Insights by: Sumit Kochar, Shivam Gera & Sarthak Kasliwal
“Investors’ ability to create innovative investment vehicles like SPACs spurs economic growth and brings more attention to the U.S. capital markets.“
– Nelson Griggs, President of Capital Access Platforms at Nasdaq
Background
Special Purpose Acquisition Companies (“SPAC”), colloquially known as ‘blank check companies,’ have emerged as a prominent avenue for going public in the global financial landscape. While the United States and European exchanges have predominantly witnessed their proliferation, India is now poised to embrace this innovative financial instrument. The Securities and Exchange Board of India (“SEBI”) is in the process of crafting a framework that will enable Indian companies to embark on the SPAC journey. This burgeoning trend is particularly evident among startups and cutting-edge technology firms in India, as they seek to follow in the footsteps of their international counterparts. It is essentially an inactive entity maintained for future use. It becomes publicly traded through an Initial Public Offering (“IPO”) with the sole purpose of acquiring another company, referred to as the target company, and subsequently becoming a separate entity, leaving the target company listed on the stock exchange. This evolving landscape underscores the transformative potential of SPACs in India’s financial ecosystem.
In straightforward terms, a SPAC collects funds from the public and goes public on the stock exchange without having a specific target company in mind for acquisition. The primary objective is to utilize the capital raised from the public, along with potential additional investments from private investors (referred to as PIPE funding), to acquire an established operating company.
SPACs Under the Microscope: Balancing Benefits and Risks
Through a quicker timeline to become public, the SPAC approach provides some benefits over a typical listing process, including as speed and assurance. In contrast to typical IPO processes, where companies’ stocks are evaluated through market-based price discovery approaches that might be impacted by market conditions, SPAC purchases are executed on predetermined prices, which are less sensitive to the risk of volatility in the public markets. Additionally, SPAC structures are better suited for non-traditional and emerging technology enterprises, whose future worth may not be entirely obvious to public investors.
There are some specific obligations for SPAC, which can be considered as a good move for the investors. The issuer of the SPAC must put all of the proceeds from the IPO into an interest-bearing escrow account managed by independent custodian until the business combination is closed. All escrow funds must be invested solely in short-term investment-grade liquid instruments, as detailed in the offer document. The SPAC issuer may withdraw the interest and other income derived from the amount placed in the escrow account for payment of taxes and general working capital expenses, with the prior approval by way of special resolution of the shareholders other than the sponsors.
However, it should be noted that when we compare SPAC with the conventional IPO procedure, companies that merge with SPAC and go public face less scrutiny. In such a case, misrepresenting investments to draw in investors and raise money is always a possibility. Also, if a purchase does not work out for the investors, SPAC sponsors can still make profit from it. Due to the great potential for financial mismanagement caused by false representations or omissions of the company’s prospects, there is also a substantial risk of conflict of interest and fraud.
Companies often choose to pursue the SPAC route for their IPO for two primary reasons i.e., heightened public enthusiasm for investment and a faster path to becoming publicly traded compared to traditional methods. This expedited process reduces market volatility and associated costs, thus fostering favourable Merger and Acquisition (“M&A”) pricing and instilling increased confidence in SPACs, especially in the context of generally optimistic market sentiment. However, it is of paramount importance to acknowledge that SPACs do not engage in operational business activities themselves, instead, they rely upon the reputation and credibility of their sponsors. This reliance on sponsors elevates the inherent risks and volatility levels for prospective investors.
Significant uncertainty looms over SPACs, primarily concerning their ability to identify a suitable acquisition target within a constrained timeframe. In the Indian context, SPACs are not subjected to regulatory scrutiny, monitoring, or audits, owing to their absence of substantial business assets or a predefined minimum net worth. Concerns about performance, similar to other publicly traded companies, can adversely affect the valuation of SPAC stocks.
The absence of a comprehensive regulatory framework for SPACs in India necessitates revisions to existing regulatory norms by the SEBI and the introduction of new regulations tailored to accommodate the distinctive characteristics of SPACs. A prominent concern revolves around the transparency and disclosure aspects of SPAC operations. Historical instances of fund misappropriation by promoters in conventional listings have fostered apprehensions that SPACs may provide opportunities for similar mismanagement with comparatively lower oversight.
