- Oshin Malpani
A Chance for SPACs in India: From Wall Street to Dalal Street
[Oshin is a student at NALSAR University of Law, Hyderabad.]
A SPAC or special purpose acquisition company is an alternative to an initial public offer (IPO) to raise money. SPACs are formed as a blank check, clean-shell investment structures. They aim to make a targeted private or unlisted company public by the modes of acquisition, buyout, or reverse merger. A management or venture (or a ‘sponsor’ manned by private equity funds or seasoned execs) sets up the SPAC with some nominal holding. The remaining holding is offered to prospective public shareholders who subscribe to the common stock of SPAC and a proportional warrant of future fund utilization. At the time of the public offer, there is no identified target to acquire or reverse-merger. Rather, the sponsors identify these targets within a prescribed timeframe, upon successfully raising and pooling funds from the public. At identification, the subscribers are either given a chance to withdraw their money pre-acquisition or continue as shareholders of the henceforth public company. However, SPACs are not given carte blanche over the money raised. The proceeds from the offer are deposited in an escrow account that is either appropriated back to investors on a failed acquisition (and SPAC liquidation) or are successfully financed into the target upon investor agreement. No money from the escrow is available for supplementary or incidental expenses of investigation or hunt of target acquisitions, negotiations, etcetera.
SPACs have been gaining ground in the USA and are reported to account for up to 50% initial public listings (colloquially referred to as “blank check boom”), perhaps due to the COVID-19-infested markets. It has gained traction with giants like ReNew Power and Grofers eyeing SPAC modes to enter NASDAQ. Videocon d2h was one of the early birds of India to get listed on the NASDAQ via a SPAC called Silver Eagle Acquisition Corporation. The Ministry of Finance had allowed unlisted Indian companies to list depository receipts offshore without domestic listing. Using the same, Silver Eagle identified Videocon as a lucrative acquisition target. It dispersed Videocon’s ADS and warrants to its own approving shareholders (while paying non-approving ones in cash), took it public on NASDAQ, and thereafter, dissolved itself, having achieved its purpose. Indian privates like Solar Semiconductor, Citius Power, and Yatra were also similarly acquired by NASDAQ-listed SPACs in 2008 and 2014 respectively.
However, these SPACs were of foreign origin, tapping into Indian firms, and no Indian origin SPAC listing has been possible yet. This begs the question as to how SPACs could have a chance in India. In answer, the article examines the SPAC charm and then discusses two possible incongruences of SPAC imports in the Indian markets.
The SPAC Charm
SPACs have three identifiable charms over the traditional mode of IPO to raise money. These are set out below.
Traditional IPOs are heavy from procedural, temporal, and financial standpoints. However, SPACs are, by default, faster, 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”). Take, for example, the disclosure requirements. For IPOs, these are cumbersome and hefty but not as much for the SPAC structure. So, for the d2h listing, the offer of the acquisition and shares thereof was made solely to Silver Eagle’s holders, leading to streamlined disclosure and orientation process, that too to an investor base already known and studied. For another example of efficiency, consider deal negotiation under SPACs. SPACs involve lesser parties (that too largely private ones), leading to quicker price setting and negotiations (while also effectively jumping the risks of soft markets or market inconsistencies).
For a SPAC investor, the scene is often opaque, given the missing operational history and reputable pedigree of companies vis-à-vis IPOs. They often have no clue as to when and where their money would be used. For all they know, their money might lie dormant for two years and the SPAC might dissolve, resulting in an undue hassle and money depreciation. But patterns from the mature SPAC markets suggest that such occurrences are rather rare. SPAC sponsors and managers do have a reputation to maintain (upon which they got investors in the first place). They have "skin in the game" due to their nominal holdings and the decisions thereof. Therefore, acquisition targets are picked with utmost care and judgment. SPAC investors also have a rather liquid option to sell their shares and warrants off (together or in disjoint units) in case of misfortune.
But understandably too, it is beyond sponsors to predict with at most certainty the results of acquisitions. After all, SPACs rely on the caliber of sponsors to spot a good investment, and the caliber might fail sometimes. Much of the SPAC litigation has arisen from this very fact. For example, in Aronson v. Lewis, 1984, 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’.
Lucrative Funding Alternative
SPACs offer a lucrative start-up-friendly mode of raising money; money that is otherwise hard to raise in the Indian markets plagued by barons, investor mistrust towards start-ups, selective, and dry, private funding, and meager governmental support. If these start-ups raise through the trust and goodwill of renowned SPACs or investee management, funding would be much easier and fleshier. The same friendliness, as already witnessed in the Videocon listing example, also extends towards relatively smaller and newer ventures who wish to tap into rich veins of funding outside India but command little interest in the domestic financial vein.
