If 2020 was the year of social distancing and being private, then I believe 2021 is the year of going public. This year has already seen 250 initial public offerings. That’s 191% higher than the same time in 2020, according to CNBC. More investors are diversifying their portfolios into direct investments through public offerings, and companies are raising enormous amounts of money at unthinkable valuations.
Every business leader must carefully evaluate all options available for capital formation. Back in 2017, I had an opportunity to lead a company to NASDAQ. We considered an IPO and merging with a special purpose acquisition company, and, finally, we decided to go ahead with NASDAQ. Each capital formation strategy has its own pros and cons. Legal, procedural and capital constraints must be weighed to decide which path a company should eventually take.
Initial Public Offerings
The traditional route to taking a company public is to go through an IPO. However, IPOs can be time-consuming and expensive endeavors. They have to be underwritten by an investment bank, scrutinized by the Securities and Exchange Commission and extensively marketed to ensure shareholders see demand for their shares. Only after all of that does the offering actually go public. Additionally, IPOs come with certain restrictions such as lockup periods, and they can open shareholders to much steeper price volatility, as seen in Airbnb’s share price since its December IPO.
The brand image and funding advantages typically outweigh the hefty time and financial expenses associated with IPOs. In my experience, public companies typically have an easier time raising more funding, securing debt and seeing a higher valuation than their private counterparts. But in the best-case scenario, IPOs take five months to conduct, and investment bankers aren’t always known for their affordable rates, either.MORE FOR YOUThe LSE Alumni Turning Their University Into A Startup PowerhouseFour New Microsoft Surface Computers Plus A Folding Phone—And Other Small Business Tech News‘We Can Control Our Own Destiny’: John Zimmer Shares Lyft’s Vision For The Company’s Future And $1 Trillion Market Opportunity
Special Purpose Acquisition Companies
A special purpose acquisition company, SPAC for short, is a corporation created for the sole purpose of bringing a private company public. The SPAC is listed publicly but does not have any operations or assets of its own. Instead, the SPAC will purchase a private company, effectively taking that formerly private company public. The catch is that investors in the SPAC don’t identify which company the entity is targeting to acquire. So, it makes sense that SPACs are sometimes referred to as “blank check companies.”
SPACs have been around in some form since the 1990s. However, it wasn’t until recently that SPACs really took off. This method to go public was typically seen as a last resort option. Now, they’re widely viewed as a clever workaround for the challenges often associated with IPOs. However, since the entity’s success is entirely dependent upon its acquisition target, it’s important to have full faith in the management team.
One person who I believe has lots of faith behind him is William Ackman. His SPAC, Pershing Square Tontine Holdings, raised $4 billion in 2020 and is the biggest blank check company. Ackman’s fund tried to acquire 10% of Universal Music Group earlier this year, but the deal fell apart "after discussions with the U.S. Securities and Exchange Commission," CNBC reported. Earlier this year, Elon Musk also caused speculation on whether he supports SPACs when he tweeted “Green eggs & SPAC.”
You might get the impression I’m anti-SPAC. Truthfully, I’m not. Like any other financial vehicle, they have their pros and cons. Virgin Galactic went public via a SPAC. That gave the company the cash injection it needed to continue innovating in space flight. Draftkings also went public in 2020 through a SPAC.
So, we found a way to make going public quicker and cheaper. But from my perspective, SPACs are sort of the financial vehicle equivalent of buying a mystery box, which means they may not be the best investing strategy for everyone. What if you want something with more SEC oversight than a SPAC but smaller than an IPO? Is it possible to have a mini IPO?
In 2015, the SEC introduced Regulation A filings as a part of the JOBS Act. Regulation A filings, referred to as "mini IPOs," allow companies to raise up to $20 million under Tier I and $75 million in a year under Tier II. By filing for Regulation A with the SEC, private companies essentially are able to raise public dollars while still remaining private. It’s not the wild west, though. A company still has to meet certain eligibility requirements, and in Tier II, there are limits on what non-accredited investors are allowed to invest.
In my experience, Reg A is lesser-known than SPACs, but it has its own success stories. Exodus, for example, raised $75 million from 6,800 shareholders during a Reg A that closed in May of this year, according to a press release by the company. Similarly, Knightscope has raised more than $40 million from more than 9,000 investors through Reg A, a press release by the company also said.
I believe Regulation A's offerings are the best-kept secret in public funding. As more retail investors enter markets on the tails of services like Robinhood and Webull, accessibility of investment vehicles has never been more important. Regulation A offers the transparency and vetting of a traditional IPO while remaining accessible to small companies and non-accredited investors. From my perspective, it will certainly pick up on the democratization of investing where SPACs left off, albeit with more due diligence this time around.
But, like every other capital formation strategy, Reg A comes with its own set of issues. The company that takes this path must address regulatory issues. The ecosystem for Reg A issuance is still evolving with just a few key players. Digital marketing can also be a big task for companies raising capital using the Reg A path.
These are the early days for these emerging trends. This holds hope to open up early-stage investing to a much larger population through a proper regulatory safety net.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Published first in Forbes.