Furthermore, the potential influx of SPACs has generated concerns about an oversupply of liquidity in the market, which could potentially lead to inflation in asset prices. Pricing complexities also emerge in SPAC acquisitions, particularly in sectors necessitating extensive regulatory approvals, introducing layers of intricacy into the pricing framework. Additionally, SPACs operate within tight timelines to identify and acquire target entities, thereby heightening the inherent risk of underperformance due to hasty decision-making. Addressing these multifaceted concerns through the formulation of a comprehensive legal and regulatory framework is imperative to cultivate a secure and efficient environment for SPAC activities in India.
Exploring SPACs in the Indian Context
SPAC transactions in India are currently in their nascent stages, and for India to establish itself as an attractive hub for SPAC deals, there is a pressing need for enhanced clarity on various legal and regulatory aspects. One noteworthy development that has sparked significant interest among Indian investors is the listing of ReNew Power[1], the country’s largest renewable energy company, on NASDAQ through a SPAC listing in August 2021. This landmark event has brought SPACs into the limelight and generated substantial attention within the Indian investment landscape. However, to fully realize the potential of SPACs in India, it is imperative that legal and regulatory uncertainties are addressed to provide a stable and conducive environment for SPAC transactions to thrive and contribute to India’s evolving financial ecosystem.
The Regulatory Framework for SPACs in India
The Company Law Committee (“CLC”) has published its report on April 13, 2022. The recommendations there include suggestions to relax early-stage business requirements, establish provisions for dissenting shareholders in SPACs, etc. This initiative reflects the growing recognition of SPACs as a financial instrument in the Indian market. In order to facilitate the incorporation of SPAC in India and their subsequent listing on domestic and international exchanges, CLC recommended for an enabling provision to recognize SPACs under the Companies Act, 2013.
Additionally, International Financial Services Centres Authority (“IFSCA”)has already provided regulatory clarity on listing SPACs in the IFSCA (Issuance and Listing of Securities), 2021. The implementation of these regulations is seen as vital because SPACs are designed to transcend national capital market boundaries. These measures aim to provide a platform for financially constrained large companies in India to access capital on international stock exchanges, akin to ReNew Power’s listing on the National Association of Securities Dealers Automated Quotations (“NASDAQ”). It offers a comprehensive framework for SPAC listing in International Financial Services Centres like the Gujarat International Finance Tec-City (“GIFT City”). These regulations provide detailed guidance on the IPO process, disclosure requirements in the initial offer document, continuous disclosure obligations, and SPAC-specific responsibilities. Some of the provisions are as follows:
- Basic requirements: To qualify for raising capital through an IPO of specified securities on Recognized Stock Exchanges (“RSE”), SPAC must include the provisions for redemption and liquidation in accordance with these regulations, and its target business combination must not have been determined before the IPO. The sponsors of issuer should have a good track record in previous year’s business combinations and cannot list securities under these regulations, if the issuer is debarred from accessing the capital market, a wilful defaulter; or a fugitive economic offender. All information in the offer document must be complete, accurate, and sufficient for potential investors to make a well-informed investment decision.
- Size and Price: The minimum issue size shall be USD fifty million or any other amount as may be specified by IFSCA. It should be kept in mind that the sponsors shall hold not less than 15% and not more than 20% of the post issue paid up capital. Also, before IPO, the sponsors shall also have combined subscription in all securities of SPAC Company, either 2.5% of the issue size or USD 10 million, whichever is less. The application size in an IPO shall not be less than USD 100,000. It is important to note that the minimum subscription received in the issue shall be at least seventy-five percent of the issue size and the minimum number of subscribers is 50 or as may be specified by the Authority.
