Piyush Soni

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Introduction

For the past decade, capital markets all over the world are on a development spree. Some of the changes, such as greater efficiency and transparency, were inevitable given the pace of technological and regulatory change.[1] However, one of the most significant developments that the international capital markets have witnessed is the resurgence of SPACs.[2] Within the first two months of 2021, SPACs have raised more than $38 billion, with an average of $296 million for 128 SPAC IPOs.[3] Last year, SPACs hauled in a record $83 billion with an average of nearly $335 million for 248 listings.[4] These numbers speak volumes on the rising craze for SPACs around the world.

Against this backdrop, this paper critically analyzes the status quo of SPACs in India. This paper is divided into 6 parts. In the first part, the author gives an introduction of SPACs and discusses their incorporation process. In the second part, the author sheds light on the pros and cons of SPACs. The third part talks about the regulatory framework of SPACs across different jurisdictions. In the fourth part of the paper, the author addresses the regulatory hurdles for SPACs in India. In the fifth part, the author discusses the recent trends of SPACs in India and their prospects, and in the end, the author concludes with some recommendations that could pave the way for their prospective regime in India.

WHAT ARE SPECIAL PURPOSE ACQUISITION COMPANIES (SPACs)?

SPACs (also called blank-cheque companies) are companies formed to raise capital in Initial Public Offering (IPO) to use the funds to acquire one or more businesses identified after the IPO.[5] Usually, a SPAC is created, or sponsored, by a team of institutional investors, professionals from the world of private equity or hedge funds.[6] The groups of expert institutional investors, who form the SPAC, are supposed to identify a target within a fixed time frame of two years and invest the IPO proceeds therein, subject to the approval of the shareholders.[7] If a SPAC is unable to find a target, it gives the money back to the shareholders.[8]

While in India, the legal position regarding the regulation of SPACs remains ambiguous, let us examine the phases in the lifespan of SPACs with regards to the USA, where the laws on SPACs have been laid down.

Phases in SPAC lifespan

The lifespan of a SPAC comprises of three phases: [9]

1. IPO Phase (around 8 weeks)

This is the initial phase of a SPAC and includes engaging counsel and editors, incorporating SPAC and selling founding shares, preparing and filing S-1, making amendments responsive to SEC comments, negotiating underwriting and ancillary agreements, roadshow, pricing, and closing.

2. Target Search and Negotiation Phase (up to 19 months)

This phase includes regular periodic sec filings, identifying target business, conducting diligence and negotiating acquisition agreement, potentially arranging committed PIPE or debt financing, preparing proxy tender/offer documents, and signing the acquisition agreements and financing commitments.

3. Approval/Closing Phase (3-5 months)

This is the last phase before the company goes public. It includes announcing acquisition agreements, filing preliminary proxy/tender offer documents, meeting with SPAC investors to discuss transactions, obtaining shareholder approval/renegotiate transactions or returning to target search, the redemption of public shares of electing holders, closing transactions, and filing super 8-K. 

Once the acquisition is complete, the SPACs reflect the identity of the target company. [10] Consequently, the unlisted target gets listed automatically. Since SPACs allow a private company to go public and get a capital influx more quickly than would have with the traditional IPO route, such structures have emerged as promising options for start-ups in India, who find it difficult to satisfy the criteria for listing through an IPO.[11]

MERITS AND RISKS ASSOCIATED WITH SPACs

To evaluate SPACs it is essential to examine the pros and cons pertaining to them. After a successful acquisition, SPAC becomes a public company and falls within the ambit of regulations framed by the country’s securities regulator. Hence, it becomes crucial that strict laws are framed keeping in mind the interests of the investors and the potential risks associated with these entities. In this section, the author has analyzed the merits of SPACs and the risks associated with them. 

