Cannabis companies are going public through SPACs. Photo credit: rthanuthattaphong.
What is a SPAC?
When a company decides to go public, which they typically do through an Initial Public Offering (IPO), they are offering shares of a private corporation to the public on the stock market. This means that anyone can own shares of the company. Once this is done, stock-traders can purchase and sell shares of these companies on corresponding stock-exchange markets.
Meanwhile, with a SPAC, the IPO is already done. This is because the SPAC is already listed on the market, but is just waiting to acquire a private company.
Private companies just have to negotiate with a SPAC that is willing to take them in. Imagine a bunch of sponsors and investors raising money (through an IPO). Then with that money, they make a deal with a private company (in this case, Leafly, Weedmaps or High Times). According to KPMG Advisory, without a SPAC, a private company that wants to IPO has to pay for financial reporting documents, build investor relations, and generate buzz and publicity. So, a SPAC deal allows for such private companies to skip the trouble of going public through an IPO themselves. Consequently, a SPAC makes the whole process of going public a lot smoother and quicker.
To sum it up as simply as possible, SPACs are just easier ways for private companies to be publicly traded. According to the Corporate Finance Institute (CFI) it’s a shell corporation. This means that it is already listed on the public market with the sole purpose of acquiring and merging with a private company, and making them public.
For example, Leafly is turning to a SPAC with a deal valued at roughly $532 million. Merida Merger Corp. I plans to go public with Leafly, listed on the Nasdaq under the ticker symbol LFLY. This deal is set to be finalized around the end of this year.
More often than not, when it comes to SPACs, the pros outweigh the cons for both the company and the investors.
First and foremost, the process of going public through a SPAC is drastically shorter than going public through an IPO.
A traditional IPO can take as long as 18 months to complete. However, a SPAC merger usually takes up to six months, risk assessment firm according to KPMG Advisory.
Faster execution means the company can get to business quicker. It also means that there is less time for a deal to fall apart. Time is money, after all.
The next ‘pro’ is easier price acquisition, or the purchasing price of the company. When a company decides to IPO, their initial offering price will heavily depend on the current market conditions at the time of listing. According to KPMG Advisory, this uncertainty in the market can lead to high-levels of risk for both the company and its investors.
A SPAC with its investors and sponsors, however, has already negotiated the price, leading to an overall safer situation for everyone involved.
Next, a SPAC merger does not need to put much effort into generating interest from public investors. This is mainly because, according to KPMG Advisory, investors and sponsors have already generated the needed funds. This allows for the companies to save a lot of money, and doesn’t require them to go through an extensive and time-consuming roadshow, or a series of presentations the company makes before they decide to IPO.
Finally, SPAC sponsors can offer a lot of help to private companies who may be uncertain of the process of going public. For example, SPACs often have a large network of connections that they can contact with to gain further expertise or assistance while going public.
While there are good reasons for a private company to merge with a SPAC, there are still many risks. Many of the cons stem from the pros.
A major con, specifically for the private company merging with a SPAC, is the initial and foreseen dilution of shares (more shares going to the SPAC team/sponsors), according to Harvard Law School’s Forum on Corporate Governance.
Typically, the SPAC’s sponsors will acquire roughly 20% of the company’s stake. This means that the company will miss-out on a good chunk of their potential earnings. Additionally, sponsors may take even more of the company’s stake via an earnout. This means that if the company reaches a certain stock price, more shares go to them. Afterall, they are the ones who do a good chunk of the work and funding for the private companies.
Another con with SPACs is that the private companies have less time to prepare for a variety of financials. With the benefit of a shorter process to go public comes with a more rapidly-approaching crunchtime. While the SPAC’s sponsors offer much help, it still usually requires the target company to handle things such as establishing investor relations as well as internal controls and issues within a relatively short period.
Next, the SPAC process requires a lot less due-diligence than an IPO. This may potentially lead to various errors throughout the process, such as restatements or incorrect valuations of businesses. Said errors can lead to lawsuits, reports KPMG Advisory, which may stunt or stop the SPAC merging process and turn away investors.
Finally, since a SPAC is already public and doesn’t involve a traditional IPO, the target company doesn’t have an underwriter. An underwriter essentially makes sure all regulations and requirements are met for a company going public. But without one, not all investment risks are assumed and evaluated. This can lead to uncertainty for the company and its investors.
SPACs are without a doubt a more frictionless way of going public as compared to traditional IPOs. However, that comes with a cost. Companies going public through SPACs tend to have less oversight, and may not be able to provide much disclosure to investors.
While all investments inherently contain some amount of risk, going public through a SPAC is a relatively safer option for private companies that want to go public. Cannabis companies may very well benefit greatly from a SPAC, since raising funds and investor awareness may be difficult with a rather controversial topic such as cannabis.
So how do these mergings of cannabis companies affect the cannabis consumer? For one, those interested in investing in and supporting cannabis companies such as Leafly, Weedmaps and High Times have the chance to do so in the coming months.
However, according to The Securities Industry and Financial Markets Association (SIFMA), SPACs have a poor track record; they typically underperform compared to traditional IPOs.
SIFMA also states that from 2015-2020, the average return for those investing in SPACs was -18.8%, versus 37.2% for traditional IPOs. Additionally, only 29% of SPACs during this time had positive returns for investors.
That said, one should always invest at their own risk.
|– “SPACs have accounted for ~70% of all IPOs in 2021. So far this year, SPACs have raised a record-breaking $129 billion – already more than they raised in 2020.” |
– “SPAC lawsuits have tripled this year, including against billionaire Bill Ackman’s SPAC. Many cases involve allegations of misleading investors.”
– “SPACs tend to lose a third of their value post-merger on average, according to a study spanning 2019 to 2020. The 50 biggest SPACs have lost 20% in value this year.”
*Credit: Robinhood Snacks