Investor Chamath Palihapitiya raised $1.1 billion for cash-strapped entrepreneurs for a method he says is more lucrative, less risky, and faster than an IPO or acquisition
- Venture capitalist Chamath Palihapitiya said on the "20 Minute VC" podcast that he believes SPACs, or special-purpose acquisition companies, are a superior alternative to traditional IPOs.
- SPACs, sometimes referred to as "blank-check companies," can reduce the time it takes for a private company to go public, from 18 months to 90 days.
- Palihapitiya has raised more than $1.1 billion for two SPACs this year, and three major companies — DraftKings, Velodyne, and Virgin Galatic — have gone public via SPACs in 2020.
- Palihapitiya believes SPACs offer a quicker, more lucrative, less encumbered, and more bespoke alternative to IPOs and DPOs.
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Chamath Palihapitiya, the founder of Social Capital Ventures and a former executive at Facebook, joined Harry Stebbings' podcast, "20 Minute VC," on Monday to explain why his investment firm has begun to focus on special-purpose acquisition companies, or SPACs, rather than traditional IPOs.
Palihapitiya is not alone in speaking up about the flaws in the process that brings private companies to public markets.
Bill Gurley, a general partner of Benchmark Capital, has become a vocal advocate of direct listings, or DPOs, as an alternative to IPOs. And Eric Ries, author of "The Lean Startup," so strongly distrusts the motivations that propel investors that he has launched an entirely new stock market, the Long-term Stock Exchange.
Palihapitiya, an early investor in Slack, watched the company DPO and witnessed firsthand many of the challenges the process produced. "They are equally as burdensome in terms of time," Palihapitiya said, comparing DPOs to IPOs, "and equally litigious."
Palihapitiya believes that the problems surrounding the IPO and DPO processes stem from a failure to acknowledge a key reality: that the primary "customers" in the process of going public should be the founders and their employees, not financial institutions or investors.
As a result, Palihapitiya has become a champion of SPACs, which largely eliminate the need for a financial intermediary and keep the focus on the needs of the private company.
How a SPAC works
To create a SPAC, investors first raise money from individuals and institutional investors, such as banks, pension funds, and endowments. The creators of the SPAC, known as sponsors, then funnel the money into the "blank-check" company, which offers no businesses or services.
Sponsors then treat the SPAC like a company on its way to an IPO, registering with the Securities Exchange Commission and filing all necessary disclosures. At this point, SPACs typically have 24 months to find a company they want to take public; during this time, investor money sits in a trust where it earns interest. When the creators of the SPAC land upon a private company they want to take public, the SPAC then "acquires" and merges with the startup.
The nature of the process, argues Palihapitiya, offers a litany of benefits to private companies looking to go public.
They take less time
Because a SPAC puts in the bureaucratic legwork long before it decides on a company to acquire, when it comes time for the actual merger, the timeline is much shorter. Instead of an 18-month slog, a SPAC can bring a private company to the public markets in 90 days, says Palihapitiya.
Not only does this expedite a typically laborious process, it also reduces the amount of attention a startup needs to allocate to the ordeal, a welcome bonus for resource-strapped private companies. According to Palihapitiya, the "pre-baked" nature of SPACs is one of their primary appeals.
Founders can make more money
Avoiding an IPO can help founders get around a common problem: disagreements between them and the underwriters valuing the price of a share. Investors and banks want to underprice shares so they can buy low and sell high. For founders, that represents lost money.
According to Jay Ritter, a professor of finance at the University of Florida, over the past 10 years, $171 billion in value eluded newly public companies and accrued to hedge funds and other Wall Street insiders in the first 24 hours following an IPO.
When a private company merges with a SPAC, the two parties agree on a price-per-share determined by market value, reducing the risk of biased or inaccurate pricing.
They have fewer rules
SPACs largely avoid the arbitrary restrictions that pockmark the IPO process, which Palihapitiya calls "byzantine and broken." Typically, founders and employees with equity must wait 180 days before they can redeem shares, a measure known as a "lockup."
This waiting period delays payout and forces shareholders to sit on their hands while the share price fluctuates over the course of its first few months.
They allow for bespoke arrangements
The traditional IPO process involves months of document-preparing, countrywide-roadshowing, and financial-handwringing, all of which results in an opening bell followed by a wave of uncertainty. For all the work the gauntlet requires, founders receive little in terms of personalization or allegiance.
On the other hand, a SPAC is, at its core, a merger.
The private company can add a member of the SPAC to their board of directors, ask for guidance, or take advantage of their new partner's resources. The two parties are now equally invested in the long-term success of the company, which is not the case in a traditional IPO.
"It's very transparent," says Palihapitiya. "I didn't invent the SPAC, I just think it's pretty simple, first-principles thinking."
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