SPAC’s Indian Import
As per the SEC, SPAC is simply, 'a company with no operations that offers securities for cash and places substantially all the offering proceeds into a trust or escrow account for future use in the acquisition of one or more private operating companies.' SEBI itself in an advisory opinion to MCA proposed to define shell companies as 'entities having no significant operational assets or business activity of its own, but acting in a pass-through capacity as a conduit.' The incongruencies begin here. Firstly, SEBI’s definition is aimed more towards regulating firms with financial irregularities and laundering inconsistencies. Hence worded in a suspicious tone, leaving SPACs as legitimate business entities short of lucid definition. Secondly, the very transplantation of the SEC definition at face value would raise some key concerns of incongruence with the security market of India. Listing and trading SPACs do seem to be conceivable options in the Indian markets since the term 'securities' has been read widely to include any instruments so declared by the government under Section 2(81) of Companies Act 2013 (CA 2013). But the fundamental problems with importing such business organizations lie with the following listing and disclosure requirements:
There has been a general mistrust of shell companies in India, and rightly so. Yet, it is hardly an exclusive Indian peculiarity. American SPACs, having their origination in blank check companies, were in their incipient days acquired notoriety as vehicles of fraud but their legitimate establishment and repute were soon established. While the American SEC definition carves a waiver to allow 'a company with no operations' to be registered, Regulation 6(1) of the SEBI’s ICDR Regulations 2018 requires a company to have some sort of operative business, history, and a 3-crore corpus of tangible assets in the preceding three years, minimum average consolidated pre-tax operating profit of 15 crores during the preceding three years and a net worth of at least 1 crore in each of the last three years. The objects clause in MoA under Section 4(1)(c) of CA 2013 requires a company to list its core business objectives. Further, there are specific requirements like that of NSE requiring a prospective listee to have positive operational cash accruals for the past two years.
But all shell companies like SPACs would only have ideas, prospective operations, and a self-proclaimed “know-how”, hence falling short of these preemptive requirements of having a running and established business, tangible assets, and an identifiable business objective (besides acquiring new companies). The 'other objects' clause that could have flexibly defined SPAC’s objects has simply been discontinued from CA 2013. And while there are age-old rulings allowing companies to acquire any business similar to the company's own (Ernest v. Nicholls, 1857) or promote other companies or helping them financially (Joint Stock Discount Company v. Brown, 1869) or acquire shares in other companies having similar objects (Re William Thomas & Co. Ltd., 1915); these are incidental objects that are premised on a corporate entity having an already established and running object and business. Section 248 of CA 2013 de-registers a company if it fails to 'commence its business within one year of its incorporation'. For SPACs, the standard timeframe to commence its “business” (of identifying and acquiring a target) usually takes 18 to 24 months, which might again lead to hurdles.
Another issue could be the disclosure requirements as to conflict of interests, the valuation of a private company (as unlike an IPO, the company seeking to go public through SPAC route does not have market-based price discovery and the sponsors, directors have to set up prices on their own), economic interests, controlling stake, etcetera. Earlier, foreign listings had to be made through limited ADR, GDR, and like foreign currency convertible/exchange bonds. However, Sections 23(3) and 23(4) of CA 2013 now allow unlisted Indian companies to undergo overseas direct listing (and exempts them from prospectus disclosure and security allotment requirements of the chapter). Still, the positive operational procedures and rules for these remain pending by SEBI and RBI, and it is unclear if they will be reasonably wide to fit in SPAC modes.
Despite these incongruences, Indian markets could operationalize SPACs through cross-border mergers whereby an Indian company would become a subsidiary of an overseas SPAC, which would then be governed under the relevant FDI and ODI Regulations. Reverse mergers are also the way to go, but the Indian regulators and judiciary are too bent towards seeing reverse mergers in merely two limited senses – first, as tax-saving tools and second, to revive ‘sick companies’, and the tests for the same have been laid down in Bihari Mills Ltd., In re, Maneklal Harilal Spg. & Mfg. Co. Ltd.,1985.
In conclusion, SPACs do have an obvious edge over the traditional modes of financing. But their import from Wall Street to Dalal Street stays put due to inactive and cryptic areas of SPAC regulation, disclosure, taxation, and liability. SPAC modes would have to be first internalized through a singular sector move and a holistic restructuring by SEBI, RBI, and relevant ministries in tandem for any possible import.