The Path to Going Public: IPO or SPAC?

  

With 331 SPAC deals enthusiastically closed in 2021, and the collective pool now trading on average 42% below purchase price— we are living in a far different landscape of capitalization opportunities than we were this time last year. Add to that a massive correction in the stock market from 2021 highs, inflation, Covid, and the looming threat of rising interest rates further affecting market liquidity, and we may well be on another planet. But it’s not all bad news. 

Though the SaaS segment hasn’t emerged untouched from market-wide volatility, SaaS continues to attract high multiples and significant investment interest in companies with strong business models and strong growth rates. *Gartner announced last week another double-digit year of IT spend growth forecasted for enterprise software at 11% to $672B in 2022 and 11.9% in 2023 (the highest growth compared to other tech categories).  The Bessemer Emerging Cloud Index (EMCLOUD) consistently tracks the outperformance of public SaaS public companies over NASDAQ, S&P 500, and Dow Jones indices.   Average revenue to market cap multiples for Bessemer Cloud Index as of last quarter was 24x (for companies with revenues between $100M-$300M)

Against this backdrop, every SaaS company would be well-served to consider three things as they plot their path to public capitalization: speed to market, the cost of its finance team’s capitalization efforts, and investment scrutiny.

Speed to Market

Where IPOs take significant preparation more than a year in advance, SPACS are comparatively swift. The speed of a SPAC may be attractive to capture urgent market conditions.   For example,  German smart home energy tech firm Tado (backed by Amazon) – currently in the race to meet Euro sustainability goals, and US social media security firm ZeroFox – dedicated to combating the growing proliferation of cyber threats – seized the market opportunity by using SPAC vehicles to access needed capital.

Another motive for sidestepping the IPO path for a SPAC acquisition can relate to a company’s cap table and investors’ exit strategies.   Investors may drive the choice between a SPAC and an IPO in order to realize a return on investment more quickly than waiting for an attractive acquirer or the long march to an IPO.

Market sentiment and multiple corrections aside, SaaS IPOs are expected to be plentiful in 2022, despite being more resource-intensive than SPACs.  Highly funded private SaaS companies in Cybersecurity, Enterprise Tech, Cybersecurity, and FinTech are expected to lead the way.  **FloQast Co-founder and CEO Mike Whitmire predicts, “The market capitalization of venture-capital-backed firms that went public last year amounted to a record $200B and it is on course to reach $500B by the end of this year. With capital available to businesses, finance teams will begin to prepare for IPOs, and we will see a wave of public companies emerging as we recover from the economic downturn. A comeback in valuations won’t impact high-quality assets. If the business is compelling then it’s not an issue to raise at a good valuation.”

The Cost Associated with that Time

For IPOs with longer lead times, the associated cost of capitalization isn’t solely direct expenses for a successful IPO—but the cost of your entire finance team’s diverted attention from the business for a two-year period. Though a SPAC can be a lot quicker, there is tremendous value in long-running IPO preparations. Some SPAC companies have found themselves scrambling after going public to put in place the people, process, and systems to stand up to public scrutiny.  In both instances—there are clear ways to manage expenses through benchmarking against peer companies going through the same process.

G&A Spend in IPO Year

Highlighting the cost of those preparations are the reported G&A expenses of 12 SaaS companies that went public via IPO in 2021. G&A spend averaged 27.11% of operating revenue, compared with the Bessemer Cloud Index average of 23.77% for $100M-$500M companies.

 

Investment Scrutiny

SPACs may be swifter, but they are no less discerning. While those pursuing one aren’t held to the same reporting standards as an IPO, and given the freedom to project future earnings immediately prior to closing—they’re still on the line to publicly report financials shortly after the ink dries on the acquisition. Substantial variances related to your accounting and organization do not go unnoticed. Investors are sensitive to change, and overly optimistic forecasts asserted at the outset of a SPAC acquisition aren’t soon forgotten. This reality requires you to dedicate the same resources you would in an IPO. With a three to a five-year timeline in mind, an effective CFO has a strategic plan to bring a company public on a solid foundation of systems to consistently monitor and report key metrics important to public investors, which is also why G&A spend is higher than some private investors might expect. 

Some overvalued businesses that raised capital at skyrocket multiples based on inflated projections are failing to meet growth rate expectations and are now challenged to grow into their valuation—which becomes increasingly difficult over time. Once public, KPIs should continue to be strong, or better yet, improve, or be able to credibly tell a good story about short-term slowdowns necessary for even greater improvement. The key to success is investing in the people, processes, and systems to know and validate your metrics at the outset and on an ongoing basis. 

Despite market volatility, the SaaS segment is particularly strong compared to others and continues to attract an incredible amount of private equity and venture capital with its characteristically high margins and returns.  We expect that investments in 2022 may be more selective and investors will demand greater accountability on operating KPIs, even in public markets.  Valuations may become more conservative in the immediate term, however, the inexorable high demand for new technologies and digital solutions should continue to drive strong investment in those companies that are in the top quartile against peer benchmarks for key SaaS performance metrics. 

Article Sources: 
*Gartner: IT spending growth forecast for 2022-2023
**FloQast: Market Capitalization prediction for 2022

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