SPACs – Value Proposition & Regulatory Framework

– Megha Mittal

[mittal@vinodkothari.com]

The concept of Special Purpose Acquisition Companies (‘SPACs’) has gained significant attention and importance in India in recent times – from a subject preserved to select classes, the surge in transactions over 2020, has made it pave its way to every investor’s dictionary. And with all the spotlight that SPACs have attracted, the numbers seem to only lend to the hype. To begin with, the global SPAC IPO proceeds in 2020 alone is estimated to be $83 billion USD[1] with a total of 251 listings. This figure is further projected to grow to a massive 711 listings in 2021 with an average IPO size of USD 294.5 Million as on 15th August, 2021[2].

Globally, SPACs have become the investment vehicle of choice, more-so by startups looking for funding; and the US has been the flag bearer of the SPAC industry, leading from the front. Following shortly behind are economies like UK, Malaysia and Canada; and while India is playing catch-up, it seems to be speeding up quick enough, at least on the regulatory front.

For the uninitiated, a SPAC, often referred to as a Blank-check Company or a Shell Company, is a non-operating company with the admitted intent (read: special purpose) of acquiring of a potential target within a stipulated timeline[3].

In this article, while dealing with the basic regulatory framework via-a-vis SPACs, the author seeks to analyse the motivation(s) behind such transactions from all perspectives – the acquirer’s, the acquiree’s and the investors’.

SPACs – An introduction

As discussed above, a SPAC is essentially a Shell Company, having no business/ assets/ losses, incorporated with the objective of acquiring a target company (‘acquiree’). Naturally, at the time of its public offering, a SPAC has no business – it is only formed with the intent of acquiring another company, viz., the target. The sponsors of SPACs are typically fund managers or private equity investors. The sponsors put some of their money; but the larger part of the money is garnered through a public offering. The SPAC needs to complete the acquisition of a target within a stipulated time, or return the money raised from the investors.

A typical SPAC life-cycle would constitute the following steps –

Fig 1. Typical life cycle of a SPAC Transaction

In Fig 1. above, we see that the SPAC goes public on IFSC-DSE, post which the Sponsor searches the target company to acquire. Once such acquiree is identified and shareholders’ approval is received, the SPAC goes on to acquire the target company from the proceeds from the IPO – once such acquisition is complete, the target company generally merges with the SPAC and as a result, officially trades on IFSC-DSE. Thus, the end result is clear – the target company goes public without having to go through the regular listing process, which is both time and cost consuming.

Hence, a SPAC transaction is broadly a three-step process – (a) Formation and listing of the SPAC; (b) Identification of the target company; and (c) De-SPAC, that is, acquisition of the target company by the SPAC and consequent listing of the target company in the jurisdiction where the SPAC was initially listed.

At this juncture, before we understand the regulatory framework vis-a-vis SPACs, it is essential to understand the economics of it – with the IPO ecosystem being so well established in India, what could be the motivation and value proposition for the target companies as well as investors.

India is currently witnessing an accelerating IPO market with over 17 IPOs (BSE and NSE) in Q1 2021 versus one IPO in Q1 2020 and 10 IPOs in Q4 2020, representing an increase of 1,600% compared to Q1 2020 and an increase of 70% compared to Q4 2020. Amidst the rising trends, it would be interesting to assess how and more importantly, why, would the companies and investors make the shift from traditional IPOs to the relatively new SPAC.

Choosing between IPOs and Listing via SPACs

At the outset, it is important to understand that to distinctly choose one mode over another would not be the most efficient way, because commercial feasibility and viability are subjective matters; and hence, a safer answer to IPO vs. SPACs would be – “it depends.” Nevertheless, below we attempt to list down the pros and cons of listing via IPOs versus SPACs, so as to assess what lies in each proposition.

