Matt Johnson
The number of SPACs in the deep tech sector was skyrocketing, but a combination of increased SEC scrutiny and market forces over the past few weeks has slowed the pace of new SPAC transactions. The correction is an inevitable step on the path to mainstreaming SPACs as an alternative to IPOs, but it won’t cause them to go away. Instead, blank-check vehicles will evolve and will occupy a small and specialized — but important — part of the startup financing landscape.
The tsunami of SPAC financings sparked commentary from all corners of the capital markets community, from equity analysts and securities lawyers to VCs and fund managers — and even central bankers. That’s understandable, as more than $60 billion of SPAC deals have been announced since the beginning of 2020, plus $55 billion in PIPE capital, according to investment bank PJT Partners.
The views debated by finance experts often relate to the reasonableness of SPAC pricing and transaction structures, the alignment of incentives for stakeholders, and post-merger financial and stock price performance. But I’m not going to add another voice to the debate on the risk-reward calculus.
As the co-founder of a quantum computing software startup who worked in financial markets for two decades, I’d like to offer my perspective on two issues that I think my peers care more about: Can SPACs still solve the funding problem for capital-intensive, deep tech startups? And will they become a permanent financing option?
Keeping the lights on at deep tech startups
I believe that SPAC financings can solve a major problem for all capital-intensive technology startups: the need for faster — and potentially cheaper — access to large amounts of capital to fund product development over multiple years.
SPACs have created a limitless well of capital that deep tech startups are diving into. That’s because they are proving to be more attractive than other sources of financing, such as taking investments from later-stage VC funds or growth equity funds with finite fund sizes and specific investment themes.
The supply of growth capital from these vehicles has been astounding. In 2020, SPACs alone raised more than $83 billion via 248 IPOs, which is equal to a third of the total $300 billion raised by the entire global VC community. If the present rate of financings had continued, the annual amount of SPAC financings would have been on par with the total R&D expenditure of the U.S. government — roughly $130 billion to $150 billion.
This new supply of capital can let startups keep the lights on, helping them address a practical need while they develop products that may take a decade to field. Before SPACs, any startup that wanted to remain independent had to lurch from one round of VC financing to the next. That, as well as the intense IPO process, is a major time sink for management teams and distracts them from focusing on product development.
By merging with a blank-check company, startups can secure enough financing to continue building for many years while preserving the focused, streamlined culture that allowed them to get this far in the first place.
When properly applied, SPACs also have the potential to take emerging technologies out of the hype cycle and serve as an accelerant for development and commercial viability, enabling new industries to crystallize faster and strengthen supply chains. For proof of how this is playing out, we just have to look at SPAC IPOs from companies driving the launch of new and capital-intensive industries such as electric vehicles, next-generation batteries and power generation, and aviation/mobility technologies like electric-powered commuter aircraft.
Moving quantum computing forward
It is widely accepted that higher levels of funding correlate strongly with accelerated technology development. Let’s explore the impact of SPACs on the emerging technology closest to my heart: Quantum computing. SPACs made their first swoop into quantum computing recently with IonQ, a front-running quantum computing hardware startup, announcing plans for a merger with potential gross proceeds of $650 million.
The influx of SPAC investment in quantum computing hardware has the potential to have a dramatic impact. Boston Consulting Group estimates that the financial impact, i.e., incremental operating profits for enterprises using quantum computers, could range from $450 billion to $850 billion annually when full-scale, fault-tolerant quantum computers become available.
Quantum computing software startups like QC Ware will welcome the prospect of a significantly shorter timeline for full-scale, fault-tolerant quantum computers, as the usefulness of software only becomes concrete for enterprise customers when there is viable quantum computing hardware.
The more capital hardware development gets, the sooner we can provide a competitive edge to the verticals we concentrate on: Aerospace, chemicals, energy, finance and pharmaceuticals.
A SPAC’s place in the current financing ecosystem
Here’s what I found while working in finance for two decades: Any financial transaction or instrument can be misused or used excessively. However, 99.9% of the time, these instruments are applied in very mundane and prudent ways to achieve one of two aims:
- Intermediate capital flows: Moving capital to growing companies from investors and lenders.
