Startup acquisitions through SPACs are occurring in rapid succession in the United States. SPAC-facilitated public offerings have expanded dramatically over the past few years, primarily in the US. Whether SPACs represent a new financial innovation or a new risk born from the ultimate excess liquidity remains without definitive assessment. This column examines the background of this increase in SPAC deals and future prospects.

    "Financing" or "Exit"? That is the question.

The most common explanation of SPACs in Japan is the expression "a new form of IPO." IPO stands for Initial Public Offering, which literally translates to "initial public offering." In other words, funds raised from the market through public offerings are, in principle, paid into the legal entity (issuer) conducting the IPO, meaning it is a "fundraising act" and "financing."

However, in SPAC schemes, most of the funds raised by the SPAC are, in principle, paid to existing shareholders of the target (the startup that wishes to be acquired by the SPAC) as consideration for share transfers. In startups (if they are growing while working with reputable VCs), typically the founder holds ownership as the largest shareholder. In other words, for a SPAC to become the largest shareholder and effective controlling party of the target company and lead the merger between the SPAC and target company, it must, in principle, buy out the founder's stake. From the founder's perspective, this is nothing other than an "exit."

    In typical IPOs, "Financing" is primary and "Exit" is secondary.
Of course, even in typical IPOs, it is common for founders to include a certain portion of their holdings in the offering to obtain founding profits. The amount combining this offering portion with existing investors' (VCs') exit portions and public offering portions becomes the so-called "offering size." In this regard, typical IPOs certainly have an "exit" aspect. IPOs can be said to be hybrid deals of "financing" and "exit" to varying degrees. However, there is no room for argument that typical IPOs are primarily about "financing (fundraising)" with "exit (sale)" being secondary.

    130 out of 161 SPAC deals are "primarily exit" transactions (author's analysis)
　The author analyzes that this is actually where SPACs differ most from typical IPOs. An analysis of the shareholder composition of 161 startups acquired by SPACs from 2018 to 2020 (companies where consolidated results of SPACs and targets have been disclosed for two or more periods, regardless of whether SPACs and targets have merged) shows that in approximately 75% of them—130 companies—the largest shareholder became investment funds or institutional investors.

In other words, focusing on this point and deliberately simplifying, SPAC deals are "exit/recapitalization (shareholder structure restructuring)" deals where startup founders sell their founder stakes to SPACs to realize founding profits and exit while simultaneously handing over management to professional investors or professional managers. This is the author's analysis at present.

Of course, when SPACs and targets merge after acquisition, a portion of the funds raised by SPACs should be utilized as growth capital for targets. Therefore, it is certain that SPAC fundraising has aspects as "financing." However, based on the author's current analysis, in many cases, the "exit" element is stronger than the "financing" element.

    Why do entrepreneurs choose SPAC exits?
　Then, assuming the author's analysis is correct, why do US entrepreneurs aim for exits (or semi-exits) utilizing SPACs rather than traditional IPOs? From here it becomes completely the author's speculation, but let me raise several points.

    Founders should be able to sell at higher prices to SPACs than to operating companies
　It is a well-known fact that 90% of startup exits in the US are M&A. However, when involved in startup M&A, it becomes clear that there is a significant difference in exit prices between M&A and IPO. Needless to say, M&A valuations are overwhelmingly more likely to be lower than IPO valuations.

While a detailed analysis of this reason is not the main purpose of this article, roughly speaking, it is easier to bear risk when it is distributed broadly among general investors rather than having a single operating company assume acquisition risk.

Also, when operating companies consider M&A, they will not even consider it unless it aligns with their own strategy. In the US, it is said that many entrepreneurs start companies with the premise of "exiting to GAFA." Whether this is urban legend or reality is unknown to the author, but if "exiting to GAFA," it presupposes that the business aligns with GAFA's long-term strategy.

However, GAFA's strategies constantly change, and startups in many cases repeat pivots. The probability of successfully achieving growth in a business that aligns well with GAFA's strategy and can be sold at high prices with good timing is quite low. This is basically the same even if the exit destination is other than GAFA. When startup founders want to exit, it is very difficult to have operating companies buy them out at the right timing and at prices comparable to IPOs.

