Family Office vs Hedge Fund Money: What SPAC Sponsors Need to Know — Steve Kann

Introduction — Steve Kann & Arc Stone Securities

SPEAKER_00 0:00

It's Mike Blankenship here with the SPAC podcast. Today I'm joined by Steve Kahn. Steve, uh, why don't you tell us a little bit about yourself?

SPEAKER_01 0:08

Uh, sure, I appreciate it. Uh, I'm uh uh 30 years in the investment banking business, uh, focused on small cap companies. Um I'm currently the head of U.S. investment banking for Arkstone Securities, uh, also partner in a merchant bank called Ocean Street Partners. Um, in that 30 years of uh experience in the space, we've done just about everything you can imagine. We've been company founders a dozen times. We've run three funds of different strategies in the space. Uh, I was an equity analyst and wrote a best-selling book on investing in relatively obscure publicly traded companies. Uh, and uh, you know, the the kinds and scope and uh sizes of transactions we've done have been uh pretty across the board uh for these last 30 years and in these relatively small, relatively unknown publicly traded companies.

SPEAKER_00 0:54

Terrific. Well, Arch Art Arcstone describes itself as you know having a family office DNA, not hedge fund DNA. And for SMAC sponsors trying to source pipe capital on why that distinction matters, especially at the execution stage.

Family Office vs. Hedge Fund Money: Why It Matters for PIPE Capital

SPEAKER_01 1:11

Yeah, I mean hedge funds sort of by definition, uh hedge, ARB, you know, they're looking for uh a spread, they're looking for a trade. Uh and you know, we we are much more interested in sticky money, uh, money uh that comes from investors, not traders. Uh the investor capital is you know more foundational to being able to execute on a plan uh post DSPAC or or you know in any kind of company. Uh and that family office capital, while a little more uh esoteric and a little bit more diverse, uh, it can be just fantastic partnership capital uh to move forward on some opportunity.

SPEAKER_00 1:50

Certainly. And and you know, you mentioned microcap and other businesses. So you've described yourself as a rec, you know, recognized expert in that space. And so the spag market has historically you know struggle with post-combination share price performance in both the small and microcap stages. So you don't see it all the time, where it's just kind of a race to the bottom there. From a capital markets advisory standpoint, you know, what structural or communications mistakes uh do DSPAC companies make, you know, that can destroy that aftermarket support?

The Two Products Every De-SPAC CEO Has to Sell

SPEAKER_01 2:22

Um you know, some of it I think is not recognizing that once you're public, right? You're operating you're humming along being a very good operating company in whatever sector is a private uh company, uh, and now you're public, and a lot of management teams don't fully realize, and maybe their sponsors of the SPACs are not properly communicating, that they now have two products to sell, which is one, their widget or their technology or their service or whatever, whatever it is that they sell to generate revenue, but they now have another product to sell, which is their publicly traded share. They have to tell that story to customers for those shares, just like they would tell the story of their widget to the customers for those widgets. Uh, and that is, I think, grossly underappreciated, undervalued, uh, and and poorly executed on. Um, I think that uh most companies need to go into being public, whether it's a SPAC or a direct listing or even an IPO, with an understanding that they got to spend real money like they would uh on their on their widget. They've got to spend on their stock. Uh and I don't mean promoting it per se. I mean just uh doing marketing efforts to get the story out, to communicate the value proposition, the market opportunity, uh, the the uh disconnect and value between them and their larger peers. They have to tell that story all the time to as many people as can, will, and are able to buy their stock.

Marketing the Equity Story: Spending Like It's a Product Launch

SPEAKER_00 3:45

Yeah. And and so, you know, another question here is so you've run capital formation across pipes, IPOs, M and A for you know, for microcaps and small caps. Where do you see a SPAC or DSPAC uh transaction fitting in that toolkit of yours? And when does it make sense to to do an IPO or an RTO or direct listing?

