By Alex Zuluaga and Arda Ural, Ernst & Young
As biotech and emerging pharma companies weigh their options for raising capital, the special purpose acquisition company (SPAC) has become an increasingly popular path to the public markets. In the U.S. healthcare sector, 28 SPACs raised more than $4 billion in 2020 — nearly a third of the $14 billion raised in 74 IPOs.1 Within biotech and pharma, the popularity of SPACs has surged, with a 175% increase in announced SPAC M&As seen between 2019 and 2020, according to GlobalData.
SPACs took a slight pause following the second quarter of 2021 as SPAC sponsors and target companies across all sectors, including biotechs and emerging pharmas, weighed the ramifications of new Securities and Exchange Commission (SEC) guidance. However, activity is expected to resume at more normalized levels through the end of the year, and we will ultimately see a refresh once this most recent wave of SPACs either consummates transactions or liquidates.
Having SPACs as a viable option alongside traditional capital-raising, transactions with Big Pharma, or IPOs presents a strategic optionality question for biotech and emerging pharma companies. Navigating that question may explain why deal volume is down in both value and number for 2021 thus far in the biopharma sector.
Why A SPAC?
Historically, biotech and emerging pharma companies took a traditional approach to accessing the capital markets. Depending on the phase of clinical development, a company would seek infusions of cash from angel investors, venture capital, or private equity, and each round of investment would help advance product development and build business operations. The company then would eventually be in a position to tap into public markets as it moved past product development milestones. SPACs can streamline that process considerably, allowing biotechs and pharmas to fund the entire process at once, allowing for a narrow focus on product development and commercialization.
The SPAC itself is an investment vehicle that raises capital from investors via an IPO. That capital is placed in a trust while the SPAC seeks to acquire a target company — unidentified when the SPAC is created — and facilitate its access to public markets. In practice, a SPAC is akin to a simultaneous IPO and merger and acquisition.
The timeline from SPAC formation to acquisition — the de-SPAC deal — is generally 18 to 24 months, which offers tremendous appeal to hedge funds, private equity, and retail investors. The typical share or unit price of $10 establishes a benchmark across the asset class and is the basis for share conversions with the target company.
Each of these factors is also appealing to potential targets, which can enter the public markets with more flexibility than the IPO process affords. That versatility may also include access to larger amounts of capital. Sponsor experience can be a plus as well, offering additional guidance to operating companies regarding the capital markets and the biotech and emerging pharma space.
A Shifting Landscape
Within the SPAC landscape and across industries, the private investment in public equity, or PIPE, process has become more critical. Because the SPAC merger is subject to shareholder approval, and shareholders can opt to redeem their shares, the amount of capital available to the operating company is subject to a fair amount of variability.
To address this uncertainty, PIPE participants are approached to make a committed investment that will be funded at the time of the business combination. This assures the operating company of a certain amount of capital, regardless of how many shares are redeemed. PIPE participants are also able to fully inspect the target company’s finances and other material non-public information, contributing to increased investor trust.
The extended and explosive popularity of SPACs has drawn increased scrutiny from both regulators and investors. The SEC has questioned the disclosures on financial projections and accounting practices that SPACs have presented, and investors, including PIPE investors, have challenged valuations. This has led to a changing composition of PIPE investors and decreasing coverage over PIPE investments. These factors have also contributed to SPAC investors redeeming their shares at rates higher than expected, reducing the amount of capital for the operating company or in some cases dissolving the transaction by not meeting minimum cash conditions.
Given the pressing need for Big Pharma companies to grow their pipelines and portfolios with de-risked assets, SPACs are a competing vehicle that will lead to more frothy valuations.
In deciding whether to court a SPAC or pursue an IPO, biopharma companies should first determine the capital needs of their organization, while defining what success looks like. As one example, the unique R&D needs of many biotech companies may position SPACs as a viable option, but this will depend largely on current stages of product development and expected timeline to launch. Larger pharma organizations should consider how pending losses of exclusivity might impact their pipelines and weigh internal and external R&D investments accordingly – prioritizing adjacent therapeutic areas whenever possible to ensure successful deals. Taking these introspective steps can inform conversations among management team members as they consider how best to access the capital markets. In addition, understanding an appropriate valuation based on the maturity of your organization and its prospects is critical.
The different approaches to accessing capital can have several variables. For example, a SPAC negotiates value up front, whereas an IPO needs to go through road shows and pricing after the lengthy SEC filing process. While the IPO process is better known and comes with fewer questions, companies are not able to control their valuation destiny in the same way as they are with a SPAC.
IPO road shows may also impose a particular burden on the bandwidth of biotech or emerging pharma company leadership, as they are accountable for expeditiously moving the company’s operations to the next milestone. Another factor could be how many SPACs are currently focused on the sector. With fewer SPACs coming to market overall, biopharma companies may find themselves competing with their peers for SPAC interest, putting pressure on their internal valuations.
The Importance Of Preparation
In any case, both paths require meticulous preparation. While companies used to be able to negotiate SPAC term sheets without the benefit of Public Company Accounting Oversight Board–level financial statements, that’s no longer the case. Today it’s almost mandatory to have these more robust financials ready, so companies need to invest earlier in their finance department and accounting processes. Early-stage biotechs should take note of this step and, from the outset, build up finance functions that can support these complex transactions. This preparation also helps when running a dual- or tri-track path to accessing capital.
For those that opt for the SPAC process, it’s important to work with SPAC sponsors with strong management teams. They likely will have stronger vetting processes that consider an operating company’s goals, talent, reputation, and revenue projections. The right advisors are a must as well, from bankers who understand the biopharma sector and its trends, to lawyers who can shepherd you through complexities and negotiations, to advisors who can help you stress-test your operations.
The emergence of SPACs as a viable path in addition to more traditional funding mechanisms offers biotech and emerging pharma company boards and investors alike the opportunity to maximize value for their assets. SPACs also make the environment more competitive for Big Pharma, which can offer a straight-out bolt-on type of acquisition – ultimately driving value for both parties: biotechs seeking capital to grow and pharmas looking to acquire external R&D and bolster pipelines.
With these paths in mind, biotech and emerging pharma companies need to carefully weigh their strategic options in light of their unique situation of key clinical, regulatory, and commercial milestones.
About The Authors:
Alex Zuluaga is the SPAC co-leader for EY, where he is a partner in the Financial Accounting Advisory Services practice. Alex has more than 15 years of experience advising clients on accounting and financial reporting matters, including accelerated SEC readiness projects, cross-border acquisitions, bankruptcies, operational assessments, carve-out financial statements, and external audits.
He has extensive knowledge of SPAC mergers covering accounting, reporting, regulatory, operational and integration matters and has assisted with dozens of SPAC transactions over the last decade. Alex has a BS in Accounting from the University of Connecticut.
Arda Ural, PhD, is the EY Americas Industry Markets leader for EY’s Health Sciences and Wellness Practice. Arda has nearly 30 years’ experience in pharma, biotech and medtech, including general management, new product development, corporate strategy and M&A. Prior to joining EY, he was a Managing Director at a strategy consulting firm and worked as a VP of Strategic Marketing and a BU Lead at a medtech company. Arda holds a PhD in General Management and Finance and an MBA from Marmara University in Istanbul, as well as an MSc and BSc in Mechanical Engineering from Boğaziçi University.
The views expressed by the authors are not necessarily those of Ernst & Young LLP or other members of the global EY organization.