With nearly 200 SPAC IPOs in the first two months of 2021 alone, it’s clear that 2020’s SPAC boom wasn’t a passing trend. There were 248 SPAC IPOs in 2020, which raised over $83 billion, a significant increase over the 49 offerings in 2019.
SPACs, defined by Investopedia as “a company with no commercial operations that is formed strictly to raise capital through an IPO for the purpose of acquiring an existing company,” have not traditionally been a popular target for private equity. But lately, more PE investors are jumping on the bandwagon, including high-profile firms like Apollo, Solamere, and TPG. Several private equity-backed companies went public via SPAC last year, reports Institutional Investor.
Why is PE interested, and how, if at all, will this trend impact the lower middle market?
Why the PE interest?
Like the traditional PE process, SPAC sponsorship involves raising capital to complete a future takeover. The structure and methodology obviously differ from there, but for seasoned and sizable firms, the challenge isn’t insurmountable.
For PE, there can be clear benefits to directing resources to SPAC activity rather than LP fundraising. Most significantly, sponsors typically take 20% equity in the vehicle, in exchange for a capital outlay that is well below the post-offering market price of that share. This provides a huge opportunity for liquid returns over a relatively short timeline, with substantial built-in downside protection. It can also be easier to raise capital: PE firms that sponsor SPACs also open their doors to a wider base of investors (i.e., all public market capital), many of whom don’t share the sophistication of a typical LP and don’t require the same time commitment to acquire and service.
Once the de-SPAC has been completed (after the target company is announced), these investments are much more liquid than a traditional PE asset. While it might not be feasible to unwind all at once, the asset is still a publicly-traded entity at that point. You don’t need to find a strategic buyer to exit if there are numerous institutions ready to purchase blocks and a sea of enthused retail investors buzzing around.
The SPAC world further advantages private equity firms with a history of exiting through IPOs. There are numerous legal, regulatory, governance, and accounting hurdles to clear when listing for a public offering. These requirements can be daunting to meet within a SPAC timeline, so sponsors with experience bringing portfolio companies to public exits are very attractive partners to acquisition targets.
Where does the lower middle market fit in?
There are significant hurdles to SPACs in the lower middle market landscape. LMM firms don’t operate at the scale typical of SPAC transactions, and have less experience with IPOs. Ultimately, smaller shops might not have the bandwidth to effectively join in on the sponsorship craze — especially as competition heats up among a motley collection of investors ranging from PE and VC leaders to eccentric billionaires to sports data analytics pioneers.
What’s more, with increased competition and regulatory attention, the de-SPAC process — already not for the faint of heart — appears to be growing even more complex. For smaller firms, this adds risk and expense, pulling valuable resources away from other investments. For these reasons, it seems the SPAC sponsorship trend is for the moment more suited to larger organizations. On the investment side, LMM shops with the ability to engage in PIPE transactions might find some opportunities by helping SPACs bridge the capital gap to take over their targets, but this too comes with its own set of operational challenges for the uninitiated.
However, middle market firms may still benefit from the SPAC trend. The rising popularity and volume of these vehicles (which each have a limited amount of time to deploy capital) should drive overall valuations higher, improving returns for all investors.
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