SPEAKER_01 4:06

Well, it's interesting. That's the topic of this uh conference I'm speaking at tomorrow, which is okay, you have some uh some benefit, you see some benefit to being public. Well, there's lots of ways to be public. There's four ways to be

Four Ways to Go Public — SPAC, IPO, Direct Listing, Reverse Merger

SPEAKER_01 4:18

public, uh, and each has their own challenges and advantages. Obviously, with the SPAC, um, there's already sort of an audience for the for whatever the D-SPAC, you know, the post-uh merger story is. Uh, there's uh sometimes capital left out in the trust, less so now than there used to be. Uh, there's access to capital because it usually trades pretty well. So you can usually get pipe capital to execute on. Um, and that's for certain kinds of, I would say, mostly mature companies, uh, where, you know, there's some fundamentals you can point to where you can properly value the stock and uh uh sort of properly um uh sort of analyze uh how well it's priced in that D-SPAC process. Uh the direct listing is a whole nother animal. Uh, specifically for companies that don't necessarily need a lot of capital. Uh they have a lot of shareholders, maybe that they're trying to give some liquidity to early shareholders. Uh, they meet all the requirements, but they don't um necessarily need the capital right now, but they'd like the access to capital markets to go forward. Uh, that can be a very uh interesting uh strategy and something that we're trying to specialize in a little bit now. Uh regular way IPOs are really hard to do right now for relatively small companies. If you're not raising $40 or $50 million, it's hard to do right now. These smaller $15, $20, $25 million NASDAQ IPOs have had a lot of difficulty getting done. Uh so companies are looking for alternatives, whether it's SPACs or direct listings, or even more uh common now, are uh trying to find a reverse merger target, uh, meaning a NASDAQ company that maybe has failed in its uh execution of its plan and is sitting there with an asset, with shareholders, well, with a ticker symbol, uh, and now is now looking for sort of a second bite of the apple for those shareholders who are in something that's uh maybe not gonna go, not gonna work.

Skin in the Game: How Arc Stone Structures Advisory Compensation

SPEAKER_00 6:08

Yeah, I mean, all that makes sense. And so, you know, let's talk about Arcstone. So you guys often take equity positions and wait in your compensation towards stock, as opposed to just cash from the company. So when you're supporting, you know, when you're you know, how does that skin in the game model work and evaluate for uh SPAC sponsors and D SPAC targets before agreeing to work with you?

SPEAKER_01 6:31

Uh it would be interesting to see how that would work uh in this in the SPACs or D SPACs. Uh we have that that form of compensation is usually when we find an already listed company that is grossly mispriced. We're in two of them right now, where we're looking at it like uh this thing is one-fifth where it should trade relative to its comparables. Why would I want cash when I think the stock is going to be a 5X or right or whatever over the next 12 months with our help, let's say. Uh, and so for those kinds of opportunities, we're definitely looking at stock as a key component to what we uh will accept in advisory shares or uh in um in uh success-based compensation, you know, through some sort of uh capital raise or MA transaction. Uh on a SPAC, uh, a little trickier, uh, you know, in part because of the way they're structured with the uh, you know, the the you know, you got the money and trust over here, and then you're negotiating. Uh it depends on when you're whether you're with the buy side or the sell side. If I'm on the sell side, uh meaning the the the the target side, uh yeah, I can probably negotiate some comp there. I want I want shares in the spec post post-transaction. On the uh on the spec side, on the buy side in those kinds of transactions, a little trickier in part because you don't know where you're gonna land post post-transaction in terms of capital structure, and what is what is that equity really gonna be worth, if that makes sense.

SPEAKER_00 7:54

It completely makes sense, and you have to really evaluate the you know the value and then kind of go forward on that. It totally makes sense. So, you know, when you are supporting a D-SPAC transactions, how do you think about the sequencing for it? You know, when do institutional investors come in versus family office versus retail? How do you think about that? Because I understand you have uh thousands upon thousands of qualified contacts and you know using that network. How do you think about it from a D SPAC perspective?

Sequencing PIPE Capital: Institutional vs. Family Office vs. Retail

SPEAKER_01 8:22

Well, I hate to make a convenient answer, uh, give a convenient answer, but it depends on the deal and and how uh how how well priced it is. Uh, you know, if it's well priced, you can get institutional capital because that's smart money. Um, the more aggressively priced a D-SPAC, uh, you know, a SPAC transaction is, uh, in terms of, hey, we're being a little speculative with this, we're being a little uh rich on our valuation because we want to get a deal done before our our you know the alarm goes off in in three months or whatever it is, uh it's you're gonna attract less institutional, it's gonna be less attractive to uh sophisticated capital. And you have to look instead then at uh family offices. I'm not saying they're not sophisticated, but I'm saying they're maybe more willing to take a bet on a business model and a and a market opportunity. Uh uh and then you know, retail is uh one of two things, I think. Either, you know, it's a tough deal to get done with institutions and you have to rely on retail, uh, who again are maybe looking at the long-term big picture. They're kind of getting sold on the and excited about a story uh versus fundamentals, which would be more attractive to institutions. Um and then, of course, you want retail institutional support in the open market once you're, you know, once you do your transaction. But uh, I was referencing really the pipe money, uh, institution versus family office versus retail, uh, uh in the deep spec process. Once it starts trading, of course, you want everybody to be buying the stock, um, uh whether you're institution or or retail. I don't know if that fully answers your question.

