SPACs: An Alternative to IPO for Private Companies?
Author: Rishi Raj
3rd year law student at Maharashtra National Law University, Aurangabad
A Special Purpose Acquisition Company (SPAC) is a company with no business of its own that aims to raise capital via Initial Public Offering (IPO). It is formed to allow investors to contribute the funds via the IPOs, which are then used to acquire an unspecified target within a limited time frame. SPACs have been around in various terms for a number of years but during the pandemic and act as an alternative to a traditional IPO for fund raisings as in SPAC, a company has to follow less stringent regulatory frameworks compared to IPO. With the passage of time, SPACs are garnering the markets of private companies, acquiring them, and listing them on the stock exchanges. According to the Bloomberg data, there were 54 SPAC IPOs deals worth $54 billion, 250 SPAC IPOs deal worth $80 billion globally in 2019 and 2020 respectively. However, as of 18 August, 2021, more than 700 SPAC IPOs have transacted deals worth $174 billion globally.
II. SPACs: A popular option for companies to go public
SPACs have become a popular option to raise capital in recent years. A SPAC, also known as a “blank cheque company,” is similar to a more well-known method of raising capital i.e., the IPO. Even though there are some significant differences between SPACs and an IPO, both are opportunities for investors to get in on the ground floor of potential/target firms. SPACs provide companies with a number of key advantages and have become a popular alternative to IPOs.
A. Time Duration
In a traditional IPO, there is no fixed timing. An IPO depends upon several factors and going public can take the process from a few months to a few years. However, with SPACs, the acquisitions have to be completed within a limited time frame i.e., within 36 months. If the company fails to acquire the target within the given time frame, then it will have to refund the money to the SPAC shareholders.
B. Chances of raising additional capital
In addition to their initial capital, founder of SPAC entity will obtain debt or Private Investment in Public Equity (PIPE) funding to not only fund the acquisition but also to fuel the growth for the merged company. Even if certain SPAC investors redeem their shares or require the SPAC to return the investment so made previously, the backup debt and equity through PIPE will ensure that the deal is completed.
In a typical IPO, the cost of investment bankers or indirect costs such as underwriting fees and marketing roadshows can range from 4% to 7% of the total proceeds. However, in SPACs, the absence of direct and indirect expenses (that includes investment banker fee, lawyers’ fee, registration and regulatory filing charges) makes it less expensive when compared to traditional IPOs.
A SPAC transaction is basically a merger, there is a lot more flexibility for investors to take into account changing market conditions and it helps to acquire a company accordingly rather than a typical IPO where the target is predetermined. It enables enterprises to advertise themselves with more forward-looking predictions, giving target companies the freedom to negotiate extra aspects of the deal that benefit them, such as structuring the transaction to bring in new investments via PIPE or adding additional debt or equity.
III. Comparative study of Legal Framework among India, US and the UK
SPACs allow investors to go shopping for the appropriate company rather than first selecting a target and then dealing with the unpredictability of fundraising. However, if the Indian government wishes to join this ship, a legislative framework that is as simple as those in other countries such as the US and the UK is needed, since SPACs are all about removing capital market barriers.
Following Renew Power's lead, more fund-strapped Indian businesses may easily obtain financing on NASDAQ. For investors and targets alike, the SPAC regime represents the light at the end of the tunnel, particularly those seeking to avoid the conventional IPO path. In an effort to make a robust regulatory framework on SPACs in India SEBI has formed an expert committee. India, specifically the existing SEBI’s expert committee, may draw learnings from the regulatory framework on SPACs in the USA and UK.
IV. India on SPACs
Excluding the IFSCA (Issuance and Listing of Securities) Regulations, 2021, there are no exact and comprehensive regulations for SPACs in India. These regulations govern not just the SPAC sponsor but also the SPAC transactions, business combinations, fund management, or merchant banking operations. Underwriting of the public offering may occur, and this will be stated in the offer document. There are a number of disclosures that must be included in an offer document under these regulations, such as information on the issuer’s financial condition and the company’s capital structure. An escrow account for the underwriting commission is required, with a minimum of 50% of the money to be held until the company combination is completed successfully.
Nonetheless, Indian firms have taken this path before. For example, in 2016, Terrapin 3 Acquisition Corp bought Yatra Online Inc. through reverse merger, valuing one of India's top three online travel agencies at $218 Million. Similarly, there are news reports stating that Byjus is considering going public through a SPAC deal by merging with one of the SPACs of Churchill Capital - an American investment banking firm. The following are the existing Indian legislations which may be applicable to SPACs:
A. SEBI (Issuance of Capital and Disclosure Requirements) Regulations 2018
According to Regulation 6(1) of the SEBI (Issuance of Capital and Disclosure Requirements) Regulations 2018, a company must have net tangible assets of 3 crore rupees, an operating profit of 15 crore rupees, and a net worth of 1 crore rupees for the previous three years to be eligible for an IPO. SPACs are essentially shell companies until the de-SPAC process is complete. Accordingly, it is unlikely for SPACs to be listed on any recognised stock exchange in India without an amendment.
B. Foreign Exchange Management Act, 1999
During the de-SPAC process, target company investors and shareholders receive shares in the newly formed SPAC. FEMA and its regulations allow residents and stockholders to send up to $250,000 per year. The Reserve Bank of India (RBI) regularly adjusts the restriction based on foreign reserves and macroeconomic factors. The RBI generally requires that the fair market value of the company's shares be within the Liberalized Remittance Scheme parameters. This may be an issue when De-SPAC acquisition costs are expected to exceed the RBI's maximum limit. So, either raise the current threshold or exclude certain transactions from the Liberalized Remittance Scheme.
