any time where private investors are locked into the assets they buy. These dynamics create shorter-term performance demands on public investors relative to private investors, which often results in shorter-term investment theses. Good sponsors must understand these unique demands from public investors and help the acquisition company anchor their long-term vision with investors to create a stable base.
Despite the short-term performance demands of the public markets, there is a strong desire for long-term growth opportunities. Everyone wants to find the next Tesla or Facebook to own for a decade. Good sponsors should be able to credibly explain why public market investors should believe in the long-term growth potential of their investments and frame how to measure progress along the way in an effort to navigate short-term market demands.
Good sponsors bring exposure to their companies
Over the long-term, great public companies that consistently execute and ultimately deliver strong earnings always earn investor attention and fair market valuations. In the short term, public investors are trying to figure out which companies are going to be great and allocate capital appropriately.
Since most new SPACs will be smaller cap companies with limited investor attention, good sponsors should help to bring short-term attention to the companies they acquire. Short-term attention can be beneficial because for a small cap company it may result in a valuation higher given greater demand for shares. Higher valuations create optionality for the company in terms of raising additional capital on attractive terms or using stock as a currency to make strategic acquisitions.
Higher valuations may also create a higher bar for performance, but if the company and sponsor do a good job anchoring a stable investor base on the long term as described in point two, the company should be offered some flexibility on quarterly demands so long as progress is made toward the long-term vision. A company that doesn’t perform over the medium to long term is going to suffer multiple compression and abandonment no matter what, so we believe maximizing optionality in the nearer term as a way to potentially accelerate the company’s progress is worth any short-term pressure. This is a venture mindset applied to the public markets — use all levers to create dominant positions in nascent markets.
It’s important to note that exposure doesn’t mean pushing a stock price beyond reason. Exposure should come with a rational view of near-term price activity given long-term potential. If near-term speculation gets out of hand, we believe good sponsors should try to temper markets as well. A sponsor that develops a reputation for pumping up companies well beyond reason will quickly be recognized as a bad sponsor.
Good sponsors attract good companies
Companies considering a SPAC will come to realize that the marketing component of being a public company is where sponsors can add the most value. If a sponsor can understand early-stage company dynamics, help position a long-term vision with public investors, and bring attention to the company, that sponsor should attract good companies, creating a virtuous cycle of good sponsors marrying good companies.
We can invert the duty of a good sponsor to create a fifth rule: Good sponsors should help public investors avoid bad companies. Investing in venture-stage companies is not the domain of most public market investors. It requires unique analytical skills, a strong vision for the future, and a stomach for potential volatility before valuations can be tied to tangible output. Reputation matters in all things, and as good sponsors build a reputation for helping position good companies in the public markets, those sponsors will operate as the gatekeepers of public venture capital.