Traditionally, when a company wishes to go public, they typically go through a traditional IPO process. This initial public offering requires following a lengthy process that can be both costly and time-consuming. As a result, some startups and businesses have chosen alternative routes. Some companies have decided that a direct listing allows a better strategy. Over the years, other options have also emerged. These include various types of mergers and acquisitions that enable a company to bypass traditional requirements. (Read more about the growth potential of mergers and acquisitions in this Bold story.)
In recent months, reverse mergers and special purpose acquisition companies (SPACs) have increased in popularity. These represent ways by which companies can go public by merging or acquiring other entities. Interestingly, these are not new approaches or concepts, as they had been popular in previous decades. However, understanding their advantages and disadvantages is essential before choosing which public offering strategy to pursue. Only then can companies best position themselves to achieve the company goals they desire.
“Regardless of what path they choose, the endpoint is the same. And you wake up after the ringing of the bell at the exchange, and you have an obligation to the stakeholders.” – David Ethridge, Deals Managing Director and U.S. IPO Services Leader, PricewaterhouseCooper
Understanding Reverse Mergers and SPACs
Before a company can decide how best to go public, various options for going public should be well understood. In terms of a traditional IPO, companies must first hire banks to underwrite their company. They then publicize their business’s potential to investors. They are also required to sell a block of shares at a set price before finally going public. In terms of benefits, a traditional IPO is well structured, highly predictable, and offers a great way to publicly promote a business. It also allows a great way to raise capital. However, it can be costly and often requires several months to complete.
One option that businesses may choose instead of a traditional IPO is a direct listing. Unlike a traditional IPO, a direct listing does not require bank underwriting, and it does not require selling a block of shares. As a result, it is often less expensive and much more efficient. However, it does not provide an opportunity to raise capital in the process. It also has limited opportunities to publicly promote company services and products. Understanding this, companies that pursue a direct listing usually have strong brand recognition already with little need for capital.
In addition to traditional IPO’s and a direct listing, two other options also exist for going public. The first involves SPACs, which are essentially public companies created by investors. Once formed, SPACs have two years to acquire an existing private company. Upon its acquisition, the private company becomes public by default. Reverse mergers are quite similar to SPACs. However, with reverse mergers, a private company merges with an existing public company in order for itself to become public. In both cases, SPACs and the public company purchased in reverse mergers usually have little or no value. This makes both SPACs and reverse mergers typically easier, faster, and less expensive ways for going public.
“[SPACs and reverse mergers] actually create competition around the way we distribute shares to the public market, and competition to the IPO process is probably a good thing. [But] for good competition and good decision making, you need good information.” – Chairman Jay Clayton, Former SEC Chairman
Looking at SPACs and Reverse Mergers Historically
In recent months, both reverse mergers and SPACs have gained attention. Specifically, in the first quarter of 2021 alone, more than 300 SPACs formed. In the process, they raised more than $100 billion in capital from investors. This has been complemented by the increasing use of AI in mergers and acquisitions. While SPACs have two years to find private companies to acquire, they do not have to specify these companies in advance. Because of this, some believe there is currently a bubble of SPACs that is unsustainable. The same applies for reverse mergers. There is likely a limited amount of existing public companies with which private companies might choose to merge. Based on the increasing number of SPACs and reverse mergers as of late, skepticism is therefore on the rise.
This is not the first time such bubbles have existed. Reverse mergers have been around since the 1970s. They reached their peak around 2010, at which time investors, regulators and even the media became skeptical. In terms of SPACs, they have been present since the 1990s. They too have undergone their ups and downs over the years. The recent attraction of SPACs and reverse mergers reflect industry changes. Because there are more speculative companies in pre-revenue stages that need capital, these vehicles for going public look attractive. Specifically, these options permit discussions of future revenue projections where traditional IPO’s do not. Companies in biotech, cleantech, and electric vehicles find SPACs and reverse mergers a valued option for this reason.
The Bottom Line for SPACs and Reverse Mergers
When it comes to SPACs and reverse mergers, these could offer ideal opportunities for going public in select cases. But for SPACs, their share price has historically fallen in value after an acquisition. And in terms of reverse mergers, the subsequent merger must be immediately compliant with all SEC rules. Plus, recent comments by the SEC suggest upcoming changes are likely in regulating these public options. Greater transparency and access to information are probably going to be required. Certainly, SPACs and reverse mergers may be a great choice for some strong companies looking to avoid the IPO process. But they aren’t likely to replace traditional IPOs as a preferred route for going public any time soon.
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