MERITS OF SPACs

For budding start-ups and companies, backed by competent, skillful, experienced, and renowned sponsors, SPACs are an attractive option to access public market funds within a short span. Some of the benefits of SPACs are discussed below:

 PREFERENCE OVER TRADITIONAL IPOs

Traditional IPOs are burdensome and require financial due diligence and several other procedural obligations. On the other hand, SPACs, by their nature, are swift, flexible, and cheaper at offering private equity to a wide spectrum of investors from venture capitalists to even retail investors (and hence called “the poor man’s private equity fund”). [12] Further, the IPO process is swifter in the case of SPACs because SPAC financial statements in the IPO registration statement are concise and can be prepared in a matter of weeks (compared to months for an operating business). There are no historical financial results to be disclosed or assets to be described, and business risk factors are minimal.[13] SPACs provide a faster timeline to listing with no requirements of book building process and roadshow. Raising money via a book building IPO requires a lot of marketing and promotion-related expenses.[14]

FAVOURABLE PERIOD TIME

The most compelling advantage of a SPAC is the time it takes between intent to go public and being traded on an exchange. A company’s executive team would not want to devote 12–18 months of back and forth with the SEC and underwriters, followed by a pre-IPO roadshow. SPACs allow companies to go public in 4–6 months, leaving extra time for the team to focus on building the business and increasing shareholder value.[15]

COST EFFECTIVENESS

Although expenses for a SPAC are not much different from expenses for a traditional IPO, the structure of underwriter discounts and the overall underwriting process can be more favorable for a company looking to go public. Underwriters of a traditional IPO can be one or more investment banks, who receive an underwriting discount as compensation for marketing and selling the IPO, and the discount for underwriters of a traditional IPO is usually around 3.5–7%. However, the underwriting discount for a SPAC IPO is 5.5%, with 2% being paid at the time of the IPO and the remaining 3.5% paid at the time of the de-SPAC transaction (i.e. target business acquisition).[16]

RISKS ASSOCIATED WITH SPACS

While the benefits of SPACs have been discussed in detail, it is essential to examine the risks associated as well.  Some of the most common risks associated with SPACs are discussed below.

RISK FOR RETAIL INVESTORS

Although SPACs could enable the listing of start-ups on domestic stock exchanges without encountering the cumbersome, stringent, and expensive listing process, the possibility of the risks associated with SPACs cannot be ruled out. Since the SPAC route is opted by the start-ups to obtain faster, easier listing, therefore, retail investors must be cautious of the risk such listing may entail. [17]

As per the rules for SPACs in the USA, investors have the right to redeem their shares and claim a refund of the amount they invested, till the acquisition of a target. [18] However, in India, the redemption of shares is allowed only in the case of preference shares and not in equity shares. Post-merger too, the shares of the merged entity are traded on the stock exchanges and an analysis by Goldman Sachs found that SPACs tend to underperform the broader markets and returns are all over the places. [19]

POTENTIAL RISKS OF FRAUDS

The most prevalent case of fraud in SPACs is the case of a Greek streaming company, Akazoo, which was listed on the markets in 2019. The company’s board launched an investigation and eventually concluded that the company’s previous management had ‘participated in a sophisticated scheme to falsify Akazoo’s books and records, including the documents that had been given to the acquiring SPAC. [20] Hence, the investors should consider these risks before investing in SPACs.

POOR MANAGEMENT BY THE SPONSORS

While investing in SPACs, the investors rely on the experience and expertise of the sponsors, which might fail sometimes. There have been few instances of such failure. For example, in Aronson v. Lewis, 1984 [21], the investors claimed that the management beguiled them with tall promises while the management sought immunity for having ‘acted on an informed basis, in good faith for the best interests of the company. Hence, the investors must review the business background of SPAC management and its sponsors.

SPONSORS UNSUCCESSFUL IN INDENTIFYING TARGET

The SPAC structure requires investors’ funds to be held in an escrow account, filing of a post-effective amendment upon execution of an acquisition agreement, and the return of the escrowed funds if the acquisition has not occurred within 18 months of the effective date of the initial registration statement. [22] Moreover, investors may be able to sell the SPAC units in the secondary market. However, investors will have to bear the opportunity cost of waiting for an acquisition by the SPAC or sell the units in the secondary market.[23]

OTHER RISKS

Recently, several SPACs had to undergo litigation due to varied reasons. These matters included alleged securities fraud in connection with SPAC business combination, a challenge to fees being paid to SPAC sponsor[25], and SPAC shareholder suing SPAC for failure to honor his redemption right[26] among others. 

REFERENCES

¹ Mark Pumfrey, “Five trends that will shape financial markets in 2020 and beyond”, Liquidnet (24-01-2020), <https://www.liquidnet.com/expert-insights/five-trends-that-will-shape-financial-markets-in-2020-and-beyond> (last accessed on 16-04-2021). 

