[Kartik Singh is a 4th-year student at National Law University, Odisha]
Introduction
Special Purpose Acquisition Companies (SPACs) have become the latest sensation in the financial markets as an alternative way to list private companies on the stock exchanges thereby making them public. It is a form of investment which gained momentum in the US and the European markets and has now trickled into emerging markets. Numbers suggest that since the beginning on 2020 SPACs have raised more than $ 130 billion and as of March 2021 i.e., three months into the year, the SPAC market has already surpassed the total amount raised by SPACs in 2020.
The sudden rise of the SPAC market has caught the attention of various global securities market regulators who are now monitoring and studying the modus operandi of SPACs considering the potential regulatory concerns they may have. However, several jurisdictions have welcomed the rise of SPACs. For instance, Singapore has recently rolled out rules for SPAC listing; Britain has revised its SPAC rules to attract more listings to its market and Australia too is considering its viability. In the Indian context, the Securities and Exchange Board of India (SEBI) has also constituted a committee to introduce SPAC framework in India in light of several Indian companies like ReNew Power opting foreign listing through the US-SPAC route. This article attempts to examine the risks associated with SPACs and what regulatory changes may be needed to introduce a SPAC framework in India.
What are SPACs?
SPACs, also known as “blank-cheque companies”, are shell companies which are formed for the sole purpose of raising funds from the public through an Initial Public Offering (IPO). At the time of public offering SPACs neither have any commercial operations of their own nor do they have any assets.
The essential question then arises is why would people want to invest in a company having no business operations? It is because the proceeds collected by the SPAC through the IPO is utilized to acquire or merge with an unlisted target company. Such acquisition or merger achieves two-fold objectives i.e., first, the SPAC reflects the identity of the target company vis-à-vis its commercial business operations and second, the unlisted target company becomes a listed company bypassing the traditional IPO route. This serves as an easier and less complicated alternative way of public listing especially for start-ups looking to raise money.
Considering the potential risks associated of investing in a shell company, the SPAC is required to complete the acquisition or merger of/with a target company in a specified time frame ranging typically between 24-26 months, irrespective of the jurisdictional regulations it is subjected to. A failure on part of the SPAC to complete such a transaction within the time frame entails a responsibility of returning the amount back to the investors with interest.
Risks and Concerns Associated with SPACs
Although SPACs facilitate a faster access to capital and listing on a stock exchange to an unlisted company, the potential grave risks associated with it cannot be overlooked which has prompted several global securities market regulators to tighten the regulatory norms around the working of SPACs. Redemption of shares is one such aspect wherein the investors can claim a refund of the amount invested by them in the SPACs. While some jurisdictions allow redemption of shares, for instance, the Securities and Exchange Commission (SEC) in the US allows 100% redemption of shares to the investors, jurisdictions like India does not allow for the same by virtue of Section 55 of the Companies Act, 2013. This, in effect, leaves the investors to look out for themselves by having to exchange trade the shares in the market, the value of which may be extremely volatile thereby posing great risks for the investors.
Transparency and full disclosure form an integral part of any financial deal. It is in this respect robust regulations ensuring no conflict of interest between the sponsors (founders of SPAC) and investors in the acquisition of a target company is the utmost duty of the market regulators. Jurisdictions around the world are working on this aspect, for instance, the US last year issued directives regarding disclosure considerations, however, the efficacy of these directions remain largely untested. Moreover, considering the increasing popularity of SPACs, several other considerations like safety of IPO proceeds, acquisition process vis-à-vis the target company, voting rights on the shares, etc. also need to be given due importance.
Regulatory Framework of SPACs in India
The Indian regulatory framework, as of now, debars the registration and listings of SPACs in India even though the word “SPAC” has not been expressly used in any of the laws/regulations. However, there are several legal provisions which indirectly prohibit the registration of SPACs in India, among which the Companies Act, 2013 stands as the most notable hindrance. Section 4(1)(c) of the Companies Act enshrines that the Memorandum of the company must state the objects for which the company is being incorporated. Further, Section 248 confers power on the Registrar of Companies (ROC) to strike off the name of the companies that fail to commence business operations within one year of incorporation. Considering a SPAC does not have any commercial operations until it acquires a target company within two years, the modus operandi of SPACs is in direct conflict with the provisions of the Companies Act.
If a company intends to go public through an IPO, it must abide by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations) since it prescribes the eligibility criteria for companies that wish to issue a public offer. Regulation 6(1) of the said regulations mandate that a company shall be eligible to issue an IPO only if it has net tangible assets of three crores rupees and has an average operating profit of fifteen crore rupees in preceding three years.
However, the said regulations also provide an alternative under Regulation 6(2) in the case the aforementioned criteria cannot be satisfied. The company may go public through the book-building process and shall allot 75% of the net offer to the Qualified Institutional Buyers. However, in such a scenario the investment opportunities for retail investors would shrink substantially. Thus, SPACs fail to fulfill the eligible criteria prescribed by the ICDR Regulations.
Scope for Deregulating SPAC Market in India?
Investors play a huge part in creating an ecosystem that is welcoming for SPACs. In the Indian context, SEBI’s investor protection mechanism has been designed to protect the interests of the investors, more so for the retail/individual investors than the institutional investors. The primary rationale behind this is that individual investors, unlike expert institutional investors, lack the requisite know-how to deal in complex corporate transactions which makes them prone to higher risk.
The inherent nature of SPACs makes it imperative for investors to identify potential risks to assist them to make timely exit decisions from the merger transaction. SEBI’s high attention towards individual investors suggest they might not be ready yet to get involved in a SPAC transaction. Furthermore, SPACs introduction in India would also necessitate certain clarifications in the tax provisions. As per Section 45 of the Income Tax Act, 1961, any gain derived by a person from transfer of capital assets would be subject to Capital Gains Tax. Considering a SPAC merger transaction would involve transfer of assets, the said provision would be attracted. However, merger under a scheme of amalgamation is tax neutral, subject to certain conditions. Therefore, some clarity regarding the application of Section 45 and tax neutrality would be highly required, if SPACs are allowed to operate in India.
Conclusion
In times of tech-savvy startups, SPACs as a structure is fascinating and appeals to the interests of both private equity and retail investors to grab a slice of the action of quick capital formation that many venture capitalists have observed. The regulatory framework for SPACs in different jurisdictions is loaded with both parallels and differences. However, from an Indian viewpoint, significant efforts would be necessary on the part of regulators, as it will necessitate amending several key aspects of major corporate sector legislations in order to promote India as a favorable destination for SPACs IPO and listings.