Introduction
Special Purpose Acquisition Companies (“SPAC”), which is a popular option for companies that wish to go public in a relatively short period, exploded in the early 1990s in the United States, which doubtlessly caught the markets off-guard.
In recent years, SPACs have emerged as a popular tool for companies to raise funds and make their portfolio companies go public. SPACs are essentially shell companies that are created for the sole purpose of raising capital through an initial public offering (“IPO”), to acquire an existing company within the specified timeframe.
Moreover, SPACs offer investors the opportunity to invest in a company before it goes public, potentially offering larger returns as the acquired company’s value increases upon listing. Additionally, it offers investors the option to redeem their shares before the acquisition is completed, providing built-in protection for them. The rise of SPACs has been said to potentially disrupt the traditional private equity model, as they offer companies a more flexible and faster way to go public without the rigorous due diligence that traditional IPOs require.
Importance
The significance of having companies with specific goals at the outset for buying targets is rising amongst the private equity investors. According to the Research of SPAC, till September 2022, there were 681 active SPACs.[1] Its use has altered the investing environment and created new opportunities and benefits, especially for private equity sponsors, SPACs have several benefits.
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- Private equity funds receive outright ownership position of the post-IPO SPAC, which increases the potential upside of post-combination entity.
- SPACs serve as a co-investment vehicle, allowing private equity sponsors to do transactions simultaneously with less leverage and more equity.
- The owners of the target companies can negotiate a nominal price when selling to a SPAC due to a restricted time window to initiate a deal. When there is a merger with SPAC sponsored by prominent financiers and business executives, it provides the target company with good management and enhanced market visibility.
- In a private portfolio company, SPACs provide clearer liquidity certainty for sellers who receive SPAC equity in the transaction, as compared to an illiquid interest.
SPAC was set up to raise capital through a public offer and thereafter undertake a business combination with an unlisted operating company to enable the listing of the shares of the unlisted company within a limited period and according to the legal requirements.
Advantages of SPAC
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- The SPACs provide benefits for businesses that have been considering going public but could not be due to a variety of reasons. The traditional IPO procedure takes nearly six months to more than a year, whereas the route to public offering utilizing a SPAC takes a few months.
- Due to the short window of opportunity to start a deal, owners of the target company may also be able to negotiate a higher price when selling such a company to a SPAC. The target company usually benefits from experienced management and increased market awareness if it is merged with a SPAC sponsored by well-known financiers and business executives.
- The global pandemic may have contributed to the rise of SPACs in 2020, as many businesses opted against traditional IPOs due to turbulence in the market coupled with increased uncertainty.
- SPAC is an advantageous way for a small company to raise cash without having to conduct an IPO of its own. There is little interest in the market for small company IPOs, which effectively leaves smaller companies with fewer options to raise capital. In many cases, operating company management teams do not wish to give up a portion of control to private equity investors and prefer the SPAC model.
- SPACs, which usually occur in the US, are subject to SEC regulations, which provide increased transparency regarding the financial condition of both the SPAC and the company that it merges with.
Regulatory Framework at Present
An Indian firm may merge with a SPAC which is listed in a foreign jurisdiction, and it must adhere to the Companies Act, 203, and the Foreign Exchange Management (Cross-Border Merger) Regulations, 2018. In India, these mergers are known as offshore merger, which needs a court-mandated procedure as well as clearance from the National Company Law Tribunal. Representatives from several key governing bodies, such as the Registrar of Companies and tax authorities, would be requested as part of the process. This method is usually time-consuming and influences deal assurance.
One of the oft discussed ways to do a SPAC is through a share swap. A share swap can be carried out in which the shareholders of the Indian company decided to shift their holding in the Indian company to the foreign-listed SPAC in exchange for the foreign-listed SPAC releasing shares. While this share swap framework may be regarded under the automatic route for non-resident investors of the Indian company, the fully automated route is not accessible for investors resident in India owing to grey areas in foreign exchange regulations, and they would require additional approval from the RBI, which could be a long-drawn process and hence negating the benefits that a SPAC structure brings.
Current Position of SPACs in India
In the United States, the legal structure explicitly allows for and governs blank check firms. The creation of similar corporeal players in India may be impossible due to some restrictions under Indian law. Recently in India, there has been a rise in public interest in SPACs, with an Indian business that generates more than USD 1 billion by joining a US-listed SPAC.[2]
Under American law, SPAC may conduct any business operations for 18-24 months until it merges with an operating entity, whereas a company registered in India that does not commence corporate activities within one year of incorporation may get struck off the register of companies preserved by the Registrar of Companies. Further, under the Indian securities legislation, some qualification conditions for public offerings are necessary, including minimum net worth, operational earnings, and net physical assets. This is in contrast to a typical SPAC, which has no activities or assets until the de-SPAC transaction is completed. In India, the public listing of SPACs is not permitted due to the regulatory environment. There are potential improvements on the horizon that will allow for the national listing of SPACs.[3]
Legal and regulatory hurdles concerning SPACs in India
Under Indian Company laws, when a company is formed, it is required to have a Memorandum of Association, which specifies its business objectives. However, in the case of a SPAC, it is difficult to specify the business objective since the business of the target company is usually unknown at this stage. Conversely, in the US, a SPAC is accorded 24 months to undertake the business combination.
