SPACs Are Venture Capital in Public Markets
We should stop thinking of SPACs only as an IPO alternative and think of them more as a venture capital alternative.
A SPAC isn’t just a vehicle to go public, it’s a vehicle for a company to raise a substantial amount of new capital to deploy toward some business purpose. The point of the financial markets is for investors to allocate capital, and SPACs are another tool to serve that purpose.
If we look at how SPACs are being used today through the lens of capital allocation rather than as a go-public mechanism, they start to look a lot like the large, late-stage venture financing rounds we’ve seen throughout the past decade. It’s common for high growth but unprofitable private tech companies to raise hundreds of millions to billions of dollars to achieve business goals — think Unity, Airbnb, Snowflake, Palantir, and Affirm as recent IPO examples. Over the last decade, the boom in late-stage private capital enabled companies like these to stay private longer, but it also shifted traditional growth-stage returns from the public markets to the private markets. SPACs represent a reintroduction of those types of returns to the public markets, but they don’t come without risk, perhaps even new risk relative to public growth opportunities of the past.
A common criticism of the SPAC boom is that companies coming public are low quality, often because they have yet to generate any revenue; however, this is also common in late-stage venture. Companies like Rivian, Cruise, Argo, Nuro, and Aurora, all of which I believe generate minimal revenue, have raised hundreds of millions to billions in private funding. Companies like Elon Musk’s Neuralink and recent social craze Clubhouse are likely to raise hundreds of millions from private investors before they start generating any real revenue.
Investors that only look at the world through a traditional value lens may view companies with no revenue as low quality, but I would argue a company is low quality only if it can’t generate an adequate return on equity capital invested. In venture investing, thoughtful expectations for aggressive future growth and long-term profitability build the return case, not consistent performance based on present metrics. Of course, a market willing to adopt new products and strong execution by management always determine investment success. It’s hard to think about the value of future cash flows that might be more than a decade away, but that’s a requirement for investing in venture-like growth, as is an acceptance of failure.
The expectation of late-stage venture capitalists is that some portion of their portfolio fails entirely, and those zeroes or near zeroes are more than made up for by winners. The difference is that zeroes are softened by private marks in late-stage venture funds, while zeroes will be very public and painful for SPACs and their investors. Adding to the challenge is that SPACs don’t only grant institutional investors access to speculative growth companies, they also grant access to retail investors. Retail investors have proven that they’re willing to discount possible future performance far more aggressively than institutional investors, helping to promote historically high valuations for tech in general, and SPACs in particular. All public market investors, institutional and retail, need to be prepared to contemplate zero as a potential outcome for aggressive growth companies, just as a venture capitalist would.
There will certainly be some blow ups in the SPAC harvest of the past year and next year plus. That’s to be expected as part of venture-style investing. There will be some lapses in diligence by sponsors. That’s to be expected with frothy markets full of capital to be deployed, although still unacceptable. There will also be some wild successes: businesses that deserve the capital they are allocated by public market investors that grow into transformative companies and great investments.
All of this suggests to me that quality SPAC sponsors are more important than ever with more SPACs entering the market than ever before. A quality sponsor will understand the venture-like risk profile of the investment and balance it with a venture-like view of possible future returns. A quality sponsor will do the necessary diligence to find a quality target and de-risk an investment as much as possible before agreeing to a transaction. But even a quality sponsor can’t guarantee investment success at any valuation if a SPAC’s price discounts an excessively aggressive view of the future opportunity. Tread carefully.