Special Purpose Acquisition Company (SPACs) in India

Also popularly known as Special Purpose Acquisition Company, they are a different company with no commercial operations. SPACs are strictly formed for raising capital via an IPO (IPO) that is further used for possessing an existing company. SPAC might seem like a recent trend, but they have been in the market for decades.

Some also know them as the blank check companies. In recent years, SPACs have become quite popular and attracted numerous big-name investors and underwriters, leading to the rise of record amounts of money for IPOs in 2019. Likewise, in 2020, over fifty SPACs have been established by August in the US that has raised almost $21.5 billion.

What is SPAC IPO? Meaning Defined

Special Purpose Acquisition Companies are publicly-listed, non-operating companies that have been established with the sole purpose of identifying and purchasing a private company, thereby allowing the potential target to get publicly listed on the stock exchange of the respective country. However, it is known as a reverse merger when a publicly-traded company or SPAC acquires a private company compared to a traditional merger where a public company is turned into a private one by another private company.

Private companies prefer to be purchased by SPACs as it is less burdensome and more flexible than becoming a public company via an IPO. The financial markets’ receptiveness towards new public offerings usually varies depending on the investors’ risk appetite and the current economic conditions.

Moreover, SPAC acquisitions are preferred by private companies as their major shareholders, and founders get the opportunity to sell their ownership at a higher percentage during a reverse merger compared to an IPO. Besides, the private companies’ founders also get to avoid typical lock-up periods to sell the newly acquired public shares that they would have otherwise faced during an initial public offering.

How does SPAC IPO Investment Work?

SPACs are used for raising capital for acquiring an IPO. The SPAC IPO structure would typically include a warrant combined with a Class A stock share. The warrant provides the shareholders with the option to purchase more stocks later at fixed prices. Hence, the SPAC IPO investors can use the warrants to buy more stock shares after identifying the acquisition target and the completion of the transaction.

The SPAC stocks are usually priced at ten dollars per share. However, the warrants are set with a 15% higher price compared to the IPO. Once the IPO is completed, the warrants are traded separately after a few weeks.

An escrow account is set up where eighty-five percent of the SPAC IPO proceeds are stored for future acquisition. However, even ninety-seven percent of the raised capital is stored in the escrow account in some cases. In comparison, the other three percent is used for covering SPAC operating expenses and IPO underwriting. The escrow account funds are typically invested in various government bonds.

The management of the SPAC searches for potential acquisition targets once an IPO is formed. They have two years to identify a suitable acquisition target and closing the deal. In case the SPAC sponsors fail to do so, the capital that has been raised is given back to the investors. Once the target has been identified, the sponsors have to announce it to the public formally.  

Lastly, the business goes for approval to the relevant authorities. Once it is approved, the required capital is raised, and ultimately the transaction is closed, the acquired firm gets listed on the relevant stock exchange.

SPAC Investment in India: an introduction

Just like the global capital markets, India has also been embracing different new, innovative initiatives. The Union Budget had recently announced the One Securities Markets Code that effectively showed that trading in corporate bond and hold markets is highly progressive, promising, and creative. Likewise, India can also look into the concept of SPAC (Special Purpose Acquisition Company) as an alternative for IPOs (Initial Public Offers).

Although IPOs have been a well-established and old methodology for companies and businesses that want to get themselves listed on the stock exchange, the practice has highly evolved in India and the world market. India’s IPO processes and market are also well structured, which has further facilitated using SPAC as a more suitable alternative to IPO.

In the United States, SPAC has gradually gained traction in the last decade. It has significantly emerged in India as a preferred option in the last three years. Globally, SPAC has been used as a listing option in 2020 for all alternative transactions. That means more than fifty percent of the global transactions were conducted through SPACs, which raised as much as $83 billion. Considering the success of SPACs in the USA markets, Indian regulators have also examined whether the SPAC approach’s merits can be incorporated in India.

To give an insight to it, SPACs are blank cheque companies formed by experienced sponsors or a management team with minimal invested capital that results in an average of 20% interest in SPAC. In contrast, the public shareholders yield the remaining 80% of the interest through units offered by the SPAC shares’ IPOs. Every unit would include a part of a warrant that would be used for future fundraise and shares of the common stock. Therefore, a SPAC IPO has its origin in an investment hypothesis focused on a specific geography or a sector that is executed through the IPO proceeds.