When it comes to fundraising via an IPO, the existing regulatory framework prescribed by the SEBI, i.e., Issue of Capital and Disclosure Requirement Regulations, 2018 (“ICDR”), has detailed provisions concerning the eligibility criteria that the issuing company must satisfy. A SPAC might find it very difficult to comply with these conditions. According to the provisions of ICDR, a company that wishes to undertake an IPO must-have during the last three years of its operation, an operating profit of at least Rs 15 crores, net tangible assets of at least Rs 3 crores, and a net worth of at least Rs 1 crore. Furthermore, if the company has changed its name within the last year, at least 50% of the revenue, should be earned by the company from the activity indicated by its new name. If the above conditions are not satisfied then the only option available to the company is to undertake an IPO with the process of book-building, where it allows at least 75% of the net offer to qualified institutional buyers and shall need to refund the full subscription money if it fails to perform it. All these terms and conditions can pose serious challenges to SPACs in India since it would be extremely difficult to satisfy most of the conditions mentioned under the ICDR.[4]
Recent SPAC Transaction
In August 2021, India’s largest renewable energy company Renew Power started trading on NASDAQ through a SPAC listing and this has generated a lot of interest in SPACs from Indian investors. It is listed through a reverse triangular merger, details of which are:-
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- The exchange of equity shareholding of existing shareholders of Renew Power Private Limited (Indian Company) with the shares of Renew Energy Global Limited (“Renew Global”), a holding company that is incorporated in England for the business combination.
- Thereupon, a fully-owned subsidiary of Renew Global merged with the NASDAQ-listed SPAC- RMG Acquisition Corporation II.
- Renew Global listing on NASDAQ under a new symbol-RNW.
Way Forward
In India, SEBI has instituted a committee of experts to evaluate the feasibility of introducing regulations for SPACs. The Ministry of Corporate Affairs also published the Company Law Committee Report in March 2022 and made a few observations regarding the SPACs.[5] It also recommended relaxing the requirements to carry out businesses in the early days, and laying down the provisions on exit options to the dissenting shareholders of a SPAC if they disagree with the choice of the identified target company. It also recommended the introduction of an enabling provision that recognizes SPACs under the Companies Act 2013 and allows entrepreneurs to list a SPAC incorporated in India on domestic and global exchanges.
In addition, the International Financial Services Centres Authority Act (“IFSCA”) was passed in 2019 by India.[6] The IFSCA has recently come up with IFSCA (Issuance and Listing of Securities) Regulations, 2021 (“IFSCA Regulations”) which introduced a listing framework for SPACs, to enable SPACs in IFSCAs like GIFT City. According to the IFSCA Regulations, to become eligible to raise money through an IPO on an IFSC stock exchange:-
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- A SPAC must not have identified the target business combination before the IPO and should follow the provisions of redemption and liquidation in line with the IFSCA Regulations.
- The sponsors of a SPAC should have a good track record in SPAC transactions, business combinations, fund management, or merchant banking activities.
- A sponsor is someone who is sponsoring the formation of the SPAC and should include persons holding any specified securities of the SPAC before IPO.
The IFSCA Regulations also mandate that the SPAC issuer must complete the business combination within a maximum of 36 months from the date of listing. It also provides in detail the IPO process to be followed, disclosures in the initial offer document as well as continuous disclosure requirements, SPAC-specific obligations, etc.
There is a need for a regulatory framework as in foreign jurisdictions because the very essence of SPACs lies in neutralizing capital market boundaries. Large companies, which are fund strapped in India, can access capital on NASDAQ, which follows the path laid down by Renew Power’s listing on NASDAQ. IFSCA Regulations, have resulted in India’s first attempt to allow and regulate SPACs. It is expected that SEBI will soon introduce its regulations to ease the listing of SPACs on Indian stock exchanges.
Issues and Concerns with SPACs
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- Registration and regulatory framework– In India, currently there is an absence of a regulatory framework for SPACs, therefore SEBI needs to modify the existing rules and introduce new ones to accommodate SPACs.
- Transparency and disclosures– A key concern with SPACs is transparency and disclosure. Indian markets have seen several instances where promoters have allegedly misused funds even in regular listings, and there is a fear that SPACs could be used for similar purposes with less oversight.
- Oversupply of liquidity– Some sections of the market have raised the concern that the entry of SPACs could lead to an oversupply of liquidity in the market, leading to asset price inflation.
- Pricing issues– Pricing of acquisition targets can also be a challenge, as certain industries require significant regulatory approvals which add additional complexity to the pricing regime.
- Risk of underperformance– SPACs typically have a limited window to identify and acquire a target company, which could result in the acquisition of a company that may underperform in the future.
Conclusion
SPAC is a specialized operating and investment entity that brings together various stakeholders like sponsors, private operating companies, and public market investors. While the US experience gives some solace that SPACs can offer a possible alternative to traditional IPOs for publicly listing their shares, there are many challenges concerning the same in India, Domestic regulators such as the SEBI may come up with amendments to current regulations and perhaps new regulations which cover SPACs, which would open up new vistas for such companies and domestic investors.
Authored by Prashant Kataria
Footnotes
[1]https://stockmarketmba.com/listofallspacs.php#:~:text=List%20of%20All%20Special%20Purpose,764%20SPACs%20in%20our%20database.
[2] https://www.sec.gov/rules/proposed/2022/33-11048.pdf
[3] SCC Online, SPAC Regulations In India: Identifying Regulatory Challenges And The Way Forward, (Issued on June 8, 2021)
[4] https://www.sebi.gov.in/sebi_data/commondocs/subsection1_p.pdf
[5]https://www.mca.gov.in/bin/dms/getdocument?mds=bwsK%252FBEAFTVdpdKuv5IR5w%253D%253D&type=open