    No interest in "scaling up" the company.
　Also, among founders, there is a considerable probability of people who are "not interested in management." For such people, there may be many cases where they cannot feel passion for continuing to manage and scale up the company after an IPO. This might be similar to what is called "listing as the goal" in Japan. Regardless of scale, founders may inherently have such elements to a greater or lesser extent, whether in Japan or the US.

    SPACs are "the best of both worlds" between IPO and M&A exit for founders
　For such entrepreneurs, M&A to operating companies was previously almost the only exit option. However, as mentioned above, M&A to operating companies has lower valuations compared to IPOs, and in many cases, comes with troublesome elements like lock-ups and earn-outs.

Wasting precious years of life as a hired president at an operating company's subsidiary with dead mackerel eyes is no longer bearable. For such founders, SPAC exits that buy out their stakes at prices close to IPO levels and enable clean management handovers may be quite attractive as a third option.

    SPAC deals may accelerate the US startup ecosystem.
　If the author's analysis hits the mark to some degree, the increase in SPAC deals will allow founders to choose exits with more satisfactory conditions and acquire more founding profits. This will undoubtedly work positively whether exited founders become serial entrepreneurs or angel investors.

Also, in SPAC schemes, it is believed that in most cases they acquire 100% of the target company's shares (because having minority shareholders remaining after merger creates various complications). If founders want to hold shares after listing, they would first sell their shares and then reinvest in the SPAC. In other words, venture capital firms that have supported target companies would also completely exit under the same conditions as founders and realize profits.
If the larger founding profits and venture capital returns acquired through sales to SPACs are reinvested in new innovations in "shorter cycles" and "on a larger scale," the US startup ecosystem may become even more robust. Oh, how terrifying this is.

    Some questions regarding SPAC "conventional wisdom"
　Now, based on the previous analysis, let me touch on some analyses commonly said about SPACs. What is mostly said about SPACs so far are roughly the following points.

    Less stringent review than typical IPOs, faster listing (backdoor listing)
    Don't want securities companies to extract hefty underwriting fees (direct listing)

　Existing evaluations and discussions of SPACs, particularly in Japan, probably generally converge on these two points. Certainly, backdoor listing and securities companies' "intermediation" do represent problems with existing IPOs. However, if we only view SPACs as one form of IPO without also focusing on their aspects as "exit" deals, we may misjudge the overall picture.

    What happens "afterward" to startups acquired by SPACs?
　Finally, one more point. What happens afterward to the many startups that go public through SPACs and whose founders will likely hand over to professional managers? Roughly three stories are conceivable.

Case 1: Startups that have been driven by the founder's charisma, special abilities, and entrepreneurial spirit lose their entrepreneurial spirit and become "ordinary or below-ordinary boring companies" but continue to exist reasonably well.

Case 2: "Biased, distorted companies" due to "the founder's arbitrary decisions, prejudices, and self-righteousness" are handed over to "mature professional managers" and develop as "excellent companies that continue to meet shareholder expectations."

Case 3: Startups that originally had no unique advantages or competitiveness are exposed as "paper tigers" that merely succeeded in selling out well through the founder's "exit," leading to continuous troubles such as fraud and litigation that damage investors.

    Will SPACs become a new "source of income" for PE? Let's see their performance first.
Which case will ultimately become the "mainstream" for SPACs? The key holders are likely SPAC organizers and lead investors. SPACs may be understood as being organized primarily by super serial entrepreneurs like Virgin founder Richard Branson. However, looking at SPAC arrangers, you notice that buyout fund players are actually very numerous. According to EY research, 10% of SPACs organized in the most recent 15 months were by PE. PE firms are originally professionals at LBOs utilizing special purpose acquisition companies. Structures like SPACs are, in a sense, familiar territory for PE.

　However, many startups are loss-making, and traditional LBOs probably do not fit well. Many SPACs appear to be structured and operated as no-leverage schemes (not utilizing loans for acquisition funds).

In other words, buyout funds entering SPACs basically need to steadily improve the value of acquired startups. Whether the result becomes Case 1, 2, or 3 above will become clear in about five years. At that time, what methods will PE use to realize investment exits? PIPEs? Will they demonstrate their true nature as "company resale dealers" and aim for even more substantial profits through further LBOs by taking targets private again? Including such methods, the current position of SPACs can be said to be the "let's see their performance" phase.