- Obligations specifically for SPAC: The issuer of the SPAC must put all of the proceeds from the IPO into an interest-bearing escrow account managed by independent custodian until the business combination is closed. All escrow funds must be invested solely in short-term investment-grade liquid instruments, as detailed in the offer document. The SPAC issuer may withdraw the interest and other income derived from the amount placed in the escrow account for payment of taxes and general working capital expenses, with the prior approval by way of special resolution of the shareholders other than the sponsors. In order to seek shareholder approval for the proposed business combination, the SPAC must submit to the recognized stock exchange(s) a comprehensive prospectus outlining all relevant disclosures, such as details about the target company, the business combination transaction, the process involved in the business combination, the resulting issuer company, etc. There should be majority vote in favor of business combination and shareholders (other than the sponsors) who vote against the business combination have the right to redeem their securities in exchange for a proportional share of the total amount held in escrow. In the event of change in control of the SPAC, the shareholder will have the same redemption rights as mentioned.
- Time frame: Within a year of receiving IFSCA’s observations of proposed listing, the issuer must make its offer to subscribe. To the extent possible, the SPAC issuer shall complete the business combination within the timeframe set forth in the offer document, but in no event later than 36 months after the date of listing on a recognized stock exchange (s). The escrow account will be liquidated in accordance with these regulations and the disclosures in the offer document, if the business combination is not completed within the allowed time frame.
As a pioneering effort, the IFSCA Regulations represent India’s initial attempt to permit and regulate SPACs, with the expectation that SEBI will soon introduce its regulatory framework to facilitate the listing of SPACs on Indian stock exchanges, further enhancing the investment landscape.
Further, under the Companies Act, 2013, companies are required to have a Memorandum of Association (“MOA”) that outlines their business objectives when they are formed. However, in the case of a SPAC, specifying the business objective can be challenging because the target company’s business is usually unknown at the initial stage. Regarding fundraising through an IPO in India, the existing regulatory framework set by the SEBI known as the Issue of Capital and Disclosure Requirement Regulations, 2018 (“ICDR”), lays out detailed provisions regarding eligibility criteria for companies seeking to go public. These criteria can pose significant challenges for SPACs. SEBI has specific eligibility criteria for listing that a SPAC is unlikely to satisfy at the time of an IPO under securities laws. According to regulation 6(1) of ICDR, a company wishing to undertake an IPO must meet specific financial benchmarks, including having an operating profit of at least Rs 15 crores over the last three years, net tangible assets of at least Rs 3 crores, and a net worth of at least Rs 1 crore. Additionally, if the company has changed its name within the last year, at least 50% of its revenue should be earned from the activity indicated by its new name. If a company does not meet these conditions, its only option is to proceed with an IPO using the book-building process. In this process, at least 75% of the net offer must be allocated to qualified institutional buyers, and the company must refund the full subscription amount if it fails to meet its obligations.[2] These stringent terms and conditions can present significant hurdles for SPACs in India, as satisfying most of the requirements outlined in ICDR can be extremely challenging.
Section 455 of the Companies Act, 2013 defines a dormant company as an entity formed and registered for a future project or to hold an asset or intellectual property, with no significant ongoing transactions. While it may be argued that SPACs are unnecessary in light of the provision for dormant companies, they are distinct concepts. A dormant company is typically a private limited company, whereas SPACs, by definition, must be public companies. Furthermore, a SPAC is established to facilitate the target company’s public offering rather than to hold an asset. Therefore, a dormant company is not equivalent to a SPAC.
Furthermore, cross-border mergers of Indian and foreign companies involve meeting various requirements, including prior approval from the National Company Law Tribunal (“NCLT”), adherence to valuation standards, compliance with reporting requirements, and certification. The Reserve Bank of India (“RBI”) has established regulations governing both inbound and outbound mergers involving Indian and foreign companies.[3] This cumbersome process poses a deterrent to sponsors and investors seeking to capitalize on timely opportunities.
It is to be noted that regulatory authorities in India are taking significant steps to evaluate and regulate SPACs. The SEBI has convened a committee of experts to assess the feasibility of introducing regulatory guidelines for SPACs.
