Exploring Special Purpose Acquisition Companies: Challenges and Opportunities in India

Introduction

Special Purpose Acquisition Companies (SPACs), also known as “blank-check companies”, are publicly listed traded corporations whose objective is to acquire a target business. They are pooling vehicles, similar to investments funds, but with the difference that the capital pooled, generally required to be kept in escrow, has to be utilised to acquire the target usually within a fixed time frame (1-2 years).¹ SPACs, owing to their peculiar features, are usually governed by specific regulations meant to avoid misuse of the framework.² The company is at its infancy stage and lacks an established strategy or goal. However, its strategic plan indicates that it intends to combine or acquire another company, entity, or individual.³

Such companies are used often in the United States, United Kingdom and certain other developed nations. In the US, SPACs require approval from the Securities and Exchange Commission (SEC) and are listed on stock exchanges such as the NASDAQ or the NYSE. Capital is raised through an IPO, which is then used to acquire the target (either a specific company already identified, or one identified by the Board of the SPAC in line with its prospectus). Ultimately the acquired target is merged into the SPAC by a reverse merger⁴.

In the Indian context, implementing acquisitions of Indian companies through SPACs listed outside India has had challenges owing to regulatory hurdles. India does not have a regime specific to SPACs, and due to certain regulatory restrictions, SPACs have not been very successful / common thus far. However, since SPACs have proved to be effective in spurring mergers and acquisitions activity, the conversation on SPACs comes up after every financial slow-down and is starting again in the context of reviving the economy in a post-Covid era.

The Indian regulatory and tax regime has been evolving at a very fast pace over the last few years, and the author shall endeavor to assess whether hitherto identified challenges that made SPACs difficult to implement in India still survive, or whether there is more scope now of utilizing the regime to effectuate Indian M&A

To pool resources and finance a merger or acquisition opportunity within a certain time

limit, a SPAC is established, its main objectives tend to be purchases of private enterprises.⁵ In general, the merger potential is still unknown. A SPAC is a pure shell corporation created especially to buy one or more running firms over a certain period of time, generally a couple of years, and gain public recognition through the unit IPO.⁶ Typically, a sponsor or an experienced management team may incorporate a SPAC with nominal capital, which will translate into a 20% stake in the company (often referred to as founder shares). Public shareholders own the remaining 80% shareholding through “units” that were made available at the SPAC’s first public offering (IPO). The funds raised by the founders of SPAC through the IPO are deposited with respectable monetary institutions in escrow accounts, where they remain until a deal with potential targets is completed. In the event that no suitable target is found within a predetermined period of time after the IPO, the SPAC is liquidated, and investors obtain the funds recovered

from the escrow accounts. SPAC units can be exchanged quickly, while shares and warrants can only be traded after the day on which the underwriters’ SPAC units are available for trading, while shares and warrants can only be traded if the underwriters’ overallotment rights are exercised. Trading of common shares and warrants typically begins two weeks following the IPO.⁷

Following the identification of a target firm and the announcement of a merger, Shareholders in the SPAC that are open to the general public can cast votes opposing the agreement or redeemed their shares. Via a private investment in public equity (PIPE) transaction, it might issue loans or additional shares, if it needs more money to finish the merger. The founders of the SPAC must liquidate the organisation and restore any funds held in trust accounts to investors if they are unable to complete the merger before the IPO date.

THE US FRAMEWORK

The standard process for an initial public offering (IPO) for a SPAC involves filing a registration statement with the Securities and Exchange Commission of the United States (“SEC”), and responding to any SEC remarks, conducting a road show, and then securing a firm committed underwriting. The funds raised from the initial public offering (IPO) will be held in an account for trust until they become available either to finance the business combination or to repay shares issued. The business or management group that establishes the SPAC will finance offering expenditures, including the upfront component of the underwriting discount and a small amount of operating capital (the “sponsor”). Following the initial public offering (IPO), To acquire a firm or assets, SPAC will search for acquisition prospects and establish a merger or purchase agreement (also known as the “business combination”). The sponsor may extend a further loan to the SPAC if it requires more money to pursue the business combination or cover other costs. Before executing an acquisition deal, the SPAC would often secure committed debt or equity financing, such as a private investment in public equity (“PIPE”) commitment, to fund a certain amount of the cost of buying for the company combination. Following that, the purchase agreement and the committed funding will be disclosed to the general public.

