“meaningful” for a large investment fund. This subsequent investment changes
the average cost basis for the sponsor, of course, but they still benefit greatly
from the aforementioned “promote” aspect of the pre-acquisition ownership.
For some of biotech’s blue-chip crossover or later stage investors, being a SPAC
sponsor seems like a no-brainer in light of both the “juice” on the returns and
the guaranteed capital allocation. Plus it doesn’t require doing something
dramatically different than what they have already proven they can do: many of
these crossover investors are incredibly skilled at doing diligence and picking
great stories to help build and scale into the public markets.
So the benefits to a SPAC sponsor are very real. Let’s turn to the merger targets.
Alternative Path to Going Public
Today’s IPO market for biotech companies is obviously very strong, but it’s not
perfect – as I mentioned in the latter section of my recent blog post on the
structural changes to the IPO process .
While we’ve come a long way since the pain of the 2000s, the IPO process today
is really a two-step dilutive process with lots of exposure to risky market
volatility. It’s a two-step process because of how dominant the role of the
crossover round has become in recent years. Without crossover-insiders capable
of buying significant coverage of your IPO book, it’s hard to drive the euphoric
demand and over-subscribed sentiment common to hot IPO stories today. And
it’s very dilutive: sell 25-33% in the crossover round and then sell another 20-
30% in the IPO. Don’t forget to add the greenshoe dilution, too. That’s 50%+
dilution in a matter of a few months or quarters. And with the 25-40% first day
price “pop” that is customary in 2020 for many IPOs, the “money left on the
table” from both dilution and the price appreciation is not insignificant.
Further, the extended timeline of a typical IPO process, from the closing of the
crossover to the pricing of the offering, which means there’s significant risk
associated with both intrinsic (like pipeline news) and extrinsic (like macro
issues) events. This create risk around both the raise and the valuation.
At least in theory, a SPAC merger transaction to “go public” can address both of
these concerns.
Because it replaces the two-step of crossover and IPO, at valuations that
approach that of the IPO itself, there is often slightly less total dilution (10-15%
less), according to bankers familiar with IPOs and SPACs. For context, even
avoiding just 10% extra dilution would have been $3-4B of value for existing
private shareholders in IPOs this year – that’s not an insignificant figure.
And once a SPAC sponsor has done its deep diligence, and mutually agreed on a
merger with a target company, there’s a valuation discussion. SPAC price ​
discovery is largely a direct negotiation between the SPAC sponsor and the
target, which is why sophisticated later stage biotech investors make smart
SPAC sponsors – they know how biotech pricing in the market is
occurring. Further, the concurrent PIPE acts as an important source of price
validation, supporting the valuation negotiated by the sponsor. In contrast, while
in theory a biotech IPO is priced by a multi-day book-building process with
scores of investors putting in their orders, the reality is that IPO pricing is largely
driven by the pricing appetite of a few large accounts (which is not so different
than the SPAC after all). Plus IPO valuations can often be anchored by the
crossovers, who don’t want higher valuations as the IPO is where more of their
capital gets put to work versus the crossover round (as discussed in the last
section of this recent blog ).
With a specific valuation mutually agreed for the merger, there’s a clear albeit
complicated timetable for closing the deal and trading as a public company (aka
the “de-SPACing” process). For a merger target, both the timeline to being
public, as well as the pre-specified scale of the valuation and capital raise, are
better “controlled” in a SPAC process.
Importantly, another feature of some SPAC negotiations that is favorable for
merger targets is the concept of earn-outs. To bridge the bid-ask spread on
valuation, a merger target might accept some of future equity milestones if the
pipeline delivers more than the SPAC sponsor expected, or if certain price
targets are met. These types of future value concepts aren’t available in a
traditional IPO process.
There are a lot of other wrinkles with a SPAC, including the redemption
possibility during the de-SPACing process (i.e., IPO investors can get their money
back before the acquisition closes if they don’t like the deal), so they aren’t for
everyone. And these complexities need to be understood before embarking on a
SPAC path. We actually had a SPAC biotech deal fall apart back in 2008, the last
time SPAC’s got frothy, when Dynogen Pharmaceuticals wasn’t able to get
shareholder support for it’s merger with Apex BioVentures.
It is worth noting that times have changed a lot since the SPAC bubble of 2007-
2008. Until recent years, SPACs were largely considered a “dirty” financing with
oddball investors. Today, the quality SPACs are full of some of best biotech
investors in the business, so any negative stigma that was around is certainly no
longer in place. The strength and breadth of the investor base is critical to the
success of any IPO route, including SPACs.
Importantly for management teams and biotech Boards, SPACs simply provide
more options: it’s great to have another strategic path for accessing public
market capital beyond the traditional IPO process. What was once commonly
called a dual-track process (S1/IPO and M&A) might now become a “three-track
process” that includes exploring SPAC options for many aspiring biotechs.
What kind of biotech should look for a SPAC acquisition?​