Special Purpose Acquisition Companies - A viable alternative to IPOs?
Published: Nov 15, 2021
By Prashanth Shivadass & Sneha Philip*
What is SPAC?
A Special Purpose Acquisition Company ("SPAC") is a company formed only for the purpose of generating capital through an initial public offering ("IPO") and subsequently acquiring and merging with a private company 1. SPACs have turned into a well-known vehicle for a variety of transactions, including converting a private firm to a public company. When contrasted with typical IPOs, SPAC exchange permits a privately-owned business to become a publicly traded corporation with more prominent pricing certainty and control over terms of the merger/acquisition.
SPACs are essentially companies that do not have any operations of their own i.e., no active business. Additionally, they do not possess any assets other than cash and limited investments, including the IPO proceeds. Their sole business is to discover a private company with significant growth prospects and to take that firm public via a reverse merger/takeover. While the initial business combination can be structured in a variety of ways, the merged company that emerges from the deal is a publicly traded entity that carries on the target company's operations.
SPACs exist solely for the purpose of acquiring another firm (known as target company) and have no other commercial operations. Venture capitalists, hedge funds, institutional investors, and other business entities will serve as initial "sponsors" for SPAC. The SPAC, which is made up of a group of specialist institutional investors, is tasked with identifying a target company within a two-year time frame 2 and, thereafter, invest the IPO proceeds subject to shareholder approval. If such target company is not identified, the investment is returned to the investors along with interest as prescribed under the terms and conditions of the SPAC deal. When the deal is completed, the SPACs will reflect the target company's identity and consequently, the unlisted target is automatically listed on the stock exchange, i.e., the company is deemed to have gone public and the traders may buy and sell shares of the company.
Validity of SPACs and its Legal Framework in India
The SPAC structure is not supported by India's present regulatory framework. The Companies Act, 2013, allows the Registrar of Companies to strike off the names of companies that do not begin operations within one year after incorporation 3. Identifying a target and doing due diligence might take up to two years for SPACs. In order for SPACs to operate in India, enabling provisions will need to be introduced to the Companies Act.
The Companies Act also stipulates that a company must have certain commercial objectives, which must be stated in the "object clause" of the Memorandum of Association (MoA). 4 This presents a problem for a SPAC, as its primary goal is to purchase another firm, which stays unidentified, i.e., the SPAC has yet to identify a target and complete a business combination.
SPACs are also not recognized under the Securities and Exchange Board of India Act, 1992. A company must have net tangible assets of at least INR 3 crores in the previous three years, minimum average consolidated pre-tax operating profits of INR 15 crores in any three of the previous five years, and net worth of at least INR 1 crore in each of the previous three years to be eligible for public listing. 5 SPACs will not be able to make an IPO in India due to an absence of operational income and net tangible assets.
Section 234 of the Companies Act, 2013 deals with the merger or amalgamation of an Indian company with a foreign entity. The clause requires any foreign company merging into an Indian company to acquire prior approval from the Reserve Bank of India 6, which is rather time consuming for SPACs and does not fulfil the objective of achieving a faster acquisition process.
SPACs v. IPOs: How can SPACs be an alternative to IPOs?
In the US, all SPAC transactions are supervised by the US Securities and Exchange Commission (SEC), which has imposed extensive SEC filings, reporting, and disclosure procedures, for giving effect to transactions involving SPACs in order to ensure transparency and trust. Sponsors and investors have begun to view SPACs as a superior alternative to traditional IPOs due to their "well-regulated" nature in the United States. Furthermore, each stock exchange has its own SPAC policies, showing that countries across the globe are providing an opportunity for SPACs as an alternative to IPOs because of its fast and convenient nature. For example, the London Stock Exchange requires a listed firm to delist and re-apply in the event of a reverse merger with another listed entity, whereas the Australian Securities Exchange allows reverse mergers on a case-by-case basis. 7
The company will benefit from a number of advantages if it decides to go public through a SPAC. A traditional IPO has certain risks, for instance, the listing values are not fixed and are subject to change based on the market forces, whereas this can be avoided if one follows the SPAC route; the process of going public through a SPAC for the private company is by and large quicker than the conventional IPO process; SPACs can benefit from the knowledge and expertise of the initial sponsors, who may receive seats on the board of the private company once it goes public.
SPACs, on the other hand, can be more expensive than traditional IPOs due to the higher percentage of funds raised by IPO underwriters. The SPAC sponsors will likewise get a huge lump of stock, sometimes up to twenty per cent, if they choose to sell soon after the merger to realize a profit, causing the share price to fall.
Whether SPACs are a feasible substitute for IPOs in India?
SPACs have emerged as an attractive possibility for start-ups in India, who find it difficult to meet the criteria for listing through an IPO. While SPACs have been around for a while, their expansion has taken a hit due to market volatility caused by the COVID pandemic. While several companies in the United States of America postponed their IPO due to concerns about the failure of the public offering, others chose to merge with a SPAC as an alternative. 8
SPACs currently, do not fall under any substantial regulatory requirements set by the Indian legislature. However, India's market regulator - Securities and Exchange Board of India (SEBI), has set up a committee of specialists to look into the viability of introducing SPAC regulations in India 9 which might improve the chances of start-ups listing domestically. As India's IPO market is large and developed, SPACs have a good chance of succeeding. Flexible rules encompassing factors such as incorporation, compliance, and governance are needed to be created if India considers listing SPACs.
(*The authors are Partner and Associate respectively, with Shivadass & Shivadass (Law Chambers). The Authors would like to acknowledge the contributions of Mr. Achyutha R Bharadwaj, a 4th Year law student from Christ (Deemed to be University).
(The views expressed are strictly personal.)
1 "Special Purpose Acquisition Companies", Division of Corporation Finance, Securities and Exchange Commission, CF Disclosure Guidance: Topic No. 11 (Dec 22, 2020), https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies#_edn1
2 " What You Need to Know About SPACs - Updated Investor Bulletin", Investors Alerts and Bulletins, US Securities and Exchange Commission (May 25, 2021), https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin ( Period to consummate the initial business combination)
3Section 248, Companies Act, No. 18 of 2013.
4 Section 4, Companies Act, No. 18 of 2013.
5 Regulation 6 of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009; see also http://www.iepf.gov.in/IEPF/Eligibility_norms.html
6Section 234, Companies Act, No. 18 of 2013.
7Main Market, A guide to listing on London Stock Exchange, Pg. no. 40, London Stock Exchange, https://docs.londonstockexchange.com/sites/default/files/documents/guide-main-market-pdf.pdf ; Reverse Takeovers, Shareholder Approval Requirements - Exposure Draft Listing Rule Amendments, Pg. no. 7/23, Australian Securities Exchange (April 12 2017), https://www.asx.com.au/documents/public-consultations/Reverse-Takeovers-Exposure-Draft-Listing-Rule-Amendments.pdf
9 Sebi plans to come out with framework for SPACs, Economic Times (June 24, 2021, 12:56 PM), https://economictimes.indiatimes.com/markets/stocks/news/sebi-plans-to-come-out-with-framework-for-spacs/articleshow/83803425.cms