Private Equity Goes Public (Again)

Nearly one year after the business development company (BDC) phenomenon fizzled under the weight of its own pointlessness, private equity firms have found a new vehicle to ride into the public markets. They are specified purpose acquisition companies (SPACs), which otherwise are known as blank check acquisition companies. For those with long memories, these “companies” once were the darlings of both penny-stock traders and con artists, given their relative lack of regulation. Today, however, they’ve gone legit.

Every SPAC has a slightly different back-story, but their general structures are similar: Newly-formed companies without assets, whose stated purpose is to acquire an unidentified company in a loosely defined industry. They are typically managed by a small group of executives with operating expertise, whose ranks more and more frequently are including part-time assistance from board members who double as managing directors or general partners with private equity firms (and from VC firms, in particular).

Recent SPACs, for example, have included the participation of individuals from such firms as Paladin Capital Group, Pequot Capital, McCown De Leeuw, SV Life Sciences, Lightspeed Venture Partners, Praxis Capital Ventures and the GE Asia Capital Technology Fund. There even was a new SPAC filing yesterday that listed its CFO as Dave Brophy, the Michigan B-School professor who serves as director of the school’s center for venture capital and entrepreneurship.

This is a decent primer on SPACs, which typically trade on the OTC Bulletin Board, although a few have begun hitting the AMEX.

So why are so many private equity firms taking a public flier on companies which, by definition, have no real assets, let alone a product or product in development? The best answer seems to be that many VC-supported SPACs are the next evolution of the venture partner movement, which already has spawned entrepreneurs-in-residence. Perhaps consider them management teams-in-residence.

SV Life Sciences, for example, is involved in an SPAC managed by the same team that founded and ran former SV Life Sciences portfolio company Laser Vision Centers Inc. Jim Garvey, CEO and managing general partner of SV Life Sciences, says his firm was approached by the team to participate, and will act as an advisor when the SPAC is considering certain deals, and also possibly provide select deal-flow. He calls it a very low-risk venture, given that SV life Sciences will only spend significant money if the SPAC both raises its IPO and then finds a deal (many SPACs are unable to do either). To date, the firm only had put in about $3,000.

Such vehicles seem to make sense for VC firms on a one-off basis, but one really has to wonder how many of them will get off the ground. There has been a massive surge in such offerings so far in 2005, and it is impossible to ignore the 2004 business development company parallels. After Apollo priced a BDC early last year, almost all the big LBO players filed into the fray, including Blackstone Group, KKR and Thomas H. Lee Partners. Subsequently, they all pulled the offerings due to saturated market disinterest, although KKR successfully reconfigured its attempt as a real estate inv*stment trust (REIT).

I’d assume the same file/withdraw/disappear scenario will play out with SPACs, because there can only be so many buyers interested in such amorphous securities. To put it in layman's metaphor, imagine coming home from Best Buy and telling your spouse that you spent $1,000 on a “new electronics product.” You can’t explain what it is or what it does, but were assured by Jimmy at Best Buy (who you believe to be a high-tech god) that it will revolutionize your life, once it’s shipped to you within the next year. How long until you’re sleeping on the couch?

More on SPACs in the next issue of Buyouts Magazine, including a discussion of why so many have been filed in 2005 ("It's just cyclical" is a popular explanation). If you’ve got any insights/input, please send it my way…

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