Series Tea

October 14, 2020

Kevin Hartz:
Explaining SPACs

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This week we’re having tea with Kevin Hartz, co-founder and chairman of Eventbrite. He's an early investor in startups like PayPal, Airbnb, Pinterest, and Mercury. Most recently, he founded A-*, a new special-purpose acquisition company (SPAC) which raised $200 million to acquire A-One and take it public.

In this episode, Kevin shares:

    Highlights from Series Tea with Kevin Hartz

    This interview has been lightly edited for length and clarity.

    You're an entrepreneur, you've taken a company public. You've been an early stage investor but you're not a late stage VC or a PE person. What was your journey from learning about SPACs to launching A-* and A-One? How did that happen?

    I've founded two companies that have been out in the public market, Xoom and Eventbrite. There's this conventional wisdom that says, "Never go public, stay private." But being out in the public markets has been a great experience for both companies. Xoom was eventually acquired by PayPal in 2015, but the public markets helped build a muscle that can atrophy after round after round of private financing, which I went through myself as a founder.

    In terms of how did I go from early stage investor to a $200 million vehicle... a SPAC is simply IPO-ing a company with $200 million in trust and we're looking for a partner in the private side which will subsume that and take that capital and establish itself as that primary entity, as a public company.

    After that, it's no different than an IPO or a direct listing. The finished product is a wonderfully enduring public company. We're looking for enduring businesses that we want to hold stock in for 10 years, 20 years, 30 years. Not ones that we want to flip six months after, which has been one of the critiques of SPACs.

    What was the journey? Was it Chamath that made you think about doing a SPAC?

    I think if you spoke to Chamath, he would probably say he invented the whole category. No, I'm kidding. Chamath's a very bright person and he is truly an innovator in coming first to this market.

    I was actually on a panel in 2012 where we talked about, “Do you stay private or do you go public?” I thought it was really nuts that companies were staying private for so long. It's really a divergence from where the status quo was 15, 20 years ago.

    We have a four-year vesting on shares. You're all familiar as founders of your companies that there's a four-year vest on your team members and even on yourself. That four-year vest was the amount of time you're supposed to be a private company before going public.

    So the average was four years. I think it was Amazon that was founded in '93 and maybe went public in '96 or so, three or four years after its inception. And then there's this conventional thinking that says, "You can't be a long-term company," and Amazon went public at a $500 million market cap selling books, and look where it is now. That inspiration of being out in the public markets competing has always been there. The market is moving now back that way and we see the tailwinds.

    So you saw these tailwinds. How did you make the decision to go after this as your next thing?

    I'm supposed to tell you how difficult and arduous it is and warn people from doing it. But to be honest and against my own best interest, it was very simple to get up and running.

    We had a ragtag team of four of us, Laura, Spike and Troy. We had our org meeting—the first meeting with your bank—on June 18th. We retained Goodwin, our law firm. We worked with Goldman Sachs. Part of the legitimization of SPACs is having the big, prominent banks like Goldman and Morgan Stanley backing these deals. Then we filed our confidential filing on the 1st of July.

    Our comments came back from the SEC at the end of July, so the government really held things back. Our filing was flipped to public on August 2nd, and we had a couple weeks required before we could do our roadshow. We did our roadshow in one day, all via Zoom, and the company was public on August 18th.

    60 days from zero to a public entity. It's $200 million in a trust account and this is the easy work. The hard work is finding a great company.

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    That’s absolutely insane that you did it in 60 days. That's obviously after you've built up this network, that you felt confident you could get $200 million in a relatively quick fashion from institutional investors.

    Well, I don't like to sleep very often, but it was a lot of fun.

    The SPAC is $200 million. And then it can target up to 5x valuation in a company?

    We chose $200 million, and we intentionally chose that amount because of the companies we want to reach. It's usually around 5x; 4-6x range. But we try not to use the term target; it sounds like one is an assassin.

    We're looking for a partner company. We're not out there to hunt big game. We're out there to find a company that we have a great deal of respect and admiration for and be a quiet partner to help bring them into the public markets.

    We can also add what's called a PIPE—Private Investment in a Public Entity—and actually bring in more capital. If a company needs $500 million, we can add $300 million via a PIPE. And the cost of capital is much lower when you raise a PIPE. It's less than 3% versus the 7.5% of a traditional IPO.

    Did you have to pay the 7.5% for the SPAC as well?