After the signature declaration, the SPAC will conduct a required tenders offer or shareholder vote, giving prospective investors the option to return their publicly traded shares to the SPAC as a substitute for cash that is approximately equal to the IPO price. If the funding and, if necessary, the shareholders sanction the business combination. After signing the declaration, the SPAC will conduct a required tender offer or shareholder vote, giving the public investors the option to return their publicly traded shares to the SPAC in exchange for cash that is approximately equal to the IPO price. The business arrangement, also known as the “De-SPAC transaction,” will be completed and the SPAC and the target business will merge into a publicly traded that operate company if the financing and other requirements outlined in the acquisition agreement are met. If the shareholders approve the business combination (if necessary). ⁸ After their IPO, SPACs must either complete a business combination or liquidate within a predetermined window of time. Though most SPACs choose 24 months from the IPO close as the period, stock market guidelines allow a duration as long as three years.⁹

Corporate Governance Requirements

According to the stock exchange listing criteria, SPACs must have a majority of unbiased board members; however, there are phase-in exclusions that apply to all newly public firms. At the IPO, the sponsor appoints the SPAC’s directors; the SPAC board then appoints additional directors as needed. A SPAC will typically not conduct an open election for directors until after the De-SPAC transaction, and some SPACs stipulate that only pioneer shares will be eligible to vote in voting for directors until after the De-SPAC event.

The SEC frequently demands that the IPO prospectus include a statement stating that the SPAC is not currently considering any business combination and that neither the officers nor directors of the SPAC have individually chosen nor given any thought to a target business for the business combination, nor have they had any discussions with underwriters or other advisors about potential target businesses. The SPAC, its officers, and directors should decline to interact

with any unsolicited interest from possible targets and instead state that they will not take the offer into consideration until the IPO is finished.¹⁰

SPACs were present in the technology, healthcare, and retail industries up until several years ago, but more lately they have started to appear in the homeland security as well as government contracting domains.

LESSONS LEARNT FROM BLIND POOL TRUSTS

Though they have unique characteristics that make them less vulnerable to the abuses traditionally associated with blind trusts, they are comparable to the blind pool trusts that rose to prominence in the 1990s. SPACs are specifically blank-check businesses that are “going public” with the goal of acquiring or merging with another business using the money earned through the initial public offering (IPO).¹¹

In hindsight, the decrease in blind pool trust numbers happened when authorities aimed to bring fraudulent cases to justice, and blind trusts haven’t exactly had the best of reputations ever since.¹² SPACs, on the other hand, are set up differently from blind pools of the 1980s and 1990s in order to safeguard investors. In other words, SPACs are intended to provide several assurances to prospective investors. Additionally, if the purchase against which they voted is authorised by the majority of shareholders, investors will have the option to redeem their shares.¹³

¹⁰ Why special purpose acquisition companies (SPACs) have become a popular way to go public, August 12, 2020, PWC US, available at https://blog.businesswire.com/a-spac-ipo-renaissance-and-the-de-spac-communications- necessities#:~:text=A%20traditional%20IPO%20is%20marketed,and%20retail%2C%20domestic%20or%20foreign (last visited on September 05, 2024).

