SPACs are threatening Silicon Valley's famous startup lifecycle of failure

  • Special purpose acquisition companies are booming, and there are more than 400 looking for targets.
  • As SPACs fight for deals, they may take some low-quality startups public. 
  • Before the SPAC craze, those startups normally may have taken vulture funds’ money or just died.
  • See more stories on Insider’s business page.

In 2019, WeWork tumbled from initial public offering talks to near bankruptcy in six weeks.

A year and a half later, the real estate company is again set to go public, this time by merging with a Shaquille O’Neal-advised special-purpose acquisition company in a deal announced Friday. 

For WeWork and its backers, the public listing is a tale of redemption. For critics, it’s the latest evidence of an overheated SPAC market. 

But a more fundamental question, perhaps not yet fully appreciated, is what the SPAC boom means for Silicon Valley’s vaunted startup ecosystem, where failure is considered a vital component. By offering an alternative route to raise capital from the public markets, SPACs provide a lifeline for promising innovations to grow into a business, but they might also serve as a form of artificial life support for troubled or problematic startups. 

Multiple SPACs approached WeWork in December, CEO Sandeep Mathrani said Friday on CNBC.

“Sometimes you don’t pick the path; the path picks you,” he said. 

The interest in WeWork reflected the acquisition mania for the 435 SPACs currently searching for targets before their clock runs out and they’re forced to return investors’ money. 

Academics and regulators, among others, are concerned that SPAC sponsors may sacrifice quality for the sake of getting a deal done amidst such competition. Already, the SEC is investigating at least a trio of companies that went public via SPAC: health insurance startup Clover Health, electric truck company Lordstown Motors, and electric car company Nikola. 

Some people have joked on Twitter that even Theranos might have gone public via SPAC if only it had  been founded a few years later. 

The lessons of failing

Silicon Valley lore is full of examples of entrepreneurs whose failures led to crucial lessons that ultimately led to game-changing new products. Jeff Hawkins, one of the creators of the Palm Pilot, began working on the pioneering handheld computing device after his previous company Grid Computing didn’t catch fire. Twitter and Slack were both born amid the failure of other startups its founders were involved in. 

In the current environment of cheap money and SPACs, the risk is that these lessons won’t happen to the same degree.

Underpinning SPAC mania and the ever-increasing flood of private markets money are prolonged record-low interest rates, said Andy Moore, the CEO of B. Riley Securities, an investment bank that’s sponsored multiple SPACs.  

“I would suggest SPACs — and their recent growth and prominence — are simply one instrument through which the Fed’s zero interest rate policy has manifested itself,” Moore told Insider. “SPACs or no SPACs, in the world where capital is costless, startups will persist for far longer than they might otherwise.” 

In the venture capital business that underpins Silicon Valley, failure is part of the model. VCs who scout the field for startups to fund expect that some of their picks will fail because they assume that the runaway hits will more than offset the duds. Masyoshi Son, the CEO of SoftBank, said last year that 15 of his Vision Fund’s 100 companies might not make it. By that yardstick, the Vision Fund’s portfolio has held up pretty well throughout the pandemic, with just two companies that have filed for bankruptcy, while others have gone or plan to go public via SPAC. 

Competing with vultures

Some SPACs are competing with investors in distressed assets to find troubled companies that need a lifeline, further illustrating how some companies coming to the public market are of a different grade than those passing an IPO roadshow. 

Adam Cohen, who runs the credit-focused hedge fund Caspian Capital, told Insider earlier this month that he sees SPAC mania ending “in tears.” His firm was evaluating at least a dozen different names in the distressed space that have been taken public by SPACs over the past half year, allowing these companies to refinance their debt thanks to the equity infusion.

“We’re extremely mystified, slash angry, slash jealous of it,” he said.

George Schultze runs Schultze Asset Management, a $200 million hedge fund that goes after distressed opportunities. He launched a SPAC at the end of 2018 and took Clever Leaves, a cannabis company, public in December in a $205 million deal.

He told Insider earlier this month he viewed the SPAC as an extension of the investment strategy he was already running.

“There’s a lot of overlap,” he said. “There are a lot of companies we look at day to day that could use a SPAC solution.”

Lots of lottery tickets, very few big winners

Academics are still making sense of the evolving SPAC boom. There’s some evidence showing SPACs can indeed provide the fuel to ignite a startup’s growth — as well as evidence that bad companies will still be bad companies even after getting a SPAC lifeline.

A recent working paper from a University of Illinois professor and two Harvard professors found that compared with companies from 2003 to 2020 that went public via IPO, those that agree to a SPAC “are riskier, but have higher or similar growth rates.”

The SPAC targets were smaller and had lower revenue when they went public. Several years later, they had similar or higher growth rates to those that took the IPO route. 

But patterns are also emerging that show which startups will remain duds, even after reaching the public markets. via a SPAC. Deals done at the end of a SPAC’s lifecycle tend to underperform, much like in private equity, said a March working paper from a University of South Carolina professor and a pair of University of Florida professors. 

When businesses underperform or go belly up after merging with a SPAC, Silicon’s Valley’s failure formula still occurs — just with a delay. And that leaves public investors, rather than VCs, holding the bag.

Josef Schuster, whose firm created created the IPOX SPAC index, noted that long-term research on IPO performance shows that underperformance is driven by smaller companies – exactly the kind set to hit the US in droves via SPACs. 

“Amongst those many lottery tickets, there will only be very few big winners,” he said.

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