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Chamath Palihapitiya on Why SPACs Are (Usually) Better Than IPOs

By Keith Speights - Jan 22, 2021 at 6:11AM

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Special purpose acquisition companies offer several distinct advantages over IPOs, according to this successful venture capitalist.

In the past, most companies that wanted to go public conducted initial public offerings (IPOs). Recently, though, the use of special purpose acquisition companies (SPACs) to take companies public has become popular. One of the leaders of this trend is Chamath Palihapitiya, venture capitalist and CEO of Social Capital. In this Motley Fool Live video recorded on Nov. 16, 2020, Tom Gardner, co-founder and CEO of The Motley Fool, and Bill Mann, director of small cap research, talk with Palihapitiya about the advantages that SPACs offer over direct IPOs.

Tom Gardner: [MUSIC] Well, we're really looking forward to this next 90 minutes together, so I guess we'll start with some quick introductions. We did call out Vivek and Andrew and Chamath, and your roles are, Co-Founder of Clover Health (NASDAQ: CLOV), and Founder, CEO of Social Capital, and Chief Technology Officer, President and Board Director of Clover Health.

You're stuck with Bill and I. We don't really have any great titles to offer. We haven't really gotten out there in the awesome ways that you all have, though. We're really excited to talk about SPACs, Clover Health, and investing in general. I think the best opening question for everyone out here today is just a quick definition of SPAC. Probably we all know it by now, but obviously it's an exciting development most, so much in the last year. So -- definition of SPAC and how it's different -- better or more special than IPOs?

Chamath Palihapitiya: Yeah. I guess, I can take that. SPAC is a special purpose acquisition company. So what is it? It's basically a group of people. The leader of that group of people is called the sponsor. In my case, it's myself and I have a handful of partners that I consistently work with in these things. We file an S-1 and go through a traditional IPO process, except that what we are describing in the S-1 is essentially a company that has one asset, just money. It doesn't make a product, it doesn't sell anything.

Then the purpose of that vehicle is in the business of finding another company to acquire. Whereas Google's S-1 would have described a search engine in the business of acquiring users and providing them relevant information, etc. Ours is a shell company, a balance sheet of cash which we then use to go and find the business that we think is really compelling and interesting.

We can describe that interest on many dimensions. It could be geographical, it could be about a specific vertical. Then we go and we buy that company. When we do that, it's effectively a merger. So for the company that we acquire, they go public by being acquired by us. What it does is that it allows them to actually write an S-4 document together. By writing an S-4 versus an S-1, we are covered under a different body of securities law that's enforceable by the SEC. The major differences there for the purposes of the viewers, of the listeners, is essentially that it allows you to talk about the future.

The reason why I think that single thing is such an important feature for SPACs and why SPACs are really important part of building a modern portfolio, is that in a world of zero rates, I would put out there that everything is about the future, and that you need to be really understanding the potential of a company's performance in 2023, '25, '27, '29, 2030 even. Those future cash flows, especially for technology companies, are very poorly described by looking at the past. So 2016 through 2019 don't really mean much for 2025's earnings. That's not true for other businesses, but it is very true for tech businesses.

So the S-4 process allows Vivek and Andrew, myself, the ability to really understand the business, underwrite the future for many years out, then have a conversation with people who may potentially be interested in buying it about describing that future performance and then give folks the chance to buy. There's a bunch of other secondary features that I think SPAC gives. It allows retail, much better access to growth and growth investments than traditional IPOs do. It provides certainty of price.

So I think there's a lot of other things that it gives you. But the first thing that I described, bringing forward a shell and then acquiring a business so that you can talk about that business's future prospects, is probably the single distinguishing feature that I think matters.

Tom Gardner: Is there a situation that you can think of where an IPO is a better process than a SPAC at this point?

Chamath Palihapitiya: Absolutely. I think that there are three legs of a capital market's tool now for liquidity: there is the traditional IPO, there is the direct listing process, and there is a SPAC process.

Last year, I went through both the direct listing. I was the Series A investor in Slack (NYSE: WORK). We listed through direct listing and I bought Virgin Galactic (NYSE: SPCE) and brought that company publicly aspect. What I would tell you is that the IPO is incredibly powerful for businesses whose cash flow characteristics are relatively predictable, last year, to date, to next year -- frankly, more importantly, who probably are better off being judged by the past than on being forced to produce a forecast and be talking about the future.

I think that there are many companies for whom that process then is probably the best. There are many companies in private equity portfolios that probably fall into that category. I think the direct listing is really good for a company that has a really great brand, whether it's institutional buy-side investors or retail who identify with that brand and would want to be associated with it. Spotify (NYSE: SPOT) and Slack are great examples. Recently, Palantir (NYSE: PLTR) and Asana (NYSE: ASAN) are others, and I think there could be many more over time.

Now, there's some rumblings that it could change, but the key feature there is that you don't really need any money. You're not trying to raise any capital, you're just listing the shares. Then I think, the direct listing, though, just pales in comparison, and the IPO pales in comparison to the SPAC, which is singularly the best for any company whose best growth is ahead of them.

Bill Mann: I was going to ask if you thought that it might change. The SEC is talking about allowing companies to raise capital along with the original listing of the security. Do you think that that would change the calculus a little bit, not necessarily for you, but for people who are going into the public markets in general?

Chamath Palihapitiya: I think actually, what it's going to do is it's going to exacerbate the principal agent dilemma and the comfort that exists in the public markets. I think what we have is the beginnings of the rebels storming the compound. We have an entrenched orthodoxy of people that have helped keep other rich people rich for a really long time. If you want to talk about what's really exacerbated the inequality gap, it's been that. I don't think it's necessarily that Mark Zuckerberg shouldn't have been rich. I think it's just that the return stream that is available to normal ordinary folks is just not the same as if you're a qualified investor or if you have a foundation or access to hedge funds, if you're part of the entrenched aristocracy.

Underneath that, is a massive principal agent conflict, and I think the IPOs are riddled with them, and I think the direct listings are riddled with them. Because fundamentally what you are not having is an individual or group of individuals who are personally underwriting an outcome with their own capital.

While you have a people who want to optimize for velocity of transaction, the minute that happens and your taxing and you make the same money, no matter the outcome, you're going to have a whole bunch of crappy outcomes. Or, the best outcomes are only going to go to the favorite few where the banks have, for example, great prime brokerage relationships where they're making hundreds of millions of them on trading fees and margin and other things. Those are their real customers.

I think it's just going to further shine a light on the principal agent conflict that exists in the capital markets and how it entrenches returns to the few. Whereas I think what's SPAC do, at least some, when they're executed correctly breaks the principal agent conflict, creates an access to return stream that otherwise wouldn't be available to ordinary normal folks, and starts to make the principal agent conflict more balanced and tilted more toward the principals.

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