OFFERING GREATER CERTAINTY EVEN IN VOLATILE MARKETS WITH LOW LIQUIDITY

Even in situations where liquidity is restricted by factors such as market instability, this strategy enables businesses to obtain funding. SPACs may also shorten the time it takes for a firm to go public and reduce transaction costs. Compared to an IPO, SPACs offer shareholders more liquidity and more assurance for a transaction, including a predetermined “clearing” price. Investing in a SPAC gives investors a discounted cash position in a trust with a “option” to acquire the company should the acquisition be successful. Even in situations where liquidity is restricted by factors such as market instability, this strategy enables businesses to obtain funding. SPACs may also shorten the time it takes for a firm to go public and reduce transaction costs. Compared to an IPO, SPACs offer shareholders more liquidity and more certainty for a transaction, including a negotiated “clearing” price. Investing in a SPAC gives investors a discounted cash position in a trust along with a “option” to buy the company should the acquisition be successful. It resembles purchasing a call option on an unidentified underlying asset to some extent.¹⁴ If the SPAC’s management team locates a private firm that is undervalued and wants to go public, investors can be drawn in by the upside potential. Excellent merger partners are being sought after by high calibre SPAC sponsors, and investors like the structure of both because it permits deeper and more direct due diligence with the business and allows them to freely purchase stock on the open market following the announcement of the deal without being constrained by the investment bank equity capital markets process, which typically benefits a small number of chosen institutional investors.¹⁵

ADVANTAGES OVER PRIVATE EQUITY INVESTMENTS

The ability to trade shares at any time to withdraw from an investment in a SPAC is one of the main advantages for investors.¹⁶ Unlike private equity investments, which may entail longer-term obligations that the investor is committed into, this.¹⁷ SPACs are more appealing to certain institutional investors than private equity investments because they give them more control over exposure to specific industries. Furthermore, there is protection against downside since the investors must approve the acquisition or risk having to sell their shares. Due of SPACs’ ability to expose investors to private equity-style transactions, hedge funds have begun investing in them.¹⁸

SPACs are a valuable alternative to other investing options for three reasons:

1. Formerly exclusive to institutional clients like hedge funds and investment banks, they give the public access to the investments in the private equity
2. The voting power of shareholders over any merger or acquisition and SEC reporting requirements, such as the filing of financial statements, demonstrate that SPACs are more accessible than private equity
3. By retaining the IPO proceeds in trust and paying them back if an acquisition is not completed within 18 months, SPACs provide investors a limited SPACs are actually a type of reverse merger, but they carry less risk, which makes them more appealing.¹⁹
4. BENEFITS FOR UNDERWRITERS AND VENTURE CAPITALISTS

Underwriters and venture capitalists can benefit from lower fees. Investment banks may receive income from SPACs when the IPO market isn’t particularly strong. SPACs are useful in the capital markets during challenging initial public offerings (IPOs). An SPAC allows the acquired company to obtain public financing quicker than it would through a typical IPO.²⁰

TIME AND COST SAVER

The cost of going public is high, and there are occasions when the market is sluggish and IPO pricing could be low. Private companies can enter the public market through SPACs without having to go through the tedious and costly “roadshows” that come with IPOs.²¹ Funds are raised more quickly by a successful SPAC IPO than by private equity firms. Seeking investments from pension funds, affluent venture capitalists, and other major investors is the process of raising

private equity funds. SPACs can draw in both individual and institutional investors from the open market by holding a public offering. Some private corporations may be reluctant to finance with private equity when it comes to corporate control difficulties because they fear losing management control.²² Therefore, selling out to a SPAC can be an option for certain privately owned companies looking to exit the market. SPACs are therefore an alternative to conventional IPOs and private equity when it comes to funding companies that are expanding or facilitating venture capital investors’ exits.²³

Investors face risk since they are lending money to a management team without knowing much about the underlying assets that will be bought, such as the purchased company’s solvency or unidentified liabilities in the future. The risk of the SPAC will also be impacted by management’s capacity to carry out its responsibilities in the short- and long-term operations of the company. A further problem for investors is low trading volume. SPACs’ relatively thin liquidity and unknowable level of business risk may cause them to trade at a discount to the trust’s cash.²⁴ This discount may be understood as the SPAC’s risk surcharge.

Several obstacles must be overcome during the merger of a SPAC with a target company. These include complicated accounting and financial reporting/registration requirements that may vary depending on the SPAC’s lifespan, as well as meeting an expedited schedule for public company preparedness. After signing a letter of intent, the target company’s management team will have three to five months to prepare for going public.²⁵

COMPANY’S ACT

The authorities has been clamping down on suspicious shell firms since announcing demonetisation in November 2016. Since the firms Act does not currently identify them, there has been a rush to define them. The Prime Minister’s Office established the Task Force on Shell Companies in February 2017; it was chaired by the Revenue Secretary and the Secretary of the Ministry of Corporate Affairs (MCA), respectively, and had a “mandate to check in a systematic way, through a coordinated multi-agency approach, the menace of companies indulging in illegal activities including facilitation of tax evasion and commonly referred to as shell companies.” A parliamentary committee requested in March 2018 that the government clarify what the word “shell company” means in the Company’s Act “avoid legal ambiguity and pre- empt avoidable litigations”.