SPEAKER_00 9:54

No, it fully it answers it. I mean, it really is a balance in you know, bringing in the right capital, the long-term hold. And, you know, we initially talked about hedge funds, and you know, that that can be in the arbs that come in, can be very difficult for some of these SPACs to execute, especially on the back end and see the high

Toxic Capital and Fatal Money: What Destroys Cap Structures

SPEAKER_00 10:11

reduction.

SPEAKER_01 10:11

Yeah. There there's uh there's plenty of companies taking absolutely fatal money where you know they're they're they're really blowing up their their uh cap structure to the point where if they don't execute perfectly on the money they did raise, they may not have another chance to raise money. And that's uh that's sad to see. Uh, we see it pretty regularly in the in the smaller, you know, lower end of the market.

SPEAKER_00 10:33

Yeah, certainly that toxic capital is not good for for it's certainly been detrimental. I think this has been a new round of spac and D-SPAC transactions, a little bit different than figures ago. Yeah, yeah. So, you know, your Art Stone's platform's cross-border. You mentioned it. Yes. Um and so for a SPAC sponsor looking at a D-SPAC target with international operations or a cross-border capital raise, uh, you know, where where do, in your view, where do most sponsors underestimate the complexity of that?

Cross-Border SPAC Deals and the Cultural Complexity Sponsors Miss

SPEAKER_01 11:04

Of cross-border stuff?

SPEAKER_00 11:05

Yeah, there's the execution of a cross-border deal. Because there's, you know, we see a lot of people.

SPEAKER_01 11:11

Um, you know, there's just uh well, I mean, there's there's uh so many moving parts of that. Um there's cult there's truly just cultural issues, you know, depending on uh, you know, most foreign investors they look at the United States markets and go, what? You know, it's just completely alien to them. And and there is some cultural uh, you know, sort of things to understand about you know whatever market you're in. Um, you know, when we were, we used to, I'm talking about my partner and I before we joined Artstone, we used to do European roadshows for US listed companies. That was a real niche we had. Uh, and wow, it was really different. For one, the Europeans at that time, a lot of private banks over there and lots of ultra-wealthy families, uh, they would literally write checks and uh, you know, the certificate would go into a dex drawer and they wouldn't even look at it again for five years. Well, that's different from the way the US markets typically operate or US investors. Uh, and so uh culturally, I think just just understanding what the objectives of the investors that whoever is participating in your deal, you know, matching up expectations with uh with uh on the company on the investor side with what the uh company is selling, uh if that makes sense. I think that's more exacerbated when you cross borders.

SPEAKER_00 12:29

Yeah, certainly. I mean, it's you get complications, different cultures, different, all of it's uh different. So um let's talk about a fun thing here. So you've authored a book on record cap investing and built a career around identifying undervalued companies. You know, what you know, can you give a little secret about what signals do you look for when evaluating whether a private company is genuinely undervalued versus just uh you know unable to attract capital for you know legitimate reasons?

