IPO 2.0 — SPACs

Sources: Jay R. Ritter, Warrington College of Business Administration, University of Florida; University of Chicago Center for Research in Security Prices
Source: World Bank

So, what happened with all the other high-profile private companies?

Once upon a time, selling shares to the public was an important way for companies to raise money — and for early investors to cash out. That’s was not the case in the last decade.

Sources: Jay R. Ritter, Warrington College of Business Administration, University of Florida; National Venture Capital Association. Data for 2016 and 2017 are adjusted to match previous years, which exclude unsuccessful deals.

“We are, make no mistake… we are in the middle of an enormous multivariate kind of Ponzi scheme” — Chamath Palihapityia, 2018.

This scheme can be described as venture capitalists pushing the valuations of private companies via follow-up round to increase their IRR to raise further money from Limited Partners for the next fund. On paper, the investors and Limited Partners experienced massive gains. Unfortunately, when some companies became too large and tried to IPO. The whole house of cards failed e.g. WeWork.

It reminds me of Wall Street going up to 2008. The idea was, ‘As long as someone wants to buy this [collateralized debt obligation], we’re good.’ Nobody is thinking about: Is this a good product? — Tim O’Reilly, 2020

VCs have created more financial instruments similar to CDOs than profitable companies. They stopped thinking about whether this company could survive on revenue from its customers. Deals are designed entirely around an exit.

Source: “A Bottom-Up Approach to the Risk-Adjusted Performance of the Buyout Fund Market,” by Jean-François L’Her, Rossitsa Stoyanova, Kathryn Shaw, William Scott and Charissa Lai *Adjusted for size, sector and leverage.

“A huge amount of the VC capital doesn’t return. Everybody just sees the really big wins. And I know when they happen, it’s really wonderful. But I think [those rare wins] have gotten an outsize place, and they’ve displaced other kinds of investment. It’s part of the structural inequality in our society, where we’re building businesses that are optimized for their financial return rather than their return to society.” — Tim O’Reilly, 202)

A new type of businesses

Building businesses should be more optimized for their return to society rather than their financial return.

“One of the notable aspects of compound growth is that the furthest out years are the most important. In a world where almost no one takes a truly long-term view, the market richly rewards those who do.” — Sam Altman

So, what kind of method exists to change this paradigm?

Let’s talk about SPACs, baby!

Special-purpose acquisition companies, also known as SPACs, once a last resort for owners looking to exit an investment, have become a popular choice for private companies spooked by the swings in the regular IPO market. The volume of SPAC deals hit an all-time high in 2019 and the trend is getting more accelerated in 2020.

Source: Spac Insider

IPO 2.0

One of the leading investors that have labeled SPACs as “IPO 2.0” is Chamath Palihapitiya. He has brought with his company Social Capital Hedosophia I. ()Virgin Galactic (SPCE) to market. Their mission is the following:

“Our mission is to create an alternative path to a traditional IPO for disruptive and agile technology companies to achieve their long-term objectives and overcome key deterrents to becoming public” (Social Capital Hedosophia)

Social Capital Hedosophia is offering in the process: operational excellence, broad, global reach, efficiency.

“We believe that a more streamlined and transparent path to the public market will encourage private companies, in the technology industry in particular, to go public while allowing them to remain operationally focused on long-term value creation. As a result, public market investors can gain more near-term, direct investment exposure to long-term technology themes.” (Social Capital Hedosophia, 2017)

In the recent downturn around February/March, Social Capital Hedosophia filled for IPOB, raising $414 million, and IPOC, raising $828 million. Here are a few reasons why these two vehicles offer a great investment opportunity:

  1. The public market is flooded with new investors and currently, it seems that it is decoupled from the common economic reality. There aren’t that many obvious opportunities for a 10x return on investment. While public companies have access to secondary offerings and bond issuance, private companies are facing unprecedented challenges and need cash right now. Startup funding has dried up. It would be worthwhile to go public with the right support.
  2. Chamath Palihapitiya is able to close a valuable deal for its shareholders and taking a private tech company public. He has vast experience building successful tech products for AOL and Facebook and showed his ability in identifying amazing investment opportunities at Social Capital. During the first 8 years, the fund's performance from 2011 to 2018 was 32.9% (IRR) in comparison to the 15% of the S&P500 (including dividends). During this time, he also managed to identify great investments like Slack (Work), Telsa (TSLA), Amazon (AMZN), Bitcoin, and Golden State Warriors. His investment decisions are unconventional and thoughtful. He as a sponsor has significant capital at risk if he doesn’t close a deal and makes the company long-term successful.
  3. We are at the beginning of a technological revolution not at the end. We need to focus on frontier technologies. Focus on healthcare, climate change, and education (while we are moving to become a more resilient society). You want to support the process of IPO 2.0, where long-term investors are being rewarded and not short-term thinking investment banks. Companies receive permanent capital to move forward with further R&D.
  4. You are rewarded with a one-third of a warrant for each unit of IPOB.U or IPOC.U. This enables you for further upside and rewards your patience. The additional return of investment in the case of Virgin Galactic (SPCE) reached 40% via holding the warrant until redemption.
  5. Investing in IPOB.U or IPOC.U has no principal risk because the money is held in a U.S.-based trust account at J.P. Morgan Chase Bank, N.A., with Continental Stock Transfer & Trust Company acting as trustee.
  6. There is a huge appetite for real venture capital investments. Retail investors and family offices are looking for anticorrelation and exposition to real alpha during the current pandemic and economic crisis.

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