Object Clause

“The Companies Act 1956’s “Objects” section is regarded as a significant barrier to the establishment of SPACs.²⁶ The clause mandates that applicants state what their business goal is. Regretfully, SPACs only aim to obtain targets; they do not own any independent commercial objectives. The MoA’s object clauses are, as previously stated, clauses (c) and (d). Among the MoA’s most significant clauses is this one. It outlines the reason behind the company’s formation. A business does not have the legal right to engage in any activity that goes beyond the goals specified in this section.²⁷

Companies Act 2013 has done away with specific requirement to identify the main objects and the other objects of the Company thereby giving a sense of flexibility to the Companies.²⁸ The Companies (Amendment) Ordinance, which was presented to the Parliament in 2017, suggested doing away with the “Objects” clause entirely.²⁹ But before the Act was signed, this suggestion was dropped. One of the biggest obstacles to the establishment of a SPAC

in India is this. A SPAC’s exclusive objective is to complete a merger with another corporation. It has no plans to start its own firm of any type.

Removal of a company’s name from the ROC

A company’s name may be removed from the register of companies by the registrar in accordance with Section 248 of the Company’s Act 2013 if it has “failed to commence its business within one year of its incorporation”.³⁰ An SPAC’s usual acquisition duration is between 18 and 24 months. To optimise shareholder wealth, the sponsors require this time to determine the ideal aim. This provision thus poses a significant obstacle to the implementation of SPAC.

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) REGULATIONS

331 suspected shell businesses had their trading banned by SEBI in 2017, although the majority of those entities were ultimately given the all-clear. The U.S. SEC laws served as the foundation for SEBI’s 2018 definition of shell businesses, which it provided as advice to the government. SEBI developed a set of criteria that might be used to determine whether or not a company is actively operating. According to suggestions made by SEBI, a company that serves as a conduit but lacks substantial operational assets or independent commercial activities may be referred to be a shell company.³¹

SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009

Regulation 6(1) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (amended August 2017) establishes the minimal requirements for eligibility for a public offer. These demand that the issuer possess:

1. Net tangible asset of at least INR 3 crore for each of the three years before (the previous criterion to hold a maximum of 50% of your assets in cash has been waived if the full public offering is through sale)
2. A minimum of INR 15 crore in combined pre-tax operating profit on average over any three of the previous five
3. A minimum of INR 1 crore in net worth for each of the previous three-year periods.³²

SPACs are unable to satisfy any of these requirements. They have no non-monetary tangible assets and no operating profits. Furthermore, most SPACs are unable to wait three years before being listed, even if the founders contribute financial resources.

Listing and Exchange Requirements

A SPAC must list on among the national stock exchanges for the purpose to be able to operate, Bombay Stock Exchange (“BSE”) or National Stock Exchange (“NSE”). Under BSE, The prospective company’s net worth must have exceeded Rs. 25 crores in any one of its previous three years of operations prior.³³ The company shall be in compliance with Regulation Regarding the bare minimum level of public shareholding, the firm must abide by Regulation 38 of the SEBI (Listing Obligation and Disclosure Requirements) Regulations, 2015.³⁴ Additionally, they have to provide a letter outlining the company’s current primary business activity and the revenue breakdown from that activity. In the last three finished financial years, at least 50% of the earnings must have come from the company’s primary business exercise. ³⁵ It becomes evident that a SPAC cannot be listed with the BSE as it will not be able to meet the eligibility criteria for listing its shares on the BSE.