The management or the sponsor team plans out the SPAC idea in a specific sector that helps them craft their business plan. In most cases, the management is sponsored by investors or hedge funds. It is through a public offering that the team uses the idea for raising the required resources. Once the capital is raised, the money is stored away with a trustee in an escrow bank account that would be used later when the target business has been identified.

Once a suitable target business has been identified, the SPAC would merge with it with the help of the money that is stored away in the escrow account. However, if the target business is larger than expected, more money can also be raised to support the merger. Hence, by following this method any unlisted or private target can get listed automatically. Simultaneously, according to public disclosure requirements, the details of the target company or companies are also disclosed.

The SPAC management is usually provided with 24 months for identifying and successfully completing a merger with the target company according to the plan set out by them. In case the SPAC fails to do so, the liquidation process is initiated where the money provided by the investors, along with the interest, and excluding expenses such as taxes is refunded immediately to the sponsors or investors.

SPAC investment’s primary benefits are its limited timeframe for the IPOs and the streamlined process of fundraising. Besides, the inclusion of professionals in the process of identifying a suitable target further gives the investment more merit and a well-thought-through outlook. With this new approach, almost 248 SPAC companies have been listed on the US’s stock exchange in 2020, featuring a fundraise of almost $335 million. This brings us to the mature and large IPO market in India, the regulators are considering the prospects of SPAC listings in the Indian markets along with necessary balances and checks. Although certain skepticism can be expected from the public and the corporate houses in terms of the risks that are associated with SPAC investments, the framework will eventually evolve in time and offer significant benefits.

SPAC Investment/acquisitions in India – Examples

Yatra SPAC Vehicle transaction

Yatra was acquired by Terrapin 3 Acquisition Corp (TRTL), a NASDAQ-listed SPAC. TRTL was listed on NASDAQ in 2014 and Deutsche Bank was their underwriter.

Videocon SPAC

Videocon DTH was listed on the NASDAQ through a reverse merger with Silver Eagle Acquisition Corp, a SPAC. Silver Eagle was listed in 2014 and Deutsche Bank was their underwriter.

Constellation Alpha Capital Corp SPAC Investment

Constellation Alpha Capital Corp., a SPAC, was listed on the NASDAQ in 2017. It is focussed on acquiring a target in healthcare services and manufacturing industry in India. Cowen acted as the underwriter for the offering.

Regulatory framework for SPACs in India

We can witness there is a lack of SPAC-focused laws that leads to weak regulatory frameworks in India. Some of the relevant regulations are briefly discussed below to provide a better outlook.

SPAC Regulatory framework in India

In India, the major regulatory drawback is the lack of targeted laws concerning SPACs. We summarize the relevant regulations below:

Company’s Act of India

Ever since the Indian government had announced demonetization in November 2016, various shell companies have come under the suspicion of the government. There has also been an urgent need for defining the concept of shell companies as they do not fall under the India’s Company Act. The parliamentary committee in March 2018 has requested the government for defining “shell companies” under the Company’s Act for avoiding pre-empt avoidable litigations and legal ambiguity.

A paper written by Garg et al. in 2011 has explained the “Objects” clause under the 1956 Companies Act as a primary impediment for SPACs implementation. The applicants are required to define their business objective adhering to the clause. However, SPACs do not have individual business objectives as they are only formed to acquire target companies. Therefore, the Company’s Act in 2013 had excluded the clause of “Other Objects” which took away the flexibility of defining Objects. Furthermore, in 2017, the Companies Ordinance, now Amendment was introduced in the Indian Parliament that proposed the overall elimination of the Objects clause. Nevertheless, before the signing of the Act, the proposal was removed.

According to the 2013 Company’s Act and it’s section 248, the company’s registrar can remove the name of the company from the company register in case it fails to start with its business within twelve months of its incorporation. A SPAC is typically given 12-24 months for completing its acquisition process. Such time is given to the sponsor for identifying the best acquisition target for maximizing the wealth of the shareholders. Therefore, this clause tends to become a major hurdle for smooth implementation of SPACs.

