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    How to fix SPAC: Keep your backers closed for a long time

    Business Inquiry

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    In the summer of 2019, billionaire venture capital investor, Chamath Palihapatia announced that his public shell company would merge with Richard Branson’s spaceflight business, Virgin Galactic.

    It had become a Wall Street phenomenon, using a specific purpose acquisition company – known as an SPAC or Blanc-Czech firm – to make a private business public, the initial initial public Bypassing the offering process.

    With his usual bravado, Mr. Palihapatia compared Virgin Galactic to Tesla on the day the deal was announced and forecast that it would “reach profitability in mid-2021 and should achieve real scale by ’22.” The company published an illustrated presentation for investors with financial projections up to 2023.

    Mr. Palipatia sold the deal to public investors – many of whom were mesmerized by his words and the future of space travel – by investing in his own $ 100 million business, demonstrating his commitment to the company’s future. .

    Yet this past month, he sold those shares without warning all investors who followed him into the stock. “I hated to do it, but my balance News shrunk by about $ 2B this week,” he said Wrote on twitter. He Virgin holds a significant stake in Galactic through its holding company “sponsor” stake, which the founders of an SPAC receive in exchange for putting the deal together and making a small investment.

    The sale portrayed an inconvenient truth about SPACs that are changing the financial world: investors and celebrities who put their names behind the next big title-grabbing merger, long before any of them got out. Or in many cases, missed. (Virgin Galactic’s flight timetable has slipped, forcing it to revise its forecasts.)

    “This is an incredible experiment,” said Stanford Law School Professor Michael Klassner, whose research found that public investment in SPAC after the merger has been underestimating traditional IPOs on average over the past decade, While the sponsors have made 400. Percent return.

    Mr. Palihapitiya’s commitment to his SPAC deals far exceeded the commitments actually made by his peers; He agreed to lock in his sponsorship stake of Virgin Galactic for the first two years of the deal (which expires in November) and initially invested his own funds.

    But in reviewing hundreds of deals, many of SPAC’s sponsors appear to be planning to rush to the exit, and they rarely invest their own money.

    Most of the hundreds of deals contain language that prevents sponsors from selling for only one year from the day the deal was completed, and many involve a forgery. SPACs typically price their shares in an IPO at $ 10. After SPAC merges with another company, if its shares trade more than $ 12 for more than 20 days in a 30-day period, the lockup provision disappears and the sponsors want to sell independently . (The rationale of this provision is that if the stock is 20 percent higher then the sponsors have done their job.)

    To Mr. Palipitia’s credit, many of the lockup arrangements on his SPAC deals require him to hold at least 50 percent of his sponsor stake until the share price falls to $ 15.

    The ability to build sponsors, suggesting that they do not intend to become long-term investors, is just a point of view by some critics – an example of this – often not of the interests perceived by retail investors – in various SPAC deals. Between investor classes.

    Perhaps there is a fix: what if sponsors were required to hold their shares, including any investments made at the time of the deal, for the entire duration of the financial projections that helped sell the merger?

    In other words, if a company makes a financial estimate for five years, the sponsor is banned from selling for five years. If the estimates are for one year only, the sponsor must hold the stock for only one year. This rule would align the interests of sponsors directly with those they are selling to the public – the company’s future vision.

    Financial projections are a particularly unusual feature of SPAC. When a company goes public through an IPO, the law limits it from making meaningful financial projections, so investors should rely on the company’s past performance based on how much stock it holds. Partly, the intent is to help small investors avoid pie-in-the-sky forecasts.

    But because the public is technically merging through an SPAC, companies are free to make financial forecasts. And they do – a lot of them – because most SPACs merge with early-stage companies that have no profit and, in some cases, no revenue, either. The entire selling point to investors is not what the company plans to do in 12 months but what it can do for several years in the future.

    Lynn E., former chief accountant of the Securities and Exchange Commission. Turner called the proposed fix “an excellent idea”. Because the sponsors are advertising “what are we going to do here in this time period”, they said, “They should be locked on that.”

    Mr. Palihipatia was less enthusiastic.

    “That’s not a very good idea,” he told me. “Why would a sponsor agree to a five-year lockup when management does not, nor do other investors, including PIPE investors?” (At the time of the deal, institutional investors are often invited to buy shares with favorable terms through public terms, or private investment in PIPE.)

    this is true. Management can usually sell shares after a short restricted period. But, as Mr. Turner pointed out, isn’t it the sponsor who is selling the deal to the public?

    “What if management lied?” Mr. Palihipatia argued. “Should the sponsor now give the hook for management’s bad behavior?” He Said that “there are too many corner cases where it fails.”

    Mr. Palipitia said he has a better idea: “Invest at least 10 percent of the deal size to the sponsor,” which is far higher than most sponsors. “The more they invest, the more they will need to check the projections,” he said. “This has been the only meaningful way to align sponsors, management and investors.”

    In some ways, the market is already forcing some sponsors to agree to a longer lockup. Michael Klein, a former banker who has become a serial SPAC deal-maker, recently agreed to hold his stake in Lucid Motors, a high-flying electric vehicle manufacturer, to seal the deal for at least 18 months. As a way of.

    And with more and more SPACs losing their luster – most SPACs that went public in recent weeks are now trading below their offering price – investors may demand more from sponsors, perhaps even before regulators.

    But, in the end, investors should not ask sponsors for their own deals.



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