² Andrew Brownstein, Andrew Nussbaum, David Lam, DongJu Song, Igor Kirman, Matthew Guest, and Wachtell Lipton, “The Resurgence of SPACs: Observations and Considerations”, corp.law.harvard.edu (22-08-2020), <https://corpgov.law.harvard.edu/2020/08/22/the-resurgence-of-spacs-observations-and-considerations/> (last accessed on 16-04-2020).

³ “SPAC status by year of IPO”, <https://spacinsider.com/stats/> 

⁴ Ibid 

⁵Julie Young, “Special Purpose Acquisition Company”, (24-11-2020),                <https://www.investopedia.com/terms/s/spac.asp#:~:text=A%20special%20purpose%20acquisition%20company%20(SPAC)%20is%20a%20company%20with,have%20been%20around%20for%20decades> (last accessed on 16-04-2021).

⁶ Tom Huddleson, “What is a SPAC? Explaining one of Wall Street’s hottest trends”, cnbc.com, (28-01-2021) <https://www.cnbc.com/2021/01/30/what-is-a-spac.html> (last accessed on 16-04-2021) 

⁷ Rakesh Nangia and Neha Malhotra, “Regulatory challenges for SPACs in India”, (21-03-2021), <https://www.thehindubusinessline.com/business-laws/regulatory-challenges-for-spacs-in india/article34124252.ece> (last accessed on 16-04-2021).

⁸ Ibid.

⁹ Ramey Layne, Brenda Lenahan, Terry Bokosha, Mariam Boxwala, and Zach Swartz, “Special Purpose Acquisition Companies: An Introduction” corpgov.law.harvard.edu, (06-07-2018) <https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/> (last accessed on 16-04-2021).

¹⁰ Supra note 7.

¹¹ Ibid 

¹² Andrew Ross Sorkin, “The poor man’s Private Equity: Gambling on unknown IPOs”, NYTimes, (12-02-2008), <https://www.nytimes.com/2008/02/12/business/worldbusiness/12iht-deal.1.9962658.html> (last accessed on 16-04-2021).  

¹³ Supra note 9. 

¹⁴ Lisa Pallavi Barbora, “There is difference between book building and auction method to raise capital”, (16-02-2012) <https://www.livemint.com/Money/z4evPBu8KFgIhmnC7anmeI/Did-You-Know–There-is-difference-between-book-building-and.html> (last accessed on 16-04-2021).

¹⁵ Mithun Vijayasekhar, “Advantages of SPACs” (24-08-2020), <https://mithun-vijayasekar.medium.com/advantages-of-a-spac-42f22212c175> (last accessed on 16-04-2021).

¹⁶ Ibid.

¹⁷ Supra note 7.

¹⁸ John Coates, “SPACs, IPOs and Liability Risk under the Securities Laws”, U.S. SEC (08-04-2021) <https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws#_ftn5> (last accessed on 16-04-2021) 

¹⁹ Yun Li, “Goldman Sachs’ guide to the hot SPAC market and why investors should be careful”, (03-08-2020), <https://www.cnbc.com/2020/08/03/goldman-sachs-guide-to-the-hot-spac-market-and-why-investors-should-be-careful.html>, (last accessed on 16-04-2021).

²⁰ Ortenca Aliaj, Sujeet Indap and Miles Kruppa, “Can Spacs shake off their bad reputation?” (13-08-2020), <https://www.ft.com/content/6eb655a2-21f5-4313-b287-964a63dd88b3> (last accessed on 16-04-2021).

²¹ Aronson v Lewis, 473 A.2d 805, Delaware Supreme Court, (March 01, 1984).

²² Securities Exchange Act, 1933, Rule 419 ( USA).

²³ Guidance on Special Purpose Acquisition Companies via Regulatory notice 08-54, <https://www.finra.org/rules-guidance/notices/08-54> (last accessed on 16-04-2021).

²⁴ Walter Welch V. Christopher Meaux, Civil Action No. 19-1260 (W.D. La. Aug. 17, 2020).

²⁵ Ruffalo v. TransTech Service Partners, Inc., C.A. No. 5039-VCP (Vice Chancellor Parsons), (Del. Ch. Aug. 23, 2010).

²⁶ Olivera v. Quartet Merger Corp, U.S. District Court, S.D. New York (September 7, 2015).