Identifying Mispriced Companies: Signals from 30 Years in Small Cap

SPEAKER_01 12:57

Some of those are uh the same answer. Um the you know, the the whole premise of the book is where there are inefficient markets, right? When a stock trades inefficiently, meaning not enough people know enough information about a particular opportunity to have enough activity in the stock to efficiently price it. So inefficient markets make inefficient pricing, and that is sometimes just as likely to overprice a deal as it is to underprice a deal. Uh, but some of these deals are so small uh that one, institutions can't buy them, right? Because they're, you know, sub-50 million dollar market cap or something, or they're sub-10 million dollar float, or they're sub-million dollar a day trading, or whatever the uh the parameters are within a fund as to what they can and can't even look at. And so you get these smaller names that uh uh trade so uh inefficiently uh and so few people know about it that uh they just get mispriced. Like just there's not enough people paying attention. Uh we have, I won't say the name, but we have an advisory client now where the CEO is just great news after great news after great news, and he was wonders what wonders why his stock isn't performing better. I'm like, because you may as well be announcing the news in a padded cell, you know, at an asylum because there's nobody there to hear the news. Uh and that's the that's the uh effort he has to make. Back to my very first comment is that most CEOs underestimate that they have another product to sell. They have to go be marketing that story. They can't just rely on build a mousetrap, announce a, you know, make a good press release, and they will come. You have to go find them where they are and tell that story and market that story and get it in front of as many people as you can so that it trades efficiently, so that it prices efficiently. Uh, and so that's all I look for is sort of before the crowd opportunities, before it's efficient, uh, and and find those things that are uh, you know, what I think are wildly mispriced. I mean, we're in a deal now where their peers, their larger peers, all trade at six times, five, six times revenue. It's trading at less than one time revenue. Uh, we're in another deal that's uh trading at one fifth, uh one tenth of revenue that trades at about three times revenue. Uh, and these are all companies that are at or near profitability. So it's not as if they're just lighting money on fire. Like there's a real inflection point there where they're about to cross over into cash flow uh and are just not getting any credit at all for their top line growth uh when there's you know clear uh comparables to point to to say this looks really cheap. This looks really mispriced. And so we're just looking for those deals all day, every day.

SPEAKER_00 15:35

Yeah, it makes sense. Asymmetric information, finding the right way to get that information out there, that equity story, especially when you tell it from a SPAC perspective or an IPO perspective, to get that, you know, people to understand it. So I think that's really good advice. So um, Steve, I appreciate you coming on today. Um I I don't know if you had final words for folks since it relates to SPACs and where it kind of um, you know, you kind of see it in the rest of the year. I'd love to get your view on that before we um sign off here.

SPAC Market Outlook: Why the Structure Has Meaningfully Improved

SPEAKER_01 16:06

Uh I mean, uh we we advise a couple of spacks on the buy side. Um uh we know all the major players in the SPACs uh and have kept pretty good pulse on it. Um I think the tide has turned a little bit. You know, there was obviously two or three years in the in the wasteland for SPAC uh where redemptions were out of hand and there were just an oversaturation of SPACs, and the structures have improved, uh, and the risk sharing has improved with the sponsors vis-a-vis, the uh the investors vis-a-vis, the targets. Um, I I think I think the SPAC market's in pretty, I think pretty good shape. It's really just about finding enough high quality targets. Um, and that'll always be the case. Um uh any more comments on that? Uh does that make sense?

SPEAKER_00 16:47

No, 100% makes sense. You need those high qualities, which are ones that with an IPO market that's very difficult as you mentioned earlier. Um SPACs may be the way to go and just kind of getting going through that. Uh as you said, the audience is already you know pre-baked in there and hopefully get some of that going. So um, but I appreciate your time today, Steve.

SPEAKER_01 17:06

So I I did have one more thing I wanted to say,

SPAC Bootcamp: Educating Mid-Market CEOs on Paths to Going Public

SPEAKER_01 17:09

only because we're talking about SPACs. Um, and I am in New York City. This is a hotel room. Sorry for that. Uh uh tomorrow um at uh Gray Bar in uh New York, uh, I'll be speaking, one of the speakers, at the SPAC boot camp put on by Belay Investments and McKinley SPAC. Uh this is a sponsor group and then a uh a SPAC, you know, uh sponsor, McKinley, uh, that are putting on what I think is a great um educational uh boot camp for issuers, uh, where we're talking about all the ways to go public. Uh because you know, sometimes if you're not in the game every day and you just sort of hear SPAC or hear this or that in the in the in the background, you think, uh, oh, spAC, spAC, spAC. I guess I want a spAC. I want to spec. Well, there's other ways to get public. And so we're going to be educating uh CEOs tomorrow, mid-market CEOs on, you know, what are the different ways to go public and what are the advantages, which ones are suited to which kinds of company uh companies. And uh we're we're excited about that and excited to share that opportunity to go look at that content after the fact. Um uh after the event tomorrow.

SPEAKER_00 18:15

Great. That sounds like a terrific event. Um, and so appreciate you uh spreading the word there as well. So good deal. Thanks again, Steve. This is Mike with the SPAC podcast.