    The economics are a little more complex. They're actually higher and it's one of the reasons for, “Why now?” with SPACS. The economics are coming more in line. Before, they were very egregious economics and you're seeing what's called the promote. It's like a venture carry-compress.

    And because we were able to be oversubscribed with a relatively small $200 million vehicle, we were able to push down the warrant coverage to a quarter. And so these are all the things that a company that's thinking about taking their company public should look at closely, and again, against my own best interests.

    I want to dive into why you think a company should go public earlier in their life, and I want to get pretty specific on it. Here are the reasons why I think they shouldn’t, you can tell me why they don’t matter. Or maybe they do. Number one: there's a fixed cost to being a public company. You need to have a CFO and you need to be audited. Is that just not that significant a cost?

    Honestly, very few people have asked that question. But you're right. There is a fixed cost of the filings and there's overhead. It brings a certain amount of discipline though to have audited financials, to have one's house in order. And there is a cost of capital, there is a cost to it.

    But when you weigh it against the benefits of being public, how you're going to open-source your company and get all this great feedback from investors, you're much more competitive and nimble in how you act. I think that vastly outweighs those New York Stock Exchange fees that are relatively small in comparison to these companies.

    Second: if you're still launching new things, your quarterly performance may be not that predictable. Do you want to be past that phase, where you have maybe two years of very predictable quarterly performance and growth, before you think about being public?

    We’re talking to companies with wildly unpredictable quarterly numbers because they're doing so well. If your numbers are up and to the right, that's a very exciting business that public markets want to see. And then there is just day in and day out of building a company and the vision and the notes that you give or the message that when a shareholder really understands a business, they're looking not how a company undulates quarter in, quarter out, but where it's going to be 10 years out.

    You look for those kinds of lock box investors. We've had the good fortune of having a number of them in Eventbrite like a Baillie Gifford or so on, these long-term investors. I think there's a misnomer that everything has to be perfectly orchestrated. If you have a growing business, there's always a pattern to that in there.

    That's reasonable. Ok my third point: do you want your employees to be looking at the stock ticker every day and having their emotions tied to whether the stock's going up or down on a daily basis?

    I forget the Eventbrite stock price most days. It's fun to watch the first couple weeks, but then you know where value is being created and that's inside the walls of the business. What's exciting is continuing to do what one does and that's hit these great milestones, build a business, and see more happy customers. The stock price is really a distraction from that perspective.

    The last point, which I don’t love but have heard made: once you're public, the early employees and founders have liquidity and maybe they're not as passionate about working now.

    Well, I would argue that it's just the other way around. If somebody's there to just phone it in, they're really not the right employee for a company. You look at these great companies that have been in the public markets for decades from very small numbers. Again, the Amazons, the Apples, the Googles, the Facebooks and so on and you see very high performance cultures.

    It really comes from the leadership and the hiring. If you have somebody just sitting back, then you've got more fundamental problems with your culture.

    I think there was a temporary time period, maybe this was partly led by SoftBank, where valuations were better in the private market than public market. Do you think that's ended because the Vision Fund is finished now?

    That is part of the change on the macro level. It was, “Stay private forever, take as much capital as you can, you'll win in the capital battle”. But what we’ve found are these new, emergent, nimble companies that didn't over-raise and they're performing quite well.

    I think of Notion and Figma that baked for a number of years and did that with very little capital. They now enjoy the fruits of that. I think they should be out in the public markets, but they'll be out, I'm sure, soon enough.

    Contrast that to some of these companies, WeWork being the granddaddy example, where it was fundamentally a great business. Then they over-capitalized to an excessive amount and started exhibiting all sorts of bizarre behaviors of burning capital, strange acquisitions, crazy facilities, and that actually brought their downfall. Most companies don't die of starvation. They die of indigestion. The best way to get fit is to be out in the public markets.

    Is there a revenue number where you think an entrepreneur should be considering it? I heard Chamath say $50 million is the revenue number where people should be thinking about going public.

    $50 million in triple digit growth is that number, in my perspective. That's where a company has, generally, a product that's scaling very fast. If you look at an Airbnb that has a business where you have guests and hosts and very simple transactions and transaction fees, that is carried to many billions in revenues today. That company could've been out that early, and I think that would've been a phenomenal outcome.

    So $50 million, high margin is what we look for, triple digit growth and moving into a big market with a key differentiation. Of course, if you're a founder out there, you will always want to be building a business with the best team, a big market, a clear competitive advantage, and being unique in the market.

