Hi Fintech Friends,

Welcome to part three of Signals. The point of Signals is to get you away from the headlines and dig more deeply into the trendlines.

You can read part one of Q4 Signals here and part two here.

It’s hard to talk about high-growth private technology companies these days without giving some airtime to Special Purpose Acquisition Companies, or SPACs.

What is a SPAC?

A SPAC is a shell company set up by institutional investors with the sole purpose of eventually acquiring another company. The SPAC is brought to market in an IPO, usually with a $10 share price, and the proceeds are routed into an interest-bearing trust until the company’s management are able to find a business to take public (SPAC sponsors normally have a two-year deadline).

When the sponsors identify a target, they agree on an effective enterprise value for the merged entity and take the target public by merging it with the shell company. Once the sponsors and company have agreed on an enterprise value they believe the market will support, they trade the money they raised in the shell company IPO for the corresponding number of shares in the merged entity. There is occasionally a secondary debt or equity fundraise that accompanies the merger.

At that point, investors in the original shell company IPO can swap their shares for shares of the merged company or can redeem their SPAC shares for their original investment plus interest. SPAC sponsors typically get a 20% stake in the merged company as compensation.

2020 and the rise in SPACs

Though SPACs are not a new type of investment vehicle, they have grown meteorically over the last year. As of this writing on March 6th, there have been 228 SPAC IPOs in 2021, compared to a total of 248 in 2020, meaning that 2021 is currently on-pace to 4x 2020 SPAC activity. (Editor’s note: as of March 10th, 2021 SPAC activity has exceeded all of 2020.)

And more SPACs IPOed in the year 2020 than the combined total over the 10 years preceding it:

(Source)

The modern SPAC frenzy can reasonably be said to have started with venture capitalist Chamath Palihapitiya’s launch and media tour to promote the Social Capital Hedosophia blank-check company series in 2019 (the first in the series IPOed in 2017). Chamath’s contention is that the IPO process is long, expensive, and cumbersome, which incentivizes many promising late-stage tech companies to raise private rounds instead of going public. That, in-turn, deprives retail investors of opportunities to invest in high-growth tech companies. By the time a company has the resources and capacity to go public, the argument goes, any meaningful appreciation is done.

The argument has some merit: more late-stage investors from private equity firms to pension funds have made large direct investments into private tech companies. To paraphrase Matt Levine since 2017, “private markets are the new public markets.” If this is true, then there should be a glut of valuable private tech companies with growth potential that would go public if only it weren’t so easy to raise private capital.

Enter the SPAC: money managers have rapaciously started chasing late-stage tech companies to take them public. These managers have paired with celebrities like Alex Rodriguez, Shaquille O’Neal, and Jay Z to hype their speculative shell companies while they search for targets. And as the number of well-capitalized fintechs grows, many of these targets are in financial services and fintech.

Fintech SPAC activity

It’s reasonable to feel like there are almost as many fintech SPACs as there are late-stage fintechs now. All in all, in Q4 2020 there were 21 fintech or financial services-focused SPAC events. 14 new SPACs fundraised with an explicit target of merging with a financial services company and 7 SPAC mergers were announced (though not all completed). (This quarter is already on-pace to exceed those numbers, which we will cover in Signals in Q2.)

These 21 events represented $32 billion in deal activity in Q4: $3.6 billion in fundraises and $28.4 billion in mergers (both completed and proposed).

The full data on Q4 2020 SPAC activity are available here.

So which were the financial services and fintech mergers from Q4?

1. Direct lending platform Owl Rock Capital Partners and private equity asset manager Dyal Capital Partners proposed a combination and IPO via the Altimar Acquisition SPAC at a combined enterprise value of $13 billion. This proposed merger has since run into a legal challenge from rival $50 billion investor Sixth Street, so it remains to be seen whether it is completed.
2. Fidelity’s Bill Foley completed a merger between his SPAC, Transimene Acquisition Corp II, and online payments provider Paysafe at a $9 billion valuation.
3. Lending services platform Finance of America agreed to go public through a merger with Replay Acquisition at an enterprise value of $1.9 billion.
4. Billtrust, an accounts receivable and B2B payments platform, and South Mountain Merger Corp. announced a merger at a $1.3 billion valuation.
5. Fintech Acquisition Corp III, founded by The Bancorp founder Betsy Cohen, took integrated payments provider Paya public at a $1.3 billion valuation.
6. Fintech Acquisition Corp, Betsy Cohen’s first SPAC, took e-commerce lease purchasing solution Katapult public at a $1 billion valuation.
7. Fintech Acquisition Corp IV, Betsy Cohen’s fourth SPAC, merged with investment advisor Perella Weinberg at a $975 million valuation.

Notably, these 7 fintech mergers represent an implied $5.7 billion in fees accruing to the SPAC sponsors - an incredibly lucrative proposition - meaning that we are likely to see many more investors hunting for fintechs to take public in the next couple quarters.

So what is the long-term prognosis for these financial services and fintech SPACs? I generally think of SPACs as a red flag for adverse selection. In the event of a market correction - or even absent one - I wouldn’t be surprised to see the air get sucked out of SPAC share prices first. A few reasons for caution with retail SPAC investment:

1. IPOs are a longer and more arduous path to liquidity, but they also provide fintechs with an opportunity to raise more funding, bring on more institutional investors, and avoid handing a 20% stake to a SPAC sponsor. ManyWhat’s more, private companies now have the alternative of a direct listing to go public. In all likelihood, the fintechs that can go the IPO route will continue to do so, and those will be the more well-capitalized, profitable, sought-after fintechs like Stripe (raising a private round) and Coinbase (direct listing).
2. The current wave of SPACs seems to be heavily capitalizing on buzz: with the entry of celebrity sponsors into investment marketing prospectuses (remember the Mayweather and DJ Khaled ICOs?), retail investors should be worried about whether the hype outweighs the fundamentals.
3. SPACs are chasing increasingly earlier tech targets. There is a consensus among venture capitalists that SPACs are “pulling startups forward” by 12 to 24 months (!) in terms of top-line valuation and readiness to be a public company.
4. There is an incentive disconnect between SPAC sponsors (rewarded with a 20% enterprise stake, regardless of the quality of the company they merge with), SPAC IPO investors (option to take interest on trust instead of shares), and retail investors. The parties incentivized to secure a merger are rewarded regardless of how the merger performs once completed.
5. SPAC return distributions look a lot like VC: a few big outliers with a long-tail of investments under-performing. As shown below by the Financial Times, the majority of SPAC mergers trade below their IPO price:

Yet, even though there are reasons for retail investors to be wary, we can probably expect to see continued enthusiasm for fintech SPACs as more investment managers chase reliable returns (for themselves) and more adversely-selected fintechs look for easy paths to liquidity. It remains to be seen who will be left holding the bag when underperforming fintechs inevitably go public through mergers -- hopefully retail investors will be careful enough in their diligence to make prudent investment decisions.

Expect to see more exciting SPAC coverage when this quarter concludes, which as you can see from the preview below, may outpace Q4 2020:

(Source)

(Note: For those who haven’t read it, Lex Sokolin over at Fintech Blueprint also wrote a great overview of fintech SPAC activity, with coverage of MoneyLion’s recent entry into the public markets. He accounts a little differently for the number of fintech-focused SPACs, as seen below.)

Still to come:

(4) Which products launched over the last quarter and which were shut down?