This article has been written by Mugeera Patel Course, pursuing a Diploma in Business Laws for In-House Counsels from LawSikho.

Introduction

Hollywood and Wall-street are the two major ecosystems that drive lifestyle and financing trends in the U.S. and worldwide. Every few years, there are media releases about a particular diet being the cure for it all and a particular type of investment bringing in the best returns. 

Over the years, such recommendations have included investments into Bitcoin, Hedge funds and most recently the trend is shifting towards owning or investing towards a SPAC (Special Purpose Acquisition Company). Most recently, famous American basketball player, Shaq’ O’Neal, along with two other veterans in the Telecommunication and Media Industry namely- Thomas Staggs and Kevin Mayer, who have known names in the Disney world and for innovative launches in the consumer strategizing business, came together to form a company called Forest Road Acquisition Corp and make it available for public offering. This company is said to have raised $250 million dollars in its initial public offering. 

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This piece seeks to divulge into what exactly is SPAC based companies, how do they function, it’s base in the Indian and the U.S. Legal System and why are they deemed as the new in-trend investment style and the effect of these types of companies on the Indian technology Industry.

What are the SPAC companies?

They are shell entities that are essentially seeking to raise investments from investors with the aim of acquiring up-coming private businesses and merging with them. These are the entities that usually have no business or operations associated with them when they seek to raise money. 

They follow the process of what essentially can be termed as a reverse merger where they use the process of raising money and then looking for companies to merge, hoping to strike a pot full of gold at the end. These companies do not follow the traditional course of business and do not undertake any commercial actions that a business would usually undertake like providing goods or services. According to the SEC (Security and Exchange Commission), the only asset these companies possess is the funds generated by them in their Initial public offering. 

How do SPAC companies work?

  • New-age entrepreneurs are known to develop unique processes and systems, the foundation of a SPAC company essentially starts with a unique idea or a market story that is sell-able to the investors by such entrepreneurs (in these settings they may be called sponsors). For example, If X is a famous movie star with a background in engineering and was brought in as an institutional investor for his expertise and a certain amount of funds for a line of high-tech homes designed for the A-lister movie stars, this idea instantly becomes uniquely sell-able to both the tech industry and the media industry alike due to a mix of both backgrounds.
  • Then this combination of entrepreneurs (sponsors) and the investors together will file a statement of registration with the SEC (Security and exchange commission) by filling out form S1 Under the Securities Act, 1993. This form mandates the company to disclose the type of security they are intending to offer, total number of shares and price per share, it also seeks disclosure of company property, if any. These disclosures are to be signed off and vetted by accountants.
  • While this process is ongoing, the SPAC has to create relevant agreements for underwriting agreements (agreements with investment banks or financing institutions) that includes a trust account setting agreement. This trust is where the money raised from the IPOs are kept.
  • The SEC takes an active part in the process by conducting effective due diligence on the company and issues a clearance based on documents submitted and disclosures made. After this clearance, the management of these companies starts participating in exhibitions, roadshows, conferences any place where they essentially market their business. The only difference is that key managerial person that are brought in by the sponsor sell their own expertise pertaining to the industry they are seeking to operate the SPAC in, instead of a particular business. This generates a buzz in the market which helps them with publicity and raise money further.
  • After all of this, they start offering a common stock at the price of $10 per share, this is a standard base price which is seen in most SPAC shares according to the SEC,
  • In an event that due to the efforts of the management before the share offerings, the SPAC is successful in creating a chord with people and investors, the capital from such investments is stored in trust until this newly form SPAC company decides and finds a company to acquire.
  • One of the two things that can happen during this duration, if the acquisition proves to be a fruitful one, the value of the shares in the trust rises and plus the investors get interested on it and if does not take off as intended the base price of the share remains at the value which an investor bought it for.
  • Further, if the SPAC company is unable to find an entity for merger within a period of 2 years, they are to liquidate themselves and refund the initial investment and interest on the initial amount to the shareholders.

Why are SPACs in vogue currently?

This is mainly due to two factors seen in the current market which is the market is showing signs of volatility risk, this would mean a large chunk of un-invested money before the market settles and since SPACs provide a chance of high but minimised market risk for investors, they can use this un-invested money towards experiencing the SPAC ecosystem.

Basis of these companies in Indian law and the US Corporate

India:– Shell companies have a negative notion attached to them. They are often termed as dubious cover companies for undesirable activities. Provisions of the Company Act under Section 248 are formed in such a way that restricts any company that does undertake business operations in a period of one year and provides the registrar powers to strike off any such company. The MCA also has a task force on shell companies from 2017 onwards. This indicates that such SPAC companies cannot find the approval of the MCA and the business industry in the current settings. Any individuals and companies that are interested in undertaking and forming a SPAC company, may have to collaborate with companies based in an ecosystem where such companies are acceptable.