SPAC in the USA
In the USA, a SPAC is essentially a shell company that undergoes an IPO to raise capital. The primary aim is to utilize the raised funds for executing a business combination with another company that already has operational activities. NYSE, Nasdaq, and NYSE American have rules setting forth listing requirements for a company whose business plan is to complete an IPO and engage in a de-SPAC transaction. The US Securities and Exchange Commission issue some rules pertaining to SPAC. Among other things, all three exchanges permit the initial listing of SPACs only if at least 90% of the gross proceeds from the IPO and any concurrent sale by the SPAC of equity securities will be deposited in a trust account. The entire sum collected from the IPO is held in a trust or escrow account and is only accessible to the SPAC once the business combination is successfully completed.
Following the IPO, a typical SPAC usually has a window of 18 to 24 months to acquire one or more operating businesses, and these acquisitions should have a combined value equal to at least 80% of the funds held in the trust account. Often, SPACs target larger operating companies to counteract the potentially dilutive impact of their capital structure. This structure involves a mix of public shareholders of the SPAC, the SPAC sponsor, and the pre-existing shareholders of the operating business. Due to the 80% rule, relatively smaller companies are generally not considered suitable targets for larger SPACs. Occasionally, multiple targets may be combined to meet the 80% threshold, although such multi-target business combinations are infrequent. The approval of the business combination by SPAC shareholders is required, and they have the option to redeem their SPAC shares for a pro-rata share of the funds in the trust account, which includes the IPO investment along with interest. This redemption option allows shareholders to exit instead of converting their shares into shares of the merged business. If, for any reason, the SPAC fails to execute a business combination within the specified timeframe, it undergoes liquidation, and the funds in the trust account are returned to its shareholders.
Regulations stipulate that SPACs may not identify acquisition targets before the closing of the IPO. If a target is under consideration at the time of the IPO, it, by definition, ceases to be a SPAC IPO. SPACs are typically sponsored by financial sponsors or investment teams with a proven track record of acquiring growth companies and realizing their value through public markets. The sponsor is responsible for funding IPO expenses and other operating costs during the search for a business combination target. In return, sponsors are allocated shares in the SPAC, generally constituting about 20% of the shares outstanding post-IPO. Once a target is identified, the SPAC initiates the acquisition through a process commonly referred to as “de-SPAC.” If additional funds are required to complete the acquisition, the SPAC explores options to raise capital from private equity investors. Following a successful de-SPAC transaction, the target company becomes a subsidiary of the SPAC or forms a new holding company, whose shares are listed on a stock exchange.
SPACs have been a presence in the U.S. financial landscape for the past two decades, but their popularity has surged in recent years. This can be attributed to several factors, including the involvement of well-established and highly credible sponsors in SPAC transactions, the significant growth potential of target businesses, and shorter timelines compared to traditional IPOs.
Concluding Remarks
The emergence of SPACs in India represents a significant opportunity for the country’s financial landscape, especially for startups and innovative technology firms seeking an expedited path to public listing. However, the journey to unlock the full potential of SPACs in India is not without its challenges. Regulatory uncertainties, stringent eligibility criteria, and concerns about transparency and investor protection need to be addressed comprehensively. The recent initiatives by regulatory bodies, such as the SEBI and the introduction of IFSCA regulations, are promising steps in the right direction. Expectancies are high that the SEBI will soon promulgate regulations specifically tailored to SPACs. This forthcoming regulatory framework is expected to unlock new horizons for companies considering SPACs as a means of going public and for domestic investors seeking diverse investment opportunities.
With careful regulation and thoughtful consideration of the unique dynamics of SPACs, India can create a conducive environment for SPAC transactions to thrive, attracting investment, fostering innovation, and contributing to the evolution of its financial ecosystem. As India navigates the evolving landscape of SPACs, finding the right balance between innovation and regulation will be key to harnessing their transformative potential.
[1]Economic Times, ReNew lists on Nasdaq at $4.5 billion valuation, Article dated August 26, 2021, available at
[2] Security and Exchange Board of India, available at https://www.sebi.gov.in/sebi_data/commondocs/subsection1_p.pdf
[3] Reserve Bank of India, available at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11235&Mode=0