Basis IPOs SPAC
Time involvement Listing via IPOs is a relatively time taking process, spanning upto 12 months on an average. A SPAC merger usually occurs in 3–6 months from the date of identification of the target company by the SPAC
Price Discovery Price discovery in case of an IPO depends on the then prevailing market conditions In case of listing via SPACs, since the merger/ acquisition has to be done by the SPAC, the price is subject to negotiation and not market forces. It naturally makes it a preferred option, especially in a volatile market like India
Possibility of raising Additional Capital In an IPO, the capital raised in the amount of subscription by the market – the IPO would not leave doors open for additional capital through that very process SPAC sponsors raise Private Investment in Public Equity (PIPE) funding in addition to their original capital to not only fund the transaction but also to fuel growth for the combined company. Such additional buffers may also be used for meeting the consideration during De-SPAC in case few investors choose to redeem their units.
Risk of disproportionate redemption In case of IPOs, once a shareholder purchases shares, the only way to exit at his/ her own volition would be by transferring the shares to another person. Such transfer does not affect the capital available with the company. In case of SPACs, the target company is identified after the SPACs have been listed – thus , it is very likely that a significantly larger group of unitholders choose to withdraw their investment.

 

In such cases, the SPAC is required to redeem the amount along with interest, thus seriously impacting the availability of funds to complete the De-SPAC exercise.

Cost involved Given the list of formalities, check, prerequisites required in an IPO, the cost involved in an IPO is generally on the higher end SPAC transactions simply involve a merger/ acquisition exercise – as such, the cost involved is lower.
Reliance on face (read: celebrity) value An investment in an IPO is directly made by the public, the investors, in the Company and on the basis of a detailed study about the company. However, such investment is also heavily influenced by market rumours and sentiments, thus making the pricing volatile. In case of a SPAC, given the target company is not identified at the time of listing, the investors of the SPAC units essentially have to rely on the face value and expertise of the sponsors. Thus, a great deal depends on the sponsors’ investment decision, and as such this mode is free from the impact of market rumours and influence.

The Success of SPACs – A Game of Optimal Pricing

From the above, it is evident that the primary edge that SPACs have over IPOs is the likelihood of optimal pricing. Given that De-SPAC is essentially a deal between seasoned professionals and the target company, pricing is free of market influences and market sentiments. In such cases, if the pricing is optimally determined, the likehold and predictability of success is higher as compared to a traditional IPO.

Additionally, listing via SPACs also provides a better funding option for start-ups. A closer look at the nature of companies who have gone public in the recent past would reflect that such companies are those which have already established themselves as businesses and as such have a good standing in the public eye – a successful listing in such cases is more probable as against start-ups or relatively new establishments which find it difficult to find investors and raise funds from the public.

Listing via SPACs – An Upside for Investors

Further, optimal pricing also attracts investor interest as the framework provides the investors of SPAC with the option of redemption/ withdrawal if the identified target company is not suited to them. Thus, listing via SPACs allows investors the upside of optimal pricing with a simultaneous safety net of the principal being returned if opted for.

Having understood the value proposition of SPACs, we now discuss the regulatory framework.

SPACs in India – Regulatory Framework

Like NYSE in the US, listing in India can be done on the two recognized stock exchanges – NSE and BSE. However, what is often overlooked is the listing possibilities in the International Financial Services Centres which have shown the potential of having significant positive impact of the Indian Company, thus implying that a SPAC formed in or outside India could be listed in NSE, BSE as well as with IFSCA.

That being said, regulation becomes important. While regulatory authorities across the globe have been taking necessary actions to support, regulate and monitor SPACs, closer home in India, the Securities and Exchange Board of India (‘SEBI’) has recently constituted an Expert Group for examining the feasibility of SPACs in India, and the International Financial Services Centre Authority (IFSCA) has issued the IFSCA (Issuance and Listing of Securities) Regulations, 2021 which provides a regulatory framework for SPACs IPO and listing within its jurisdiction.

Chapter VI of the IFSCA (Issuance and Listing of Securities) Regulations, 2021 has laid down the conditions and pre-requisite for listing of a SPAC in IFSC. Key elements are –

Fig 2: Key Elements of the IFSCA Listing Regulations

Besides the above, it is important to note that a full-fledged implementation and operation of SPACs would require several tweaks and amendments in other laws like the Companies Act, Income Tax Act, FEMA and SEBI Rules Regulations, so as to align the different laws in the same tune.

