The initial public offer (IPO) was once a tremendous value to an investment bank’s largest clients, both on the corporate and investor side. A private company going public would hire the bank to underwrite its IPO, creating the valuation and finding investors to buy on the IPO day. This got them access to much more money at once than they had ever been able to raise in the past, without having to directly pay it back. Furthermore, company insiders found a new avenue to cheaply offload their own ownership in the company in the future while also showing a clear path towards growth. It was a definite wealth creation tool, so it’s unsurprising that companies paid 5% or more in fees for the service.
On the investor side, the benefits of the IPO were clear, thanks to the one-day “pop” (among other benefits). A well-designed IPO would offer investors the chance to buy stock at the IPO price and then offload it at a much higher price the first day, presuming that the stock did trade above its IPO price that first day. Most of the times, this is the case, and since the margin can be 30% or more, the risk/reward proposition of buying into an IPO favored buying in almost all cases. It has only been with very rare and obviously questionable IPOs (WeWork, most obviously) that this proposition was less than clear; in other cases where the pop wasn’t there (Facebook (FB) is the best example here), IPO buyers still tended to get ahead if they were patient and held on.
That pop wasn’t the only reason to buy, however. With many IPO stocks, prices would continue to go higher if they were properly valued, because companies going public often had an incentive to IPO at a price somewhat lower than what they think they could IPO for. The reasons for this are complicated, but it basically boils down to investor confidence; a growth company may lose out of, say, $5 billion by going IPO at $15 billion instead of $20 billion, but if they go out at $20 billion and the stock doesn’t go up, the next year could show investor skepticism because of the lack of a pop that ends up costing the company more than that $5 billion.
For all these reasons, the conventional IPO has been very popular–until this year. The Special Purpose Acquisition Company (SPAC) has become a popular direct way for investors to team together without an investment bank to set up an IPO for a company about to go public. The investors team together, create the SPAC, let that IPO at a lower IPO price than the to-be-acquired company would pay, and help that acquired company go public via the SPAC much faster and with less risk of negative market movements.
SPACs are all the rage now as buy-side funds enjoy the advantages of having more control over the IPO process and companies enjoy the advantages of being able to go public faster. Whether SPACs are here to say, however, remains to be seen.