Unicorn companies have evolved from a rare occurrence to the new normal over the last decade. This has had a ripple effect on the capital markets, initially resulting in a lull in the IPO market as companies chose to stay private longer. This pipeline of private companies became filled with a stampede of unicorns and decacorns (companies worth at least $10 billion) which eventually made the move to go public with record-breaking IPO activity. Now, we are seeing a shift as the timeline to go public shortens.
The JOBS Act, enacted in 2012, was intended to make it easier for companies to go public by creating the emerging growth company (EGC) designation. However, it instead ended up creating an avenue for companies to stay private longer.
That was due to one of the less-discussed changes in the JOBS Act that increased the long-standing 500-shareholder threshold. That threshold required companies with 500 distinct shareholders to file publicly available financial statements with the Securities and Exchange Commission. With the enactment of the JOBS Act, the 500-shareholder threshold was increased to 2,000 shareholders and simultaneously removed holders of share-based awards from the assessment. As a result, private companies were no longer forced, or at least nudged and incentivized, to head toward the capital markets.
Two other factors played a significant role in the longer timeframe to pursue an IPO: 1) capital was widely available in the private markets and 2) there was a general change in mindset with boards and CEOs of private companies around staying private longer, and in some instances as long as possible, before going public and incurring the rigor that comes with it. Fast forward to today, and it is not a surprise that we have a “glut,” granted a plentiful and healthy glut, and an acceleration of capital markets plans among many companies.
A New Wave
The pipeline of disruptive, high-growth companies continues to grow from a select club of several dozen unicorns to a thriving crop of more than 900. This glut of disruptors in the system is driving the market reset.
Many high-growth companies are stuck behind the glut in need of a route to access capital to compete in an aggressive market. Unicorns tend to disrupt their industries. As such, when the “standout unicorns” ($7 billion-plus valuation) become public, they command so much attention that they raise the standards to pursue a successful IPO. This backdrop shifts the focus for more “traditional unicorns” and high-growth emerging companies to select alternative paths of capital raising.
The question of going public has turned from if? to when? to how soon? with no signs of slowing. Based on our pipeline, combined with recent filings, we anticipate more than a dozen crown jewel IPOs — standout unicorns — will dominate the IPO pipeline over the next year. The IPO is still a transformative event for companies that have the scale to take that route successfully. These transactions attract institutional and retail investor attention and position a company for future growth through M&A and additional offerings.
Investors are turning their attention beyond standout unicorns and becoming interested in promising companies at the traditional unicorn and emerging growth companies’ level. With a need for new mechanisms for capital infusion firmly established, the best solution — for institutions, companies, and individuals — might be found in the burgeoning special purpose acquisition company (SPAC). Last year’s SPAC market experienced volatility that culminated in a frenzy of retail investors flooding the market, on top of the “smart money” of the private investments in public equity (PIPE).
SPAC sponsors have a finite timeline to deploy their capital to support a disruptive idea or product. The financial structure of SPACs is a venture capitalist and private equity microcosm. There will be variation in the types of companies, and their returns, along the way. Each investment will inform the other in terms of criteria and expectations for the return on investment (ROI), and due diligence may be needed on all transactions.
Institutional investors have remained steadfast in their support of SPACs as potentially transformative distribution models. Newer market entrants, particularly in the software and cloud space, have accelerated growth in the past year. This shift to tech enablement catapulted the trajectory of software companies. To further compete and grow, they need capital — quickly. Overall, the SPAC deal flow outlook is quite positive and consists of myriad disruptive companies in multiple sectors. There is significant pent-up demand in the pipeline, with more to come from around the world.
The PIPE Window
In recent months, the frenetic activity of 2020 and the first quarter of 2021 has tempered — for now. This may be explained by two factors:
1) Regulatory announcements prompted a recalibration and slowed deal flow. However, as clarity on the rules evolved, more companies have resumed filings and their merger activity.
2) There is a window of opportunity for SPACs, just like the IPO market. The window is largely reliant on the PIPE market, the smart money aforementioned. It is natural for the PIPE to be cyclical. For example, in September and October 2020, the PIPE market softened due to the presidential election. It then returned more robust than ever in January through mid-March 2021. Going forward, we expect the PIPEs to be back with a vengeance at some point. There are three benefits of the PIPE in a SPAC deal:
1) A backstop to redemptions;
2) Deal upsizing; and
3) Validation of the SPAC deal.
When the window is open, PIPEs are very strong for a finite 10 to 13 weeks. To be positioned to capitalize during the PIPE window, companies must get financially prepared. That involves ensuring an audit is conducted and approved by a firm approved by the Public Company Accounting Oversight Board. If the audit is not finished within the open window, the company may need to prepare for the next opportunity. Given the reliance of SPACs on PIPEs, financial readiness and hitting the open window is paramount to SPAC formation.
Barrett Daniels is U.S. IPO services co-leader and West region SPAC leader at Deloitte & Touche LLP. Will Braeutigam is a partner and national SPAC execution leader and Vibhor Chandra is accounting and reporting advisory senior manager and U.S. IPO and SPAC services national team member, both also at Deloitte & Touche LLP.
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