In this pretext, while it is highly significant to provide for a robust regulatory framework, it is even more important to understand whether SPACs can be seen as a promising alternative to IPOs. In the discussion below, we shift our focus to analysing the possible motivations and de-motivation of SPACs, especially in the Indian Context.

Apart from the commercial reasons discussed above, several other factors such as clarity of applicable provisions and regulations, tax implications also play a major role in making the choice between IPOs and listing via SPACs. The former being an established process has a clear set of rules and regulations applicable to it and as such has an upper hand over SPACs which is still in the process of having the very first set of rules and regulations. Evidently, without clarity on taxation, disclosures, reporting and exchange control aspects, one could easily run afoul of the law-triggering costs and adverse consequences.

Additionally, the sector to which the target company belongs could also be a deciding factor – it has been observed that start-ups are preferred targets as opposed to bigger, more established companies. Simultaneously, start-ups may also prefer listing via SPACs, seemingly on account of simpler funding.

Thus, as mentioned above, the choice between IPOs and listing  via SPACs is indeed a function of various factors as discussed above and the manner in which the company is placed via-a-vis the factors.

De-SPAC: A Regulatory Void; Calling for Clarity

De-SPACing may agreeably be identified as the most crucial leg of this three-step process. It refers to the stage where the SPAC acquires the identified target company and the latter gets listed. As simple as it may sound, there are several questions that remain unanswered w.r.t. the modes of De-SPAC and consequences thereof.

To begin with, the most common mode of De-SPAC, across jurisdictions, would undoubtedly be mergers. In India, currently SPACs can only be listed in IFSC, which thus raises the question whether such mergers would classify as a domestic merger or a cross border merger. Such classification and consequences thereof are discussed below –

Fig 3. Possible implications of De-SPAC by merger

Besides merger, another possible mode of De-SPAC could be an acquisition and share-swap, that is, the SPAC shall acquire the shares of the target company from the latter’s existing shareholders, and in turn give them the shares of the SPAC. De-SPAC in the said manner also has several loose end. Below we tabulate key features of the different modes of de-spac and try to understand their implications as per the extant Indian provisions –

Basis

Route-1 : Merger

(see Fig. 3)

Route 2: Acquisition & Swap

Scenario 1

Scenario 2

Scenario 3

Type of transaction Domestic merger Cross-border merger Domestic merger

 

Acquisition/ Swap of Shares
Resulting entity Indian Foreign Indian Indian
Status of shareholder Indian Resident Foreign Resident Indian Resident

 

Indian Resident

 

Stamp duty Applicable Applicable

 

Applicable

 

No implications
Taxation

 

Tax neutral Tax is payable on CG Tax neutral

 

Tax is payable on CG

 

Listed entity Target gets listed Target gets listed

 

Target gets listed

 

SPAC remains listed

Target is held by the SPAC

FEMA Applicable- LRS limits will be applicable to shareholders Applicable- LRS limits will be applicable to shareholders Applicable- LRS limits will be applicable to shareholders Applicable- SPAC is a PROI
Fresh Listing Applicable Applicable Applicable No implications

 

Implications under Companies Act Compliances w.r.t merger

 

Applicable

 

Applicable

 

None

 

Conclusion – The Need for a SPAC-tacular legal makeover

From the above discussion, we understand that while SPACs hold great potential to be a success in India, like the US, UK and Malaysia, a prerequisite for such success would be a clear and distinct set of legal provisions. The IFSCA Listing Regulations have laid the foundation stone of inclusion of SPACs in the Indian legal framework; however, a lot is yet to be done. Factors such as investment classification, taxation, role of FEMA would be key factors on which the performance of SPACs in India would depend on.


[1] Source: https://spacinsider.com/stats/?utm_source=markets&utm_medium=ingest

[2] Source: ibid

[3] Readers may also see – An overview of SPACs and related concerns in India

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