SPACs may require a RBI authorisation, which might cause significant uncertainty. A round-trip structure is likely to develop with Indian residents holding shares in a foreign business that owns a strong majority of an Indian target. In order to secure RBI authorisation, the merits of each case will be examined in detail, and the authorities are expected to scrutinise the application put forth for authorisation. Additionally, SPACs may be concerned about the uncertainty around RBI authorisation timelines, especially when it has to adhere to its own timelines.
C. Stamp Duty Act, 1899
In India, the law governing the imposition of stamp duty on mergers is inconsistent, and the amount payable varies by state. In the Hindustan Lever case, the Supreme Court confirmed that a merger plan is an instrument subject to stamp duty, as was previously the case. Stamp duty levied on mergers may be another substantial obstacle to a SPAC listing in the future. According to the Supreme Court's ruling in the Hindustan Lever case, the Stamp Act applies to the plan that brings about the merger (the court/tribunal decision). Real estate ownership need not be transferred. Furthermore, in Li Taka Pharmaceuticals case, the Bombay High Court held that stamp duty valuation must be based on the transferor company's shares or other considerations. Stamp duty is inevitable since a merger must be approved by the Courts before it can be completed. As a result, even if no assets are actually transferred in a de-SPAC transaction, stamp duty is still applicable.
V. Regulatory developments in USA and UK on SPACs
While SPACs were commonplace in the US and European markets prior to the 2008 financial crisis, a series of disastrous launches in Europe during the 2008 financial crisis led to an overall decrease in their use in capital raising. SPACs are presently the preferred mode of special purpose vehicles in the United States.
Given its rising popularity in the USA and UK, the Sponsor Promote And Compensation Act of 2021 (“SPAC Bill”) was introduced in the USA in August 2021. Around the same time, the UK also introduced a Consultation Paper on proposed changes to listing requirements for SPACs. Its details have been highlighted below.
India may take cues from the USA and UK and also come up with a separate framework for SPACs to become a popular option in India too.
VI. The US on SPACs
The SPAC Bill was introduced by Senator John Kennedy on April 29, 2021. Aside from reporting the amount of cash per share that the SPAC expects to hold prior to the merger under various redemption scenarios, the Bill also requires reporting any side payments or agreements to pay sponsors, blank cheque or private equity investors for their participation in the merger. This includes any rights or warrants issued after the merger and their dilution effect. The Bill also requires the SEC to amend its rules to help individual investors by disclosing more information. If the Bill becomes law, the SEC must act within 120 days. However, this would increase the compliance burden which may impact the popularity of SPACs.
VII. The UK on SPACs
Around the same time as the USA’ aforementioned bill, the UK’s financial regulator - Financial Conduct Authority released a consultation paper on the proposed changes to the listing rules governing SPACs.
It proposes to lower the minimum amount a SPAC can raise at initial listing from 200 million pounds to 100 million pounds, introduces a 6-month extension option for the proposed two-year time-limited operating period (or three-year period if shareholders approved a twelve-month extension), a ‘redemption option’ that allows investors to depart a SPAC prior to any purchase is completed, among others.
When it comes to going public, businesses now have a choice between SPACs listed in New York, Amsterdam, and other places thanks to the introduction of UK-listed SPACs. Sponsors may establish SPACs in all of these areas to offer a diversity of quality targets. An Indian target could also benefit from the diversity of geography where it wishes to get listed considering which market is more likely to appreciate the underlying business which the target company undertakes. To what extent it will influence the decision-making process remains to be seen, especially in light of alternative listing locations' attractiveness.
If similar provisions are introduced in India through a new framework or through making changes to the existing provisions for SPACs, such as redemption options, lowering initial listing amount required, and an option to extend time-limited operating period, then it shall help to make India a popular destination for SPACs.
VIII. Concluding Remarks
Others such as the UK, Singapore, Hong Kong, Australia and GIFT City in India are also working to create a legal framework for SPAC flotation, although most of the activity is taking place in the USA.
In its August Bulletin, SEBI stated that it has set up an expert committee to look at the feasibility of SPACs in India, although no specific regulatory framework has been developed for these businesses yet. Regulations for issuing and listing securities on IFSC-authorized stock exchanges have been announced. In September 2020, Indian companies will be able to list on international stock exchanges directly. The Indian Companies Act, 2013, has a new provision that permits offshore listing of certain identified public companies in a limited number of authorised countries, making it easier for issuers to access global capital markets. De-SPACs are on the increase in India, thanks to strong valuations and an abundance of SPAC vehicles, but regulatory and tax challenges persist.
SPACs’ goals include reducing the IPO process’ risk and time, as well as any legal obstacles that stand in the way of realising the enormous potential of start-ups by raising money and creating liquidity. A draft framework for SPAC listing on the designated stock exchanges of the IFSC was published by the IFSCA in this respect. In spite of the fact that these rules are a positive step forward, they are still lacking in terms of a clear regulatory framework, which would slow the rate at which SPAC listings expand in India. As a result, it's important to modify the current legislative framework or create a new one just for SPAC mergers. To support the development of SPACs in India, current legal regulations must be modified and made more flexible, and SEBI should reorganise the laws in this direction and provide a boost to the country's start-up environment.