The IPO Strategy You May Not Know About
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There comes a time in the life cycle of a successful cannabis business when it must consider taking the evolutionary leap from privately funded to publicly traded.
Private funding will only take a cannabis business so far. Eventually, scaling up requires a large infusion of capital, often $25 million or more. That amount is difficult for any company to raise, let alone an industry effectively cut off from institutional investors' more extensive checks.
That's where the public markets come in.
Typically, an impressive, mid-sized business with large-cap aspirations would step on the path to a traditional, initial public offering. It’s a multi-layered process that requires stringent reporting and scrutiny. It can last more than a year, dominating the time and attention of the management team. After this, there is no guarantee that the IPO will successfully deliver the valuation needed. Especially in cannabis. And especially this year.
But these are not ordinary times. Investor enthusiasm for IPOs has waned across all industries in a volatile, COVID-19-fueled market. As a result, fewer companies are choosing the traditional IPO route as compared to the public offering torrent of just a few years ago.
Given this reality, investors are blazing new trails to find liquidity. Efficient markets find ways for capital to flow to well-run businesses whose products are in high demand. More than 27 percent of annualized industry growth rates will attract attention. There is plenty of capital ready to be invested in cannabis, so maybe it just takes the right investment vehicle to bridge the gap?
Thanks to the recent moves of some big-name players and high-profile deals, special purpose acquisition companies (SPACs) have emerged as one of the hottest investment strategies around.
What are SPACs?
SPACs are blank-check companies formed for the express purpose of acquiring an existing privately held company. The SPAC then issues shares during an IPO to fund the purchase of a yet-to-be-identified private company, typically at a per-share price of about $10. When SPAC shareholders identify and approve a target acquisition, they execute what is, in essence, a reverse merger. The target company, now owned by the SPAC, is now publicly listed.
There are benefits on both sides of the deal. SPAC investors enjoy some protections before the deal is fully executed. The target company can bypass many of the hurdles in executing a traditional IPO while still gaining market entry with an established base of shareholders.
Perhaps the best-known example of a SPAC involves online fantasy sports company DraftKings. In April 2020, DraftKings Inc. became a public company after completing a reverse merger with the SPAC Diamond Eagle Acquisition Corp. The deal was valued at $3.3 billion. Investors bought into Diamond Eagle for about $10 a share before the DraftKings deal was announced in December 2019. By June 2020, now trading under the DraftKings ticker, the stock peaked at $43. Other recent, notable deal announcements include Virgin Galactic, United Wholesale Mortgage, and Opendoor.
It’s no wonder that many well-known investors are establishing SPACs to explore opportunities across sectors, and why more than 40 percent of IPOs by volume this year have been SPACs. By August, SPACs had raised more than $31.6 billion, more than doubling all of last year’s volume of $12.4 billion. What’s more, some of the most powerful people in business—from Barry Sternlicht to Peter Thiel—are excited participants.
The opportunity to execute a reverse merger into a SPAC as a pathway to the public market is worth investigating for several key reasons.
Flexibility. The SPAC process diverges significantly from the typical IPO process in that a blank-check company can pursue more than one target. In the DraftKings example, Diamond Eagle simultaneously merged DraftKings and SBTech, an online gaming technology platform that powered the sportsbooks of several well-known online gaming sites and casinos. In this instance, 1+1 = 3 as SBTech provided an established technology backbone to power DraftKings sports betting capabilities.
Cannabis is a decidedly fractured market. Within the SPAC model, operators can approach a public offering with an M&A mindset. Is there a complementary line of business that would enhance a company’s story? Who would the business acquire to enhance operations and the bottom line?
Certainty. Not every IPO is successful. Because a SPAC has already raised capital through an IPO, the mechanics of the process are more like an acquisition. The timelines are much shorter: four to six months in some instances, whereas an IPO can stretch to a year or more. The target company only has to negotiate with the acquiring SPAC, not with a host of investors through a roadshow. The result is a much higher success rate of actually making it to the public market. And because of the inherent creativity of structuring a deal through a SPAC, it is very likely to offers a price much closer to real market value. As such, investors can truly get excited about the long-term growth prospects of the business combination.
Transparency. For a potential investor in any sector, a SPAC provides a "free look" as investors can redeem their investment before completing the acquisition, providing investors with extra market protection.
That means a potential investor can gradually wade into a new market like cannabis while enjoying better protections than buying the typical IPO. They can wait out the right opportunity while still getting paid a treasury rate if they decide to pull back their investment before consummating the deal. The pricing, growth story, pubco benefits, etc. will largely dictate investor appetite.
Capabilities. In many cases, a SPAC is structured more like a merger and less like a buyer-seller arrangement, which can benefit the target company and the shareholders. The SPAC and the target company are selling the same deal to the street, so it is in the interest of both to present the strongest possible package to investors. SPAC teams, particularly teams formed to address specific markets like cannabis, can bring complementary assets, experience, and resources that the existing management team may lack. But investors view them as a value-add. From institutional backing to non-cannabis CPG product development and marketing expertise, even celebrity relationships, the right SPAC can deliver the skill sets many cannabis companies need to leap to the next level.
Traditional companies in the U.S., that have a much more robust private investment market and more “go-public” resources (advisors, listing exchanges, etc.), are choosing the SPAC route to become publicly traded. If the cannabis industry is ever to achieve the long term success and acceptance that other sectors enjoy, we need to demonstrate that cannabis can be a viable investment thesis. Having a solid public option like a SPAC, drives shareholder engagement, public awareness, and long term value.
A proven model
SPACs are not new. They first gained popularity in the 80s and 90s but earned a sullied reputation. The initial rules governing SPACs lacked transparency and protections for investors. As a result, SPACs became associated with shady deals involving shell companies that should never have been traded. SPACs soon went out of style and were largely obsolete during the early 2000s.
But the new SPAC experience is starkly different from its sordid past. New, more stringent listing standards leveled the playing field for potential investors. This newfound diligence in the system has enabled SPACs to make a comeback at a time when institutional investors have cash on hand and IPO activity has slowed to a crawl. Major SPACs drive record levels of activity in the technology, consumer, and biotech industries, and cannabis companies should seriously explore them as an effective financing alternative.