    I think there's been 80 or more SPACs this year. If you're a founder considering SPACs, what's the process you should use to pick the SPAC that you go public with?

    Well, we're investors. Just as on the growth side, and even on the early-stage side, each investor and firm has its own culture and values. In a lot of the SPACs, the values are lacking and that's been an issue.

    But you're starting to see really great operators. We think of ourselves as operators as much as investors. We've walked in the shoes of founders; we've been there on that side of the table; we know the tech ecosystem. We have a certain size of SPAC, and we're not looking over our shoulder, we're really just thinking about finding a great partner.

    Every growth fund that makes 12, 20 investments a year has the same issue. There's a lot of growth funds out there. They're making a dozen plus investments a year, and that's a lot more inventory than there are of SPACs out there. I think we're just getting started. We welcome more into the market, and there's so much opportunity.

    So you think if you're an entrepreneur and you're judging a SPAC, it's very similar to how you judge a growth VC?

    Precisely. Our values are hard work, founder-CEO-centricity. We won't take a board seat unless we're asked to do it. We're not going to switch out a CEO certainly that you see in some of these private equity deals; SPACs that tend to rip and replace teams.

    We're really just entirely focused on finding a great team and they know how to build their business. But we're certainly here to help in any way.

    With IPOs and direct listings, why should an entrepreneur who is ready to go public choose a SPAC over one of these other options?

    That's a great question. That's the right question. A SPAC isn't necessarily a replacement for all this. It's another great option and each has its own characteristics. I had a great experience with two IPOs and they were a lot of fun. They were a lot of hard work.

    You're very restricted in what you can say to the market versus what you can say and publish in an S4. The time you can spend with investors in a SPAC is much superior to the quick roadshow that's put on, that the CEO and CFO go through, and can only give very limited information.

    A direct listing is all secondary. There's now this proposal for secondary and a primary. A traditional IPO is all primary, a SPAC can be primary and secondary. So there's just a wealth of different options and one can always take another private round.

    So if you were to compare a direct listing where you can take a primary and a secondary, or a SPAC where you can take a primary and a secondary, why would you choose one or the other?

    Well, a direct listing generally doesn't raise money. There's a lot of complexity and time. I think it took Spotify a year to do a direct listing. It is still a more exotic animal itself. It's a relatively new phenomenon. There are more companies doing that.

    But the nitty-gritty of the trade-offs, looking at the cost of capital, setting the price. The other advantage of a SPAC is that you can come to a very efficient price versus in a traditional IPO being negotiated last minute with your bankers and investors. Each does have a different flavor.

    But in a SPAC, the price is set by the SPAC lead? You're merging but it's a negotiation to set the price?

    It's much more of the company setting the price. You certainly don't want to excessively overprice your business. But you really set the price here. You have that autonomy to do it. And our perspective is that we just care where the company is in five to ten years.

    Now, we don't want anything to trade down and I think the company is rational in terms of where to set a good price. In our discussion with partners, that's been a very attractive aspect of it.

    Normally, when you do a VC growth round, you want to get the highest price possible. The dynamics are not like that because it's going to be public afterwards. They don't want to overshoot on price and have a correction in the public markets?

    That's a great point.

    Do you think there's an adverse selection for people who are willing to do SPACs?

    The two main points today are the cost of capital, which is coming down and will come in line. The second is the historical negative perspective of SPACs. And both of those are changing in rapid real time.

    You're seeing Reid Hoffman, you're seeing Marc Stad from Dragoneer entering the market. You're seeing Micky Malka from Ribbit Capital. And these are excellent operators and investors that really invest in the best companies on the planet. So you have seen in real-time the quality changing from when it was these boiler room deals a long time ago.

    What was the actual thing that changed that made SPACs interesting again?

    I liken it to the internet or bitcoin. Those were technological phenomena; this is a financial innovation. The fact that we could go through and be public so quickly as a vehicle, which was facilitated by Eric at Zoom. Being able to do your roadshow all virtually instead of traveling around the country. Or the team over at DocuSign or HelloSign; I signed hundreds of documents, and to be able to do that virtually was key.

    There was an aspect of COVID accelerating the trend, and the innovation economy helped buffer this in, but it’s almost like any phenomenon. The radio took decades to reach 100% penetration, venture capital took decades to mainstream. Y Combinator took maybe a decade to become this financial vehicle at the formation stage to really aid and buffer companies. Now we see SPACs at the late stage as a vehicle that's emerged very quickly to go public with all these different tailwinds aforementioned.

