Bringing a drug or digital therapeutic to market is a capital-intensive journey. The public markets beckon with access to investors, yet onerous regulatory and financial hurdles can lengthen the process of an initial public offering. Enter SPACs, or special purpose acquisition companies.
Also known as blank-check companies, SPACs represent a simpler, faster exit strategy for startups. They give aspiring biotech and digital health firms a more streamlined route to a ready source of capital. A record 40 healthcare- or life science-oriented SPACs filed IPOs in the first quarter of 2021, raising a combined $10.9 billion, before dropping to eight in the second quarter, according to S&P Global Market Intelligence data.
That second-quarter slowdown followed U.S. Securities and Exchange Commission guidance on accounting for share warrants in April. A number of independent lawsuits have targeted high-profile SPACs, claiming that they violate the Investment Company Act of 1940 by not registering as investment companies.
Nevertheless, experts predict that, for healthcare companies on the hunt for capital to fuel growth, the SPAC IPO pathway will continue to be a viable one. But will all that cash ultimately benefit healthcare?
SPACs are publicly traded shell companies that exist for one sole reason: To find a promising company and merge with it. They allow an operating company to raise money and list on an exchange. Once the other business merges with the SPAC, that business can also collect cash raised by the SPAC’s investors.
They’re an alternative financial vehicle to the more traditional way of going public, an IPO. The difference? IPOs face a lot of regulatory scrutiny; SPACs don’t, although that’s changing.
What kinds of companies typically go public through a SPAC? They’re often businesses that haven’t fully proven themselves, and for which a shortcut to the public markets is attractive. Over the past two years, an excess of capital has led to a surge in SPACs across multiple sectors, particularly healthcare.
A June report by consulting firm PriceWaterhouseCoopers found that biotechs accounted for the majority of healthcare SPAC deals for the first half of the year. That included such early stage firms as antiviral developer Pardes Biosciences, which inked a deal in February with the SPAC FS Development Corp. II, as well as pain med company Ensysce Biosciences, which partnered that same month with the SPAC Leisure Acquisition.
“It’s really remarkable what has occurred,” says attorney Keith Townsend, noting that SPACs have existed for 20 years or so. “For biotech companies and digital health companies, it’s just another lever or strategic alternative that they can evaluate to get products to market.”
They weren’t very popular until recently. Even without SPACs, 2021 has been a record year — but SPACs intensified the deal-making frenzy. As of mid-September, there were 335 IPOs and 133 SPACs in 2021, versus 199 and 28, respectively, in 2019, per Townsend.
Rock Health’s Digital Health Public Company Index, which focuses on venture-backed health companies that build and sell technologies, also showed SPAC closings outnumbering traditional IPOs through September.
“There were a lot of pent-up companies, as there had not been a lot of exits in digital health for a while,” notes Sari Kaganoff, general manager, consulting, at Rock Health, “so there were a lot of companies big enough that they could go public. Once SPACs came on the scene, a lot of companies were ready.”
Last year seven digital health companies went public, including companies like Amwell and GoodRx, with one via a SPAC deal. This year, 16 digital health companies have gone public, including nine by SPAC — such as Hims & Hers, 23andMe and Talkspace — vs. seven IPOs. And 10 more are expected to hit the exchange by year’s end, like Pear Therapeutics and Science 37.
As partner and co-head of the public company practice group at King & Spalding, Townsend has been an architect of many healthcare-related SPAC deals. He estimates that he has been involved in around 12 in some capacity.
His firm has found itself on every side of SPAC deals, from working on behalf of banks acting as placement agents (intermediaries raising capital) to working for hedge funds that invest in IPOs and PIPEs (private investments in private equity).
Bankers and lawyers representing either the target company, the SPAC or the SPAC sponsors have a few considerations in every deal. For one, they only get paid if there’s a successful transaction. And while SPACs allow a startup to list on a public market through a reverse merger and to access capital raised by the SPAC acquirer, it’s not a foregone conclusion that every SPAC will find a target with which to merge.
“You are, to some degree, making a bet when you embark on one of these transactions, because generally those companies don’t have the money in the bank to pay your fees,” Townsend explains. Lawyers and bankers receive fees for completing a SPAC IPO, he adds, “But then the SPAC doesn’t have adequate capital to pay the fees, because the money from the IPO investors is placed into trust.”
The funds are kept in the trust account for later use in merging with the target company, usually within two years of the SPAC IPO. Even if no new SPACs are created, there are almost 400 existing ones that have yet to identify an acquisition target, by PwC’s count, with nearly a half trillion dollars in buying power for M&A. Since the bulk of that must be spent by the end of 2022/early 2023 (for SPACs created by the first half of 2021), the pressure to find targets and close deals has never been greater.