Further, any merger or acquisition that happens in India is bound by relevant sections (232-240) of the Companies Act, 2013. If a foreign party is involved then the relevant sections of the (FEMA) Foreign Exchange Management Act, 1999, Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“Merger Regulations”), may apply here. The ultimate approval for a merger regime depends on the approval of the National Company Law Tribunal.

USA:– Rules are designed in a way that SPACs can avoid falling under the ambit of blank cheque companies, a concept similar to shell companies in India.  

This is clearly visible under Rule 419 under the Securities Act of 1933, which states that a blank-check company is to deposit all proceeds and securities issued in the company’s IPO into an escrow account, and there is a prohibition from transferring or trading the securities until after completion of the said business combination.

As SPACS operate in a manner where they keep in the money in the trust account, they fall under this clause partly; however, the next clause lays down that to be considered as a blank cheque company the issuer is compelled to issue a “penny stock,” as defined in Rule 3a 51-1 under the Securities Exchange Act of 1934.

As per the exclusions of this definition, any security of an issuer that has been in operation for less than three years and has at least $5 million in net tangible assets is to be excluded from being considered as a penny stock. And since SPAC companies usually have a time limit of 2 years, they fall well under this exclusion and to claim this exclusion they have to fill a Form 8-K with an audited balance sheet with the SEC which shall also demonstrate relevant IPO compliance.

It is clearly visible that the USA has an ecosystem that welcomes SPAC companies and has provisions for allowing them to thrive in the domain of their choice.

This ecosystem is strongly considered while entrepreneurs are choosing structures and markets for their business. A key example of this is that the famous Yatra.com, a famous travel website was known to be acquired by Terrapin 3 Acquisition Corp (TRTL), which is a NASDAQ-listed SPAC.  This company was listed on the NASDAQ in 2014 and Deutsche Bank was the underwriter in this particular transaction. 

And more recently Grofers, which is a household name today, is considering a similar type of arrangement. 

The examples of such deals and arrangements are slowly growing as they provide a range of opportunities otherwise not possible when companies are restricted to domestic markets only. Let’s take a look at some possible benefits, deterrents and opportunities for Indian technology industry-based companies in the SPAC market.

Benefits of rising SPAC companies

  1. The difference in timelines: While going public in the domestic market, the timeline can range anywhere between 4 months to a year. SPAC companies are said to put a limit to these timelines ranging from 4-6 months. Further, in traditional IPOS and mergers, there are specific covenants in the contract and scheme of mergers restricting anything not in line with the usual course of business. This type of arrangement is not yet seen in SPAC companies and thus allows a level of added freedom.
  2. Wider Access to Markets:  In an event of traditional IPO the company would have been listed on the local exchange market, however in terms of SPAC it is listed on the U.S. exchange market thus giving it a stronger foothold to invite investments.
  3. Documentation: One of the key factors to consider especially for early-stage start-ups as documents and disclosure brings upon an additional cost. This cost is minimised or not reduced entirely in SPAC companies. As the disclosure requirements are limited as compared to the tough vetting process in general IPOS.
  4. Reduced Market Risk: The valuation of the business to be acquired is decided and negotiated with the sponsor/main investor and not with the financing institutions. This leads to certainty in pricing instead of frequent fluctuations in the market value.
  5. Tax: There are certain tax liabilities that are deemed as grey areas in domestic settings and increase the burden of the stakeholders. To minimise such liabilities and increase, access to international capital and take upon the benefits of preferential tax-related treatments for their business. For example,  for Flipkart, to avail benefits of such a tax ecosystem is registered in Singapore. Further growing tech-based companies like Cure fit also availed this by registering in overseas jurisdictions.

Detrimental side of rising SPAC companies

  • Blind investment: Major shareholders of such a type of transaction are actually walking in a blind investment scenario, as the risk is minimised but not nil. The sponsor who intended to start the SPAC company may realise that they are not able to deliver and the funds will still stay put for the time period of two years, whereas these funds could be used elsewhere.
  • Liquidation Limitation: The SPAC may have limited trading liquidity for some period while it tries to find companies to acquire
  • The Shell notion grey area: SPAC companies currently are labelled as the alternative for shell companies, this comparison is not very well taken in many international markets and there is always a sense of suspicion involved in this type of companies. Companies in the tech industry may not want to deal with this as at any given point there are multiple regulatory issues like GDPR, sharing of data, data protection and adding onto this will increase the liability of the companies.

Conclusion 

Currently, it looks like the P in SPAC stands for the piece of pie everyone wants to get a taste of, however, with the market only picking up recently, it is going to be an interesting watch over the years to see how many companies stay on track with the valuation and going public and finding a target company within a period of 2 years and actually provide returns for the company and associated stakeholders. Indian tech companies should at all times before stepping into such transaction’s assess their long-term goals and risk management potential.

References

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