SPACs in Space – Why and Why Not
Financing space tech is an oddity, especially when a founder’s “to boldly go” vision meets financial reality. Why? Because capital is a coward. Experimenting in investments cannot take the “Success! We collected all the data we hoped for before the rocket blew up!” attitude of space tech, because experimental investment vehicles can carry investors to jail.
However, one meeting point of space tech and financing has generated headlines, namely Special Purpose Acquisition Companies (SPACs). Touted as a simpler path than a traditional IPO, the SPAC has been the high-profile route to public trading for the likes of Virgin Galactic and Momentus Space. But are SPACs the new norm for space startups, or will they become just one of a variety of ways to get to the public exchanges? Also, do space tech’s C-suite teams and the financiers really understand each other when it comes to SPACs?
Investment companies have used SPACs since the 1990s. First eyed with suspicion, they eventually became a fixture in the investment environment, especially after TPG Capital took Burger King public in this manner in 2002.
For space industry companies, the watershed moment came with the Virgin Galactic / SPCE IPO done through a SPAC, namely Social Capital Hedosophia created by Social Capital founder Chamath Palihapitiya. The fund was created to advance humanity and solve its problems; the goal complies with Virgin Galactic’s activities. Now, Momentus Space wants to follow the path. They will do so with the help of Stable Road Capital’s SPAC that initially sought for companies within the cannabis industry but has ultimately merged with a space startup.
Regardless of the industry and goals, SPAC follows the same pattern. The reasons for going this route may differ, and sometimes the target company is already identified or even waiting for the process to unfold, but the public events will be the same.
First, a shell company is formed for the purpose of acquiring an unlisted company. This shell company will go through the process of listing on a stock exchange. However, because the company has no activity, the listing process is relatively smooth.
While the company is undergoing the listing process, the management team and investment team will be hired. Bringing the management team is one aspect of a SPAC that sets the process off from a reverse merger or from going through a traditional IPO. SPACs often bring together bespoke teams focused on one set of industries and with people already known in the field.
Getting the management right is an essential component of a high-tech SPAC success story. Because the company being listed has no business track record of its own, bringing in outside investors often comes down to being able to sell the qualifications, experience and reputation of those involved.
Once they’re in, investors’ money at first gets locked into a trust account, which may be interest-bearing. To unlock the funds, investors must accept the target company, and at this time, investors usually have the chance to opt out. Also, a SPAC is usually time-limited, and if the acquisition does not happen within that time frame, investments are returned to their investors. The possibility of a return is considered a safety feature by investors. It also sets up the prospect for the team of having to sudden and unexpected holes in funding. Avoiding such holes could affect decision making from technology preferences to selecting team members who fit the investors’ whims over the techs’ vision.
In terms of funding, a space-focused SPAC can attract the attention of institutional investors because of the focus, business case, and lack of skeletons. Given that space tech, especially in terms of launch, has inherent technical risks, lowering risk elsewhere is a plus. But in some cases, companies that turn to SPACs, have something to hide. For instance, the CEO of Momentus Space has no legal right to work with the company’s technologies in the US. It seems not to be a large problem; yet, the risk for investors increases. Especially for retail investors who might not conduct overwhelming checks before investing.
While SPACs are gaining attention as investment vehicles, “attention” and “communication” are two different things. A SPAC is designed to be available only to professional investors in the company’s initial stages, and they are legally bound in the same manner that regular shell companies are. For example, while they can engage in general PR, nothing the SPAC promulgates can be construed as an offer to investors.
The hype around SPACs usually avoids addressing a ‘feature’ of SPACs. There is a considerable disparity between the offers for the retail segment and professional investors, who in the end take on less risk than retail customers, but who generally realize a greater upside even if at the end of the process the acquired entity fails on the equity market.
Another route for a company to take to become listed is a reverse merger, also called a reverse takeover. In this case, an existing private company that is already doing business takes over a listed company and avoids some of the time lag of a traditional IPO. In the space industry, the fit between the two companies involved in a reverse merger is of critical importance, as investors in the listed company could perceive the mismatch between the companies as a material issue and the price of the acquired company could drop. Also, unlike in a SPAC, the team is not brought together for the purpose of running the combined company, so corporate culture issues could arise.
The fact that the listed company is actually doing business can be seen as a two-edged sword. In some cases, the existence of a track record can be useful when the project is risky technologically. It might be easier to communicate with potential investors. However, that same track record could be an impediment depending on the company’s history.
Reverse Merger? Sometimes
SPACs have become the path of least resistance for many space tech. However, there are conditions under which a more traditional reverse merger would be preferable.
For one thing, the relative newness of SPAC popularity points to an issue. Shell companies of any sort are a reputational hazard for some investors. Perhaps SPACs are acceptable in Space Tech, but the financial world has its own considerations.
Reputational risk is, for some, only sentiment. The very real issue that would-be public Space Tech companies need to keep in mind concerns money.
For SPACs, there is a redemption risk. Depending on the agreement, stockholders may have the right to take their cash back if they do not like the proposed merger. While there are ways to plug the capital gap that the redemption creates, this is a risk that simply does not exist by conducting a reverse merger.
While redemption risk can be mitigated, there are regulatory issues that separate the two routes by definition. Since a SPAC is a specific type of shell company, the rules for shell companies do apply. In particular, securities law applies to a new SPAC in the same way as for other shell companies, and it will need to wait for three years before being able to use a Free Writing Prospectus. Communications are restricted as well; in other words, how it presents itself and to whom is limited.
Moreover, stockholders of a public company after a reverse merger can resell their stocks under SEC Rule 144, whereas SPAC shareholders need to wait for at least a year after the filing of SEC Form 10 and also be up to date as far as other filing obligations are concerned.
What this means is that while a SPAC can be a simpler way of going public and might make sense if you’re a tech company with a solid team and little else to show for it, the more traditional way gives you more flexibility when it comes to money.
IPOs Are Not Going Away
Reverse mergers might seem to be an easy way to achieve a public listing. However, there are reasons why a traditional IPO is still the common route. The US Securities Exchange Commission is explicit in its description of the risks and what happens when lines are crossed. So, for a coward such as capital, the IPO is still the tried-and-true path, even when it’s longer and more expensive.
The SEC points out that anyone considering a reverse merger process should look at the track record of the companies involved. “Deal warts”, as existing or potential litigation is called, are a potential feature of reverse mergers that IPOs don’t.
A greater issue is the potential for accounting irregularities to surface. The SEC highly recommends reviewing the company’s SEC filings and to ‘be aware’ of companies that have not done so.
The SEC regularly suspends trading of companies after reverse mergers due to failure to file or for filing false information. Sometimes, discretion really is the better part of valour.
With three of the largest IPOs in US history – Snowflake, AirBnB, and DoorDash – debuting in the last four months of 2020 for a total of $11 billion, it’s obvious that the IPO is not dead. And with the Nikola meltdown after going public via a SPAC leaving the vehicle – both truck and financial – besmirched, it’s obvious that the SPAC is not a shortcut that can remove the risk behind investment into technology.
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