Economic Interdependence: IPOs & SPACs

Economic Interdependence

Big Idea: Different stakeholders have different viewpoints on scarcity and sustainability.
Framing Question: How do different stakeholders in Canada respond to issues relating to scarcity?
Overall Expectation: Students will analyze ways in which producers and consumers participate in the Canadian economy. They will also analyze competing perspectives on scarcity and sustainability in Canada and assess their significance.
Specific Expectation E1.4: Students will explain how firms in Canada respond to issues relating to scarcity of labor and capital.
Success Criteria: (Not specified in the transcript)

Definition: A company’s first equity issue made available to the public. This occurs when a privately held company decides to go public.

New Capital: Almost all companies go public primarily because they need money to expand the business.
Future Capital: Once public, firms have greater and easier access to capital in the future.
Mergers and Acquisitions: It's easier for other companies to notice and evaluate a public firm for potential synergies.
IPOs are often used to finance acquisitions.

Expensive: A typical firm may spend about 15% of the money raised on direct expenses.
Reporting Responsibilities: Public companies must continuously file reports with the SEC/CSE and the stock exchange they list on.
Loss of Control: Ownership is transferred to outsiders who can take control and even fire the entrepreneur.

There are clear “windows of opportunity” that open and close for IPO issuers.
Determinants of suitability:
- The general stock market condition
- The industry market condition
- The frequency and size of all IPO’s in the financial cycle

An underwriter is an investment firm that acts as an intermediary between a company selling securities and the investing public.
The underwriter is the principal player in the IPO.
Typically, the underwriter buys the securities for less than the offering price and accepts the risk of not being able to sell them.

Firm Commitment Underwriting:
- The underwriter buys the entire issue, assuming full financial responsibility for any unsold shares.
- Most prevalent type of underwriting.
Best Efforts Underwriting:
- The underwriter sells as much of the issue as possible, but can return any unsold shares to the issuer without financial responsibility.

The firm must prepare a registration statement and file it with the SEC/CSE.
The registration statement discloses all material information concerning the corporation making a public offering.

The prospectus is a legal document describing details of the issuing corporation and the proposed offering to potential investors.

The road-show is presented to institutional investors around the country.
The road-show allows firms to raise interest in the company and thus the price.
Allows the firm and its underwriters to gather information from potential purchasers.

How much to charge for giving away a part of the firm is very important to the issuers.
The securities are priced based on the value of the company and expected demand for the securities.
Examples of valuation methods:
- Net Present Value
- Earnings/Price ratios

A full-fledged selling effort gets under way on the effective date of the registration statement.
A final prospectus must accompany the delivery of securities.

A special purpose acquisition company is essentially a shell company set up by investors with the sole purpose of raising money through an IPO to eventually acquire another company.
Example: Diamond Eagle Acquisition Corp. was set up in 2019 and went public as a SPAC that December. It then announced a merger with DraftKings and gambling tech platform SBTech. DraftKings began trading as a public company when the deal closed in April.
A SPAC has no commercial operations — it makes no products and does not sell anything. The SPAC’s only assets are typically the money raised in its own IPO, according to the SEC.

Usually, a SPAC is created, or sponsored, by a team of institutional investors, Wall Street professionals from the world of private equity or hedge funds, while even high-profile CEOs like Richard Branson.
When a SPAC raises money, the people buying into the IPO do not know what the eventual acquisition target company will be. Institutional investors with track records of success can more easily convince people to invest in the unknown. That’s also why a SPAC is also often called a “blank check company.”
Once the IPO raises capital (SPAC IPOs are usually priced at $10 a share) that money goes into an interest-bearing trust account until the SPAC’s founders or management team finds a private company looking to go public through an acquisition.

Once an acquisition is completed (with SPAC shareholders voting to approve the deal), the SPAC’s investors can either swap their shares for shares of the merged company or redeem their SPAC shares to get back their original investment, plus the interest accrued while that money was in trust.
The SPAC sponsors typically get about a 20% stake in the final, merged company.
However, SPAC sponsors also have a deadline by which they have to find a suitable deal, typically within about two years of the IPO. Otherwise, the SPAC is liquidated, and investors get their money back with interest.

There are risks with SPACs.
Target companies run the risk of having their acquisition be rejected by SPAC shareholders.
And investors are literally going blindly into the investment.
While the SPAC merger process does require transparency regarding the target company, the due diligence of the SPAC process is not as rigorous as a traditional IPO.

SPAC sponsors are mostly tasked with finding a workable acquisition within two years and not necessarily the best possible deal.
While some high-profile SPACs have performed reasonably well (DraftKings and Virgin Galactic have both seen their stock prices grow since going public), advisory firm Renaissance Capital found that the average returns from SPAC mergers completed between 2015 and 2020 fell short of the average post-market return for investors from an IPO.
Many are calling the SPAC trend the “Great 2020 Money Grab”, in which “a business model that incentivizes promoters to do something — anything — with other people’s money is bound to lead to significant value destruction on occasion.”

Why do some companies choose to do a direct offering? (e.g. Spotify)
Has purchasing IPOs proved to be advantageous for investors?
Find a company that is currently private, and explain why you think they remain private, and what are the specific advantages of them going public?
Why do some foreign companies list on U.S. exchanges when they do not have any U.S. operations? (e.g. Coupang)
Why do some companies decide to merge through a SPAC vs. an IPO?
Why should one limit their exposure to SPACS?
What are 5 SPAC you would be interested in investing in.