Additionally, A SPAC must be formed by a promoter group with a proven track record and long-term credibility in order for it to be listed on the NSE. Furthermore, SPACs are not suitable for listing because the NSE requires the companies to have positive operational cash accruals (Earnings before Depreciation and Tax) for the previous two years.³⁶

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (amended Mar 2017) as having significant impact on SPAC mergers in India. As per the Code, a minimum public shareholding of 25% is a necessary pre-requisite at any given point in time.³⁷

Furthermore, should a SPAC wish to purchase a private business, the Takeover Code will not be applicable. The Takeover Code does not apply to private firms. Only if the target firm is listed is the Takeover code applicable, which severely restricts the amount of control that can be purchased and lengthens the transaction period. It is noteworthy that there are no standards in the Takeover code that are unique to SPAC-like purchases.

Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018³⁸ (FEMR)

If an Indian SPAC obtains funding from foreign investors, or if one of the SPACs or the objective is listed outside of India, FEMR will apply. Under the FEMR criteria, foreign investment is permitted only if the Reserve Bank of India (RBI) approves the proposal. Both inward and outbound mergers are permitted by the FEMR Cross Border Regulation of 2018, provided that all applicable rules and regulations are followed.

SPACs, as investment vehicles, offer excellent prospects for mass investors to participate in the expansion of numerous small and mid-sized firms, as the project highlights. Therefore, it is necessary to improve the regulatory environment to make it more favorable for the formation and operation of these businesses. Most importantly, there is a crucial need to re-define what a shell company entails and that it not merely a money laundering vehicle. A separate mechanism should be brought in place to address the SPAC situations as that would grant more transparency and clarity on the legality issues surrounding the same.39

The creation of SPACs is not prohibited by the Companies Act per se, however there is a barrier because of the MoA’s object clause. Therefore, it may be simpler to integrate SPACs if a special amendment covering “Acquiring of private companies that might increase holder wealth” is included. Furthermore, the Act may stipulate that such firms must identify a sector or domain in which they intend to pursue their acquisition activities to safeguard the investors. Since SPACs are a new investment vehicle in India, the current version of the ICDR laws is quite restrictive, requiring them to follow the QIB route and imposing a minimum 50% QIB subscription requirement. This makes it exceedingly difficult for SPACs to issue capital. It is proposed to relax the threshold requirements to facilitate seamless flow, but at the same time the author acknowledges that the requirement cannot be dispensed with completely because it would make SPACs more speculative for ordinary investors. With the advent of the pandemic, it becomes more imperative to look for alternative options for acquisition of sick entities. The need for a SPAC has been prevalent for decades, but today, it has become integral to an extent. Considering the same, the regulatory authorities should consider relaxing the norms to give a breathing space for the start-ups and SMEs running into financial crisis, so much so, that they are at the brink of collapse. There is a definite need to enact the opportunities bestowed by the SPACs and the regulatory authority should devise a robust mechanism in order facilitate SPAC model-based acquisitions.

Author: Sarthak Mishra, in case of any queries please contact/write back to us via email to [email protected] or at IIPRD.

¹ Boyer, C. M., & Baigent, G. G. (2008). SPACs as Alternative Investments. The Journal of Private Equity, 11(3), 8- 15. http://dx.doi.org/10.3905/jpe.2008.707198

² Jog, V., and Sun, C. (2007). Blank Check IPOs: A Home Run for Management. Available at SSRN: http://ssrn.com/abstract=1018242 or http://dx.doi.org/10.2139/ssrn.1018242 (last visited on September 02, 2024).

³ http://www.sec.gov/answers/blankcheck.htm

⁴ L. Dimitrova, The Perverse Incentives of SPACs, Working paper, London Business School, 2012 (last visited on September 6, 2024).

⁵ A. Tran, Blank Check Acquisitions (2012), available at SSRN2070274. http://ssrn.com/abstract=2070274 or http://dx.doi.org/10.2139/ssrn.2070274

⁶ http://www.rule144solution.com/ShellCompany.asp

⁷ A. Thompson, Organizational Form and Investment Decisions: The Case of Special Purpose Acquisition Companies, (2010) Diss. Purdue University.