- Hedge financial risks: Allowing companies to make long-term plans by laying off risks outside of their control to other parties instead of requiring them to white-knuckle it through the uncertainty of future foreign currency exchange and interest rates, commodity prices, weather shocks or environmental hazards.
So is there room in the capital markets for a new animal like the SPAC or have novel financial instruments reached the end of their history?
The recent past would tell us that the former is the case. If we look back over the past 50 years, there have been a number of initially novel but poorly understood and narrowly used financing instruments that have since made their way into the mainstream. For instance, we have:
Venture capital: Modern venture capital didn’t exist in its present form before WWII. This class of risk capital started flowing to present-day Silicon Valley when the first semiconductor and electronics companies were blossoming in the 1960s.
Derivatives: Although commodity hedging contracts have existed for centuries, these instruments are now applied to mitigate risk across all aspects of modern commerce and have become a bedrock of the financial system.
Private equity: Like their early-stage venture capital cousins, private equity funds have exploded over the past several decades, markedly changing the landscape of the ownership of large corporations. Private equity control investments have led to fewer companies listing on U.S. stock exchanges and have given late-stage companies options to access large amounts of capital.
Junk bonds: Before the creation of the below-investment-grade bond market in the 1980s, there was no way for growing companies to raise debt capital from the large corporate bond market. These fixed-income instruments have now become a standard financing vehicle for fast-growing companies.
SPACs have been around in a less evolved form for several decades. A combination of structural improvements and economic circumstances has made these instruments viable for a broader set of investors and issuers.
Turning SPACs into a viable financing option
It’s clear that blank-check companies are a bull market phenomenon, but that doesn’t mean that new SPAC formations will stop should the stock markets drop sharply. For SPACs to endure, a few conditions have to be met.
First and foremost, SPACs have to deliver on their business plans. There is an unwritten agreement that issuers (the company that sells securities like stocks and bonds) enter into with their shareholders: They disclose to investors what they will achieve in the coming months and years, and the investors back that business plan with their capital.
These shareholders know that the future is very hard to predict, especially for the novel products that SPAC companies are developing, and they will make allowances for missed targets or delays. However, if investors see a sustained behavior of overpromising and underdelivering, these companies will probably wither on the vine. If a large proportion of SPAC companies consistently underperform, they will taint the entire community of SPAC issuers and that could lead to the entire market shutting down.
Secondly, SPAC financings need to provide financial advantages to the issuer beyond those offered by a regular IPO or a growth financing round. These advantages could include commanding a higher valuation than they could receive via an alternative financing route, or reducing the overall cost of the financing.
The difference between the relative overall costs of financing for traditional IPOs and SPACs is a subject of intense scrutiny, and I would say that the jury is still out. SPACs come with lower bankers’ fees, and their price discovery mechanism potentially leaves less money on the table. However, they also result in substantial dilution for existing shareholders.
Finally, SPAC transaction structures need to mature into a form that is broadly acceptable to all stakeholders. There’s a lot of room for further alignment between the parties involved in SPACs with regard to matters like valuation, incentives, disclosures, regulations and rights. Until an equilibrium is reached, it could be difficult for SPACs to take root over the long term.
The long-term outlook
I see blank-check companies evolving into a small to moderate-sized product, as they have the potential to address a part of the supply-demand equation in the capital markets. There will be both continued demand from investors to participate in high-quality, deep tech IPOs and continued supply of capital-intensive technology companies that need large amounts of capital to develop and field their products.
SPACs can allow companies to go public substantially earlier. This could be useful, as being the first to go public in an emerging technology space can offer greater visibility to the company and its products. It can also provide acquisition currency to let the company consolidate a new industry ahead of its competitors.
In my view, it is unlikely that SPACs will become as prominent as any of the foundational financing instruments that have emerged since WWII. It’s very possible, however, that SPACs will become as prominent of an alternative public equity product as, for example, direct listings have become. At the very least, SPACs will put downward pressure on IPO fees and may drive bookrunners to change their allocation policies to allow more nontraditional investors to invest in IPOs.
What private tech companies should consider before going public via a SPAC
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