    I feel like people are rushing to go public right now. Is there potentially some irrational panic—people think that the IPO markets are going to close if they don't act quickly— also fueling SPACs?

    Well, there's a certain rationality to it. Labor Day is one of these windows that open up and you see a rush of companies. We did that in September of '18 with Eventbrite; there were a slew of companies that came out during a window.

    This is, by the way, another advantage yet to be mentioned. A SPAC is already in the public market. So rain or shine, you can get out there with a SPAC vehicle. But there has been a rush. You saw Snowflake and Asana and Palantir really go for this because of this window.

    If that window closes, there's concerns about the election and so on. I don't know what's going to happen with the market. The one thing I've proven is I know nothing about the macro environment. A SPAC can be this consistent option that's always there.

    If a SPAC performs better in a down market because presumably it's cheaper to merge with companies, do you think outside a down market they’ll do well?

    That's the presumption. But there's great companies that should be in the public markets in any period of time. I had the good fortune of being a seed investor in PayPal and it was the first tech company to go public after 9/11. It was an immense success. There's really no bad time to go public with a great company.

    So you have a $200 million SPAC. Let’s say my company's worth a billion dollars. After I go public with you, I would have presumably a $1.2 billion company. What are the other costs involved? Is there some percentage of the equity that is not part of that equation and goes to you as the SPAC?

    There's a sponsor promote that comes out of that. There's warrant coverage that's mildly diluted, but still diluted. Those warrants have come down. It used to be one-to-one warrant to unit of SPAC share, and they've come down. We were the first to launch our first SPAC at a quarter warrant which is extremely low.

    What was the first thing called, something promote?

    It's called the promote. It's similar to carry in a venture fund.

    What is the promote for A1?

    The promote is essentially 20% of the $200 million as it's published, but it's negotiable.

    So after I go public with you, I'm going to have to waive $40 million to the organization, which is the promote, and a quarter of a percent.

    The warrant coverage is on the shares. And it's actually 20% post money, so $50 million.

    That's actually not that bad. That's pretty reasonable to pay that and go public at the end.

    We think so. We think it's a little high and we intend to bring it down when meeting the company. Micky Malka had a great idea of modifying the terms in a favorable way if there's a downside. It’s crazy to us in a venture fund; if you lose half the investors' money, you would never make a carry. But in a SPAC, you do. So Micky has reduced his promote to 10% in downside. But then at certain milestones, it actually raises.

    It feels like there's also a little bit of an arbitrage in that you've already done the roadshow, you've already collected the money, and the company doesn't have to go do their own roadshow and collect money.

    That's correct.

    People have entrusted you with this money and it's ready to go.

    That's correct. From a couple week diligent period, and the signing of an LOI, that deal can be announced in 30 days, which we've seen time and time again. So it's a fast pace but it's a realistic pace.

    30 days later, you're submitting all your papers, your final S4 to the SEC for review.

    How many of these are you going to do?

    The plan is to build a franchise like a Sequoia or a Benchmark. We, of course, have to be successful in our first, so we're very focused on that. But we're very excited to help innovate and get companies public sooner, and we hope to be in this for the long term.

    I guess Chamath’s got three going right now. Is 10 per year a good number for a franchise doing SPACs?

    Well, the storied venture funds are in their 15th, 18th funds with thousands of investments and sometimes a hundred IPOs. The goal is for it to outlast me.

    Is it also true that once you're public, it's much easier to get primary capital for the company?

    That's absolutely correct, and that's where we see that companies take round after round of diluted capital. In the public markets, you have so many different types of investors. And companies hit snags. Eventbrite was massively impacted by COVID, and we had an emerging matter in which Julia, the CEO, did quite brilliantly and raised $300 million.

    A growth investor is not going to be the one that makes this investment. We were able to raise a very interesting debt structure along with the public convert. And we were able to do the public convert in a few days, the debt financing with warrants in a few weeks. So it's incredible the availability of capital and different types of capital.

    Of course, you never want to be in a situation that we were in with the COVID disaster. In the case of live event ticketing, Julia and Eventbrite were harder hit than anyone out there. Maybe not as hard hit as cruise lines, but in that category. And the comeback she's staging is brilliant. But I don't think we would've been in business if we'd been a private company and had to find that capital.