It adds up to stiff competition for the top pick of the litter. “Some call it a ‘SPAC-off’ when two companies pursue the same target,” quips Kaganoff.
“The terms are tightening,” adds Townsend. “It used to be ubiquitous that a SPAC would have a two-year life. For most of the deals that we have visibility to now, that lifespan is shortening to 18 months.”
The deadline makes sense from an overall market standpoint, as IPO investors don’t want their money being tied up for a significant period of time. To Townsend, however, it’s a net negative.
“The SPACs and SPAC sponsors need as much time as possible to find the right target and close a good deal,” he explains. “The last thing we should be incentivizing is putting structures in place that force them to pull the trigger on a deal too quickly, because they’re worried about running out of runway.”
The two-year window is inclusive of regulatory review, including for the SEC to sign off on registration statements. That’s taking longer than it used to, Townsend notes. April’s SEC guidance already resulted in a number of restatements by SPACs, and poor post-acquisition returns may impact the ability of those SPACs yet to close a deal to secure financing.
Moreover, the shrinking window to find and complete a successful SPAC transaction ratchets up the pressure for them to aggressively compete with private equity and drugmakers for targets. Competition is likely to be stiff and M&A values high in the second half of 2021 and beyond, PwC predicts, adding that all dealmakers are likely to sense a more challenging dynamic.
All of which raises the risk that many SPACs ultimately will not complete a successful transaction. It also shines a light on the need for the SPAC’s sponsors and advisers to be very selective before committing to what literally could amount to a multimillion dollar investment.
For example, let’s say you have a $200 million SPAC. It wouldn’t be uncommon for a sponsor group to have $6 or $7 million invested in the SPAC.
“If the SPAC doesn’t complete the transaction, they might as well have gone up to the 50th floor of the building I’m sitting in and dumped it out the window, because it’s gone. You’re not going to recapture any of it,” Townsend quips. “As a firm, we’ve had to be somewhat entrepreneurial and evaluate the companies that we’re partnering with and really believe that they can ultimately be successful. You’ve got to believe that they are a team that is going to be able to evaluate and pick a target and then, ultimately, get to a closing.”
Within a SPAC IPO sit multiple investors. In the above example, let’s say the $200 million is invested by IPO investors. They receive units that are separable and contain shares of common stock as well as a warrant, or a right to buy more shares at a particular price. IPO investors will negotiate these terms.
Hedge funds may negotiate as part of their investment to come in for a larger chunk of the transaction, including some amount of the sponsor’s founder shares. These shares may give the sponsor 20% of the total shares outstanding post-IPO.
Even though sponsors put up a nominal amount of the equity to buy those shares (usually $25,000), they sometimes give up some of those founder shares for anchor investors that are coming in for bigger chunks, explains Townsend.
Once a target is selected by the SPAC, the SPAC and target typically raise money through a private placement, a funding round offered to a chosen group of investors. When the SPAC merger is announced, the target company announces both the merger with the SPAC and the commitment for the private placement.
The SPAC is subject to redemption, meaning that that money can be taken out by the investors if they don’t like the deal, whereas the private placement money that comes into the transaction is hard.
“You want to have as much PIPE money versus SPAC money as you can,” Townsend advises.
The suddenness of its popularity and the amount of risk may leave some industry watchers questioning how good a fit innovative clinical companies are for the SPAC model. The financing vehicle’s popularity aside, does SPAC money help prove out clinical benefit?
There’s not much evidence SPACs are being used to finance new therapies. Nevertheless, to hear Townsend tell it, more such funding vehicles are needed.
“The SPAC is one of the things that falls into the ‘more’ category,” he says. “It’s not the panacea that’s going to solve the dilemma of translating more innovation into practical use, but it can be a tool that can add to the funding that is a necessary precursor.”
SPAC targets are typically at an earlier stage than some of the companies that have gone public via a direct listing, which was the route chosen recently by eyewear startup (and unicorn) Warby Parker, along with companies like Spotify and Roblox.
“Historically, for companies at that earlier stage, it’s been a closed market,” says Townsend. “You effectively had to be a venture capital investor or someone who had kind of an inside track to be able to invest in one of those companies.”
SPACs’ accessibility to the average investor is a “great positive,” he says. “The flip side of that coin is that, if you complete a SPAC merger, once the dust settles you look up and, if you’re the target, all of a sudden you’re a public company, and with all the public-company readiness that is a prerequisite. Some of the SPAC targets have faced challenges because I’m not sure they were ready for prime time.”