⁸ Ramey Layne and Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, January 2018, Harvard          Law            School            Forum            on            Corporate            Governance,            available            at https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/#8b

⁹ https://www.pwc.com/us/en/services/audit-assurance/accounting-advisory/spac-merger.html

¹¹ Hale, L. M., SPAC: A Financing Tool with Something for everyone, (2007) Journal of Corporate Accounting & Finance, 18(2), 67-74, available at http://dx.doi.org/10.1002/jcaf.20278 (last visited on September 6, 2024).

¹² Andrew Dolbeck, Risky Business: Gambling on SPAC Investments, Weekly Corporate Growth Report, 1359 (Oct. 3, 2005), pp. 1-4.

¹³ Sara Mason, Ex-Kidder Officials Heading Latest GKN Spacs Offering, The Investment Dealers Digest, Vol. 59, No. 21 (May 24, 1993), p. 17.

¹⁴ Howe, J. S., & O’Brien, S. W. (2012). SPAC Performance, Ownership and Corporate Governance. Advances in Financial Economics, 15, 1-14, http://dx.doi.org/10.1108/S1569-3732(2012)0000015003

¹⁵https://blog.businesswire.com/a-spac-ipo-renaissance-and-the-de-spac-communications-

necessities#:~:text=A%20traditional%20IPO%20is%20marketed,and%20retail%2C%20domestic%20or%20foreign

¹⁶ (Dolbeck [2005]).

¹⁷ D. K. Heyman, From Blank Check to SPAC: The Regulator’s Response to the Market, and the Market’s Response to the Regulation, (2007), Entrepreneurial Bus. LJ, 2, 531.

¹⁸ Lynn Cowan, IPO Outlook: Shell Game Draws More Attention; Acquisition Companies Are in Position for Debuts; Key Players Still Cautious, Wall Street Journal (April 10, 2006), p. C5.

¹⁹ Abir Roy & Vyapak Desai, What’s special about special purpose acquisition vehicles?, Economic Times Mumbai (2008).

²⁰ Kit Roane, Business Buffet, US News January 30, 2006.

²¹ Michael Sisk, Back in from the Cold: Controversial Return, US Banker, Vol. 116, No. 3 (March 2006) p. 55.

²² O’Connor and Colleen Marie, Increased Competition Tightens Spac Structures; Underwriters Willing to Put Fees on the Line to Attract Investors, The Investment Dealers’ Digest (Feb 6, 2006), p. 1.

²³ Id.

²⁴ Karen Richardson, Ahead of the Tape, Wall Street Journal (Nov. 18, 2005), p. C1.

²⁵ https://www.theindianwire.com/business/how-shell-companies-go-public-spac-278585/

²⁶ Section 13(1)(c), (d), The Companies Act, 1956.

²⁷    Implementation of      SPACs     in India      –    Key Regulatory challenges, (June         2018), available      at https://mnacritique.mergersindia.com/regulatory-challenges-special-purpose-acquisition-company-india/

²⁸ Section 4(1)(c), The Companies Act, 2013.

²⁹ Companies (Amendment) Ordinance 2017.

³⁰ Section 248, The Companies Act, 2013.

³¹https://www.moneycontrol.com/news/business/sebi-gives-inputs-to-mca-for-defining-shell-companies-

2532571.html

³² Regulation 6(1), SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009.

³³ https://www.bseindia.com/downloads1/DLNorms_Co_Listed_on_NationwideSE_Nov302017.pdf

³⁴ Regulation 38, SEBI (Listing Obligation and Disclosure Requirements) Regulations, 2015

³⁵ https://www.bseindia.com/downloads1/DLNorms_Co_Listed_on_NationwideSE_Nov302017.pdf (last visited on September 05, 2024).

³⁶ https://www.nseindia.com/companies-listing/raising-capital-public-issues-emerge-eligibility-criteria (last visited on September 05, 2024).

³⁷ Rule 19(2)(B), Securities Contracts (Regulation) Rules, 1957.

³⁸ Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018

³⁹ Akila Agrawal, Yash J. Ashar, Ravi Shah, S Vivek & Avani Dalal, Using SPAC Vehicles as a Means of Listing Outside India, (August 26, 2024), India Corporate Law Blog, available at https://corporate.cyrilamarchandblogs.com/2020/09/using-spac-vehicles-as-a-means-of-listing-outside-india/