    In the later stage, we have SPACs. In the early stage, we have rolling funds. Do those interact? Is there more innovation that you're seeing across the funding spectrum?

    Well, I think it's interesting that we are starting to see venture funds with SPACs. We had a lot of conversations with venture funds that wanted to learn more. We want to encourage this. We want this to open for more business and legitimize further.

    We're encouraging venture funds to enter this market. As you saw from Dragoneer, Dragoneer is a public and private market investor and now is a SPAC investor. We think more are going to enter the market as a very similar product to what they're doing now, diligence in finding great, enduring growth businesses.

    Is there a conflict when a VC does it? Are they going to be SPACing their existing portfolio which they already have an investment with?

    There's not an SEC violation, there's not an ethical violation. It's just like a follow-on round. Now, what you can't do in a SPAC is to have a partner company already picked out and agreed upon before. But there's interestingly no conflict whatsoever.

    You see it in private equity where a firm will own a private company, a private equity firm and then will take it public. You'll also see LPs, by the way, that are tired of such long 10-plus year periods to liquidity.

    It's certainly been a bountiful, great time to be in venture in the LP business. But the timeline to liquidity is so long that I think you'll see LPs, limited partners, the investors, and the investment venture funds actually very in favor of the SPAC direction.

    So you think more of these late stage growth VCs will be entering this SPAC option?

    Behind the scenes, I hear quite a bit of discussion about it. And again, you're already seeing it happen.

    Is there something limiting SPACs from a regulatory perspective or technology perspective? Is there something that could improve that would make them even better? For example, why can't they go up to a $10 billion company?

    Well, we could reach a $10 billion company with PIPE. If the company wanted to raise a billion dollars, we could raise an $800 million PIPE where you're paying less than 3% cost of capital, and that's a brilliant outcome for a company.

    By the way, we're all familiar with the IPO pop on the primary side. That's incredibly dilutive, far more than any sponsor promote that we discussed earlier, and one of the reasons that direct listings are highlighted.

    We think that the SPAC and the direct listing offer two different products. Really, what we're focused on is bringing the promote in line and secondly, we're focused on the reputational piece. I think those are the two most important aspects right now.

    Well, why would there not be a pop in a SPAC? It's just as likely to pop, right?

    Well, there's more thought and analysis and company-led direction on pricing. So if you're a first-time founder and CEO, you're going to be much more reliant, and it just happens to be very last minute. You do the roadshow, you have this pricing meeting, and build your book, and it just happens in rapid succession. It's not the best environment for price optimization.

    But didn't Virgin Galactic pop 67% after they did the SPAC merger? It does happen.

    They did but that price was much more set by that company.

    So it's the person setting it who changes it so incentives are better aligned. The company sets a price, rather than a banker setting the price with weird incentives.

    That's absolutely correct.

    This has been a super interesting conversation. I feel like I knew a lot about SPACs, but now I know way more. Feels like I should launch one just for fun.

    What's the best fundraising advice you've ever received?

    That's to choose not the highest price but the best investor and somebody that you're willing to work with for a decade-plus. We had the good fortune of working with Sequoia and Roelof Botha both times. He's extraordinary and he really was a great guide for us and especially Julia, the CEO of Eventbrite through COVID.

    That decision 10 years ago when we signed the Series A term sheet was so important. We had a term sheet that was 2X the price and we chose to work again with Sequoia.

    Why weren't they willing to up their price to match that 2X?

    Well, the response to that is maybe I'm a lousy negotiator.

    Well, you've done okay. What's a new company or product that you're excited about?

    This company I just invested in is called Sidekick. It's a YC company and it's a telepresence device, and this is-

    I invested in it as well.

    Oh my god. I love this company. This is Sidekick and it's always on, and it's one of the most brilliant things. Julia, while she's my wife, she's the CEO of Eventbrite, and we can tap to talk at any time. So it's for teams to get that sense of being there when you can't be there.

    And telepresence is such a different modal from what we're doing with Zoom or what Alexa or others do. I'm just such a big believer in the future of telepresence, and I think this team has brilliantly hacked together a great solution that I've been using non-stop since I got it a few weeks ago.

    It's funny. When I was thinking about ideas for my startup, I don't know exactly about the feature set, but it was pretty much my second best idea for startups instead of Mercury. I'm still happy I did Mercury, but I also invested in Sidekick.

    We're both proud investors. As always, it's always important to have a great team behind it.

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    The Mercury Team