SEBI Regulations for SPAC in India

The Securities and Exchange Board of India had suspended the trading of 331 shell companies in 2017 but later gave most of them a clean chit. SEBI had acted as an advisory to the government in 2018 where they had defined the shell company according to the regulation of the US SEC.

Section 26 of SEBI Regulations of 2009 had also set certain eligibility conditions in terms of a public offer. According to the conditions, the issuer needs to have,

  • A minimum net worth of INR one crore for the past three years.
  • An average pre-tax consolidated operating profit of fifteen crore INR during any 3 of the past 5 years.
  • A minimum net tangible asset of three crore INR throughout the three preceding years.

Hence, it can be easily inferred that SPACs cannot possibly meet any of these requirements. This is because they do not have any non-monetary tangible assets or any operational profits. Moreover, even if the SPAC founders integrate monetary assets, no SPACs can wait for years before they get listed.

Exchange requirement

SPAC-related regulations change according to the SPAC exchange requirements across the globe. Some of these regulations are mentioned below,

  • In 2018, a bid was placed for encouraging SPACs as well as for reducing price distortion. The NASDAQ offered a proposal to reduce the amount of round-lot holders and maintain a net tangible asset of at least $5 million by the SPACs for remaining to be listed.
  • While handling a reverse merger of an already listed entity, the LSE (London Stock Exchange) would require that entity to delist themselves and reapply.
  • The HongKong Exchange and Australian Securities Exchange approve reverse mergers depending on specific cases.
  • The Toronto Stock Exchange of Canada has a different set of guidelines for SPACs which they actively promote.

India’s two prominent and famous stock exchanges are the Bombay Stock Exchange and the National Stock Exchange. Both the exchanges follow the regulations set forth by the SEBI. Apart from that, the NSE also requires the potential companies to have operational cash accruals for the past two years, making SPACs unqualified for listing. However, it can also be seen that SPACs in India had been successfully listed on eminent exchanges like the NASDAQ.

Besides the above laws and acts, Garg et al. had also identified the Foreign Exchange Management Regulations (2017) and SEBI Regulations (2018) as having a remarkable impact on the Indian SPAC mergers. For instance, the Takeover Code can only be applicable when the target company or companies are listed. In that case, the code sets severe restrictions on the type and extent of control that can be obtained while further increasing the time required for carrying out the transactions. Whereas the FEMR is only applicable when the target or the SPAC is listed on a foreign exchange market or when an Indian SPAC gets its investment from foreign investors. However, the FEMR guidelines only allow overseas investment after applying to the RBI (Reserve Bank of India). However, the 2018 FEMR Cross Border Regulation allows both outbound and inbound mergers subjected to compliance to all relevant regulations and laws.

Possible regulatory amendments and future of SPACs in India

As stated above, some of India’s existing rules and regulations are unfavorable for the development of SPACs. These regulations need to be redesigned to free them of their archaic nature. This would help in bringing a fresh outlook to the Indian state of the economy.

Policymakers need to redefine shell companies more effectively to alter the negative perceptions about shell companies primarily used as a vehicle of money laundering. A separate committee should be constituted for studying the potential influence of SPACs in the Indian economy, especially towards improving the start-up industry. Moreover, India also requires specific SPAC-targeted laws as they are different from the standard companies that go through regular IPOs.

Therefore, the Company’s Act needs to incorporate a separate chapter covering essential elements like SPAC incorporation, compliance, and the governance aspects related to the shareholders, board, and the management associated with the SPAC. A SPAC gets to work under standard provisions after it has concluded its acquisition. Therefore, separate chapters and provisions are required for facilitating all the applicable listing requirements and laws in terms of SPAC acquisitions. The Income Tax Law of India should also incorporate SPACs under their deductions and exemptions that are presently available only for angel investors, VCs, and start-ups. 

India Inc has witnessed rapid change in recent years. McKinsey has seized the capital market of India at approximately $140bn. Studies have suggested that more extended capital markets can also help release $100 billion of new funding every year that would effectively accelerate the growth of the Indian industry. Therefore, the regulators must adopt a new approach towards SPAC investment, thereby unlocking various prospects offered by these structures.

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