SPACs need more oversight and regulation
Well regulated, new approaches to public markets can get average investors back into the game.
By Chamath Palihapitiya
Originally published in Bloomberg on May 27, 2021.
Big Tech is known not only for being valuable and very profitable, but also for how much of that value was created in the public markets. Facebook, Apple, Amazon, Microsoft and Google raised less than $2 billion combined before going public — relying instead on public markets to finance their ambitions. As a result, average investors have been able to participate in those companies’ combined $4 trillion in gains.
Things have changed.
For example, early investors in Uber made billions of dollars as it grew exponentially as a private company. Uber raised more than $15 billion in that early stage. The first time the average investor could take a stake in Uber, however, was May 10, 2019, when the company listed on the New York Stock Exchange at a price of roughly $45. Two years later, Uber stock is up only about $6.
U.S. public markets, one of the greatest generators of wealth in the history of capitalism, should not exclusively be a place where early, connected investors get liquidity. They should be a place for all investors, on a level playing field, to participate in the growth of the economy.
Unfortunately, increased regulation for some kinds of investors with lax oversight of others, and increased disclosure for some with complete opaqueness for others, have created a market of haves and have-nots.
At the same time, the number of publicly traded companies has shrunk from approximately 8,000 to 4,000 over the past few decades. All of this has entrenched the advantage for insiders. The number of Americans invested in the stock market peaked in 2007 at almost 65%, a figure now barely above 50%.
Nowadays, when an innovative startup “goes public,” those who got early private-market access usually reap most of the rewards. I know how this system works, because I am a part of it and have benefited from it for a long time. But I also see how unsustainable it is.
The good news is that the markets have, as usual, adapted and transformed. In this case, via new avenues for companies to go public, including direct listings and special purpose acquisition companies. While direct listings are relatively new, SPACs have been around for decades. (My firm, Social Capital, is a SPAC sponsor.) Together, they are increasing the number of investible public companies and, when done right, give average investors access to potential high-growth companies at an earlier stage.
SPACs may seem opaque to some, as money is raised through an IPO before a takeover target is identified. In effect, it is a bet that the sponsor of the SPAC can find a high value company to “acquire” into the public markets. When done well, it is an opportunity to unlock a high-growth company’s access to the capital markets and give them the capital they need to scale for long term growth.
Like all IPOs, however, companies that go public via a SPAC are still a bet on the future. Some will succeed, some will fail. Everyone has to do their homework and make independent investment decisions. There was a lot of froth in the SPAC market by the tail end of 2020 and the first quarter of 2021, but the market is now telling us something that we should listen to carefully. As of May 1, of 406 SPACs seeking transactions, 21% were below their standard IPO price of $10. And of 127 SPACs that had announced but not yet closed a transaction, 37% were also below $10 per share.
This price action tells me we need more oversight and regulation. It is time to improve the regulations around the SPAC ecosystem with clear and rigorously enforced standards, to push for high deal quality and appropriate investor protections.
First, there needs to be better oversight on projections and underwriting. In order to do that, government regulators should require the principal who is sponsoring a deal to commit personal capital in it. This will force sponsors to underwrite accurate projections, since their capital will be at risk if the company misses their forecasts. Of the 127 SPACs that have announced but not closed on a deal, only 48 had some form of sponsor investment, with only 10 making long-term commitments to the companies. The best way to look at the legitimacy of a SPAC is to look at what the sponsor is investing.
Second, investors need more information and background around price discovery. The current process is set up to force different SPAC sponsors to bid against each other under tight time deadlines. This artificial feeding frenzy can often lead to less-rigorous diligence by SPAC sponsors. Requiring a more detailed outline of how each deal came together will give the market greater transparency into the dynamics that led to the pricing and valuation of a deal; and if there were multiple bidders, who they were and what those bids were. With more data around price discovery, SPAC sponsors can do a better job for themselves and for their investors.
Third, many SPACs raise additional capital in what’s called private investment in public equity. These so-called PIPE investors need investor protections and have the ability to change the terms of the deal if market conditions change materially. This will give greater power to PIPE investors and further help protect retail investors. These investor protections already exist in private-equity PIPE deals, and we need to see more of it in SPACs.
I understand why some insiders don’t like SPACs — for one thing, they make the starting line more even, and can give a large swath of investors access to the kind of high-growth companies the well-connected have been making billions of dollars off of for years. But in order for us to improve the fairness of the public markets, close the inequality gap, and prevent poor deals from tainting the broader value of companies having more access to public capital markets, we need to tighten the rules, increase disclosure and separate the wheat from the chaff.