Indeed, their management teams have to be very polished to suddenly face the public glare.
“That’s the main risk – that because there are a lot of SPACs looking for targets, a lot of companies going public will take the opportunity, even though they’re not ready for public scrutiny,” says Kaganoff, adding that some digital health firms view it as just another funding vehicle. “I have had conversations with a few people eager to get in on a SPAC that don’t seem ready.”
While Townsend declined to talk about any companies in particular, some well-known examples on the biotech side bear this out.
Roivant Sciences, for one, got off to a rough start after its SPAC merger closed October 1. The company, which has a number of subsidiaries (called “vants”) focused on various points of the drug pipeline, raised about $600 million through its SPAC merger valuing the company at more than $7 billion. But the SPAC’s share price dropped more than 30% over the ensuing days.
In another cautionary tale involving a blank-check deal, Gemini Therapeutics raised more than $200 million in a SPAC merger that closed in February. Fast-forward eight months, and Gemini has lost about 70% of its value and is letting go of 20% of its staff, while jettisoning all of its R&D and preclinical development programs to focus on a placebo-controlled study of its lead eye-disease drug expected to start next year.
Others, such as Cerevel Therapeutics Holdings, have been more successful with investors. Cerevel, which completed a transaction with blank-check company ARYA Sciences Acquisition Corp II a year ago, has seen its share price double since it started trading, thanks no doubt to positive results for its schizophrenia treatment in an early stage trial.
On the digital health side, June’s announcement by prescription digital therapeutics pioneer Pear about its forthcoming reverse merger with a SPAC took some by surprise. Not only because a company with an FDA-approved product prescribed by physicians would go the SPAC route, but also because the company that acquired Pear, Thimble Point Acquisition Corp., didn’t even state healthcare as an area of focus when it went public earlier this year.
“This implies even more of a mismatch between supply and demand,” says Kaganoff.
Asked what he wished more investors knew about SPACs vis-a-vis IPOs, Townsend says he’s “a little bit discouraged” that some companies, which fundamentally may be solid, chose the SPAC route and got punished in the market.
If several banks serve as underwriters on an IPO, as a result there could be five analysts covering that stock. “With a lot of the SPAC transactions, on the other hand, the analyst coverage is more thin because you just don’t have that same underwriter dynamic,” he laments.
Townsend also points to what he calls a “SPAC taint” on some of those companies that have not traded well. “Over time, the market’s going to look through that and judge those companies on their merits, regardless of how they came to market,” he says. “But we’re at a moment in time where that’s not the case and there’s a little bit of a disconnect between the underlying fundamentals and company stock performance.”
Some of the criticism around SPAC projections is overblown. The same thing happens in an IPO; it’s just that the company gives its projections to the analyst, who then publishes the projections as “consensus” prior to the company going public, Townsend argues. On the other hand, “Market participants need to continue to apply a lot of rigor to that and stop companies and advisors from being overzealous in their projections.”
As to whether she thinks the SPAC trend will prove to be good for patients, Kaganoff says it remains to be seen. She questions whether acquisition companies are in fact providing a viable route for their respective healthcare innovations to scale up from serving niche markets to a broader swath of the US or the world – a route which was heretofore provided mainly by M&A and the IPO.
That said, she’s looking forward to the opportunity to understand more about the financial performance of many of the digital health companies going public in this manner. Many have raised millions and are seeing revenue but — as pioneers of new business models in many cases — she suspects few are yet profitable.
“With more becoming public, I’m curious to see under the hood,” she says. “Definitely there’s some variability in SPAC performance, but we need to give it more time before we pass judgment.”
Both Townsend and Kaganoff predict the process for due diligence around SPACs will increasingly come to resemble that of IPOs and that the comparisons around deal terms will grow closer.
“If you think of it as a spectrum with acquisition on one end and IPO on the other, now [SPACs] are moving more toward IPO in terms of paperwork and finance,” says Kaganoff. “SPACs used to be able to go public with the paperwork of an M&A and now it’s somewhere in between.”
As to what effect that has, Townsend adds, “I suspect that SPAC sponsors will end up taking some haircut on their economics as the benefit of SPACs versus IPOs diminish, but they’re still going to be motivated to get deals done.”
SPACs “will continue to be a meaningful portion of the capital markets, and I think that’s healthy,” Townsend continues. “I hope that what we’ve seen over the last couple of years will continue and that some combination of IPOs and SPACs will continue to result in a robust pipeline of new companies hitting the public markets in the U.S.”