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This article is written by Sachi Bhiwgade, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho) and Smriti Katiyar (Associate, LawSikho).

Introduction

An initial public offering (“IPO”) is commonly used by businesses to raise funds, gain resources to grow their operations, etc. To achieve these goals, companies are now increasingly pursuing mergers with special purpose acquisition companies (“SPAC”) rather than a typical IPO. Despite the fact that SPAC has been around for many years, it has seen a surge in popularity from start-ups and investors alike in recent years. Recently, India’s biggest renewable power company, ReNew Power was listed on Nasdaq in the US by merging with RMG Acquisition Corp. II, a US SPAC.

SPACs are common in developed jurisdictions such as the United States, Singapore, United Kingdom and are increasingly being demanded to be permitted in India. Currently, in India, the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 do not allow for the listing of blank check companies. However, The Securities and Exchange Board of India did appoint a panel of experts in March this year, to investigate the viability of adopting SPACs in India in order to keep up with the developing market environment. A consultation paper was also published by the International Financial Services Centre Authority (IFSCA) with respect to SPAC listing. The  IFSCA (Issuance and Listing of Securities) Regulations, 2021 was brought into force on 16th July 2021. Despite the implementation of the IFSCA Regulations, there are still legal obstacles in the way.

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How does SPAC work? 

For understanding how a SPAC works we need to know what is meant by a Special Purpose Acquisition Company or a “SPAC”.

Basically, a SPAC is a “blank cheque” or a “Shell” company that is set up solely for the purpose of raising capital through an IPO and effecting a merger with a private company to enable it to go public later. SPACs are usually formed by financial institutions or private equity funds and do not have any commercial purpose.

The sponsors/ investors who incorporate the SPAC are tasked with identifying the target within a 24 to 36 months’ time frame and investing the IPO proceeds there. This is, however, subject to the approval of the shareholders, otherwise, the SPAC shareholders have the option of redeeming their shares rather than participating in the merger, in which case they will receive their entire investment back. If a SPAC fails to complete an acquisition within the set time frame, the money, together with any interest generated, is returned to investors. Thus, giving the investors a choice to exit if they do not approve a deal.

When the necessary approvals are obtained, the SPAC and the target business merge to form a publicly traded operating company, also known as a “De-SPAC” transaction.

The stakeholders involved in a SPAC are:

  • The Sponsors: The sponsors generally are experienced professionals who initiate the SPAC procedure by creating a business and working with an underwriter to prepare the SPAC to go public by an Initial Public Offer. They follow the standard filing method but because there is no active business the process of filing is quick and simple. They are required to complete the acquisition within 2 years.
  • Targets: The majority of SPAC targets are start-up companies that have gone through the process of venture capital. The companies at this stage are looking for possibilities like going public through a traditional IP or obtaining extra capital from institutional investors or PE firms. Several advantages may be available to target companies as a result of a SPAC transaction. For starters, a SPAC purchase enables a private firm target that is otherwise prepared for an IPO to essentially go public without having to hire underwriters or produce a prospectus to sell its shares to the public. SPACs may be a more appealing option than these time taking options.

Why do companies opt for SPAC over IPO?

SPACs have been seen as less expensive and provide an alternative option for private entities to go public through an IPO. SPACs raise money primarily from public equity investors and have the ability to de-risk and speed up the IPO process for their target firms. The benefit to a target company is the reduced time and effort required to go public. The rise in popularity of SPACs in 2020 may be attributable in part to their shorter time frame for going public, as many companies opted out of traditional IPOs due to market volatility and uncertainty caused by the pandemic.

Another advantage is that because a SPAC has a limited time window for executing a deal, the target company’s owners may be able to negotiate effectively and probably at a higher price when selling to one.

The profit potential for sponsors, adequate risk-adjusted returns for investors, and a relatively appealing mechanism for raising funds for targets are all benefits of successful SPACs.

Regulatory challenges in India  

SPAC transactions in India are not protected by a specialised legislative framework, and present regulatory laws provide substantial hurdles. The following are some of the regulatory challenges that need to be addressed:

Companies Act

A SPAC is usually allowed 24 months to complete the process of business combination in the United States. However, as per Section 248 of the Companies Act, 2013, a company’s name can be removed by the Registrar of Companies for failing to commence its operations or business within one year of operation. Since SPAC’s do not have any actual running business they are considered as shell companies and run a risk of getting the name struck off in India. This is also because many firms have created shell companies in the past to launder money and avoid paying taxes which has particularly barred SPAC investment in India. Additionally, SPAC might take anywhere from 24 to 36 months to complete, the sponsors require this time to pick the most advantageous target and perform due diligence. Further, the directors or promoters are also at risk of disqualification for non-compliance. This creates a significant barrier for SPACs in India. 

Furthermore, as per Section 4 of the Companies Act, for the purpose of incorporation, the Memorandum of Association (MoA) shall specify the object for which the company is incorporated. Since SPAC does not have a defined business purpose it is impossible to meet this criterion.

SEBI (ICDR) Regulations

The listing requirements of SEBI include as per Regulation 6, for the company to have for the preceding 3 years “(a)net tangible assets of at least 3 crores; (b) average operating profit of at least 15 crores; (c) net worth of at least 1 crore rupees.”  A SPAC entity will be unable to make an IPO in India due to a lack of operating income and net tangible assets.

Cross Border norms

The RBI has enacted a number of regulations if the merger between SPAC firms and the target is a cross-border merger. Section 234 of the Companies Act requires that if a foreign company wishes to merge with an Indian company, it has to obtain prior Reserve Bank of India (“RBI”) approval. Similar requirement of prior RBI approval is also mentioned under Rule 25A of Companies (Compromises, Arrangements and Amalgamations) Rules, 2016.

Further, any merger with a foreign entity requires the compliance of Foreign Exchange Management (Cross Border Merger) Regulations, 2018 Regulations, which provides that in case of an outbound merger, all properties, assets, liabilities and employees of the Indian company are required to be transferred to the foreign entity. Shares of the combined entity will be distributed to the shareholders of the Indian target, either as part of the merger consideration or as a share swap. Further, the transaction has to be under the prescribed limits under the Liberalised Remittance Scheme (LRS) which requires that the fair market value of shares acquired by Indian shareholders overseas combined to fall within the limit of USD 250,000 every financial year and the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.  Additionally, a sanction from the National Company Law Tribunal is also required.

Since the main aim for a SPAC is to speed up the IPO process and eliminate procedural obstacles, this is another problem for SPAC acquisition. Hence, numerous regulatory checks imply more time to complete the transaction which defeats the purpose for which SPAC entities are formed.

Conclusion

For a growing number of private companies, merging with a SPAC rather than issuing an IPO is a viable option for raising money. Given India’s startup ecosystem being the third-largest in the world, the Indian government allowing greater foreign investment through SPACs will have enormous potential.  SPACs have the ability to assist Indian companies with international finance and therefore, there is a need for a formal framework in India to allow SPAC transactions to take place in a meaningful fashion, due to regulatory impediments. It is pertinent for India to learn from other jurisdictions and develop a comprehensive SPACs structure in order to remain competitive.

References

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