Chamath Palihapitiya, the most vocal promoter of a new wave of blank check ventures, funded two signing deals with borrowed money while stressing the importance of sponsors having their own venture capital .
The investor is known as the “Spack king” for its series of special purpose acquisition companies, which raise capital by listing on the stock exchange and then seek to merge with a target company. Its deal to take space tourism company Virgin Galactic public in 2019 has sparked renewed interest in Spacs, bankers said.
Palihapitiya also touted significant personal investments he’s made in his own Spac deals and propose that regulators force other promoters to put their “skin in the game” more.
Yet Palihapitiya borrowed from bank Credit Suisse to fund $200 million of his initial stock purchases in Virgin Galactic in 2019 and insurer Clover Health in 2020, according to regulatory filings reviewed by the Financial Times. He secured the financing by pledging his shares in the companies to the lender.
The loan agreements indicate that Palihapitiya invested less personal money in his dealings than was previously evident as he built an empire in Spacs.
Share prices of Virgin Galactic and Clover have plunged over the past year due to lower-than-expected earnings and steep losses. Many corporate governance experts dislike insiders pledging stock because it can add to the volatility of a company’s stock and misalign incentives between insiders and ordinary shareholders.
Palihapitiya stepped down as chairman of Virgin Galactic’s board of directors last month after selling his personal stake in the company. When asked by the FT in 2020 if he had taken out a loan to fund his $100m investment in Virgin Galactic, Palihapitiya denied that was the case, writing, “That’s NOT correct.”
A spokesperson for Palihapitiya’s investment firm, Social Capital, said last week that it would be “both dishonest and naïve” to position his borrowing as “new, new or unusual”.
“A basic mechanism of financial markets is to buy and sell on margin using a standing revolving facility,” the spokesperson said. “Banks, hedge funds and large family offices all use them – it’s tax efficient and reduces the need to sell positions with embedded gains.”
Most major U.S. companies prohibit executives and investors from pledging stock, and proxy advisor Institutional Shareholder Services said in 2013 that it was “not a responsible use of equity”.
“It increases his holdings — it makes him more risky,” said Jason Zein, a finance professor at UNSW Business School who has studied stock pledging.
Stefano Bonini, an associate professor of finance at Stevens Institute of Technology, said he would “strongly disagree” that Palihapitiya’s borrowings were the skin of the game.
Spacs typically reward their creators with thousands of shares purchased for nominal sums, which can result in lucrative payouts if they are successful in striking a deal. In the case of Virgin Galactic and Clover, Palihapitiya also purchased $100 million of shares in each company at $10 each through private equity.
These deals, known as “Pipes,” help raise additional funds and give companies a stamp of approval in Spac mergers.
While Palihapitiya profitably exited his bet on Virgin Galactic, he took a hit on Clover, whose shares have fallen more than 90% from their peak.
Clover jumped to more than $28 per share in June last year after reaching a deal with Palihapitiya’s Spac. Since then, the stock has plunged, falling to $2, as it faces questions about the sustainability of the company’s business model and its relationship with medical providers.
A month before Clover went public, Palihapitiya entered into a loan agreement with Credit Suisse to fund his investment in Pipe, according to regulatory filings, which said he had pledged the 10 million shares of Pipe. to secure the deal.
Palihapitiya previously used a similar loan deal to buy the same amount of Virgin Galactic stock as the company went public, according to filings. The filings did not disclose the terms of the arrangements.
Credit Suisse declined to comment on its loans to Palihapitiya. The bank also advised its Spacs on the agreements they entered into with Clover and Virgin Galactic.
Pledging shares can be risky during stock market declines, forcing lenders to seek more collateral from shareholders who might offload their holdings to meet new demands.
In total, Palihapitiya doubled the approximately $500 million he invested in his own Spac deals and broke even on $200 million of investments he made in other people’s Spac deals. , according to an analysis by New York University law professor Michael Ohlrogge, who has studied promoter compensation.
Ohlrogge’s analysis was based on public records, which may not capture all of Palihapitiya’s buying and selling activity. In November, Palihapitiya said he sold 15% of his stake in fintech company SoFi Technologies to invest in a battery maker and two cryptocurrency companies, citing confusion over the macroeconomic environment.
Palihapitiya also sold his entire Pipe investment in Virgin Galactic for more than $300 million beginning in late 2020. Shares in the company have since fallen about three-quarters to $8.25 per share.
Ordinary investors who bought shares following Spac transactions likely performed worse than Palihapitiya. Spac deals rarely benefit new shareholders unless promoters “can hit a company and instantly make it much more valuable than it was,” Ohlrogge said.
Additional reporting by Nikou Asgari and Nicholas Megaw