This article has been written by Nikunj Arora, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

After three (03) years of its attempt to go public, ReNew Power Private Limited is getting listed on NASDAQ. The only thing with ReNew going public is that the company is not taking the traditional Initial Public Offering (“IPO”) route. The company is going to merge with NASDAQ-listed RMG Acquisition Corp II, which is a Special-Purpose Acquisition Company (“SPAC”). ReNew Power has become the first major Indian company that is going public by taking the SPAC route. 

SPACs are currently booming worldwide and investors are taking advantage of it. The SPACs have been part of the United States (“US“) since the 1990s but have become relatively popular in the Indian markets too. Although India has no regulation/statute for SPACs, the companies in India still want to go public through SPACs. The foreign SPACs look for a target private limited company in India and acquire the same for offshore listing. On the other hand, many Private Equity (“PE”) investors are getting attracted towards SPACs and diversify their strategies through SPACs as the companies provide the PE firms/investors greater valuation, global recognition and various exit horizons. 

Overview of SPACS

SPACs or ‘blank-cheque companies’ are corporate shell companies with no actual commercial operations but are created solely for raising capital through an IPO to acquire a private company. These shell companies are usually formed by a small group of ‘sponsors’ who manage the company and act as the SPAC’s management team. 

When a SPAC goes public, there is no business in the SPAC and the investors invest based on the track record of the founders. Once the investors have invested the money, the founders shall have a timeline of 18-24 months to identify an acquisition target. However, as per U.S. Securities and Exchange Commission (“SEC”) and NASDAQ rules, the timeline of 36 months has been given to a SPAC to identify a target company/business combination, but according to the market standard, the timeline of 18-24 months is being followed by the founders of SPACs.

In 2013, The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 required the SEC to lay down the rules regarding the ‘blank-cheque companies’. The SEC responded and defined a SPAC as follows:

‘Is a development stage company that has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person.

What do investors need to know before initial business combination?

1. Prospectus & Reports: An investor should carefully analyse the SPAC’s IPO prospectus as well as its periodic and current reports filed with SEC following reporting regulations. The investors need to understand the specific features of an individual SPAC which shall include equity interests held by the sponsors because SPACs are typically structured similarly. 
2. Trust Account: The proceeds of a SPAC IPO are held in a trust account and SPACs typically invest these proceeds in safe, interest-bearing instruments, hence, the investors shall carefully review the terms of an offering. A review of the IPO prospectus of the SPAC is necessary to understand the terms of the trust account, including the redemption rights.
3. Trading Price: A SPAC IPO is priced at a nominal $10 per unit. There might be fluctuations when the units, common stock and warrants begin trading. 
4. Warrants: A typical SPAC IPO provides the investors with a unit of selling securities which shall consist of shares of common stock and warrants. A warrant is a contract that allows investors to buy some number of additional shares of common stock. It is, therefore, important to understand the terms when investing.

Why are SPACS appealing?

SPACs usually require a relatively low upfront investment and there is a shorter investment horizon. The following are some reasons why SPACs are appealing:

• The management team, which are called sponsors, will contribute an amount that shall be equal to 2.5% or 3% of the gross IPO proceeds. The said contribution of the amount will be done in exchange for 20% of the outstanding shares (equity value) of the post-IPO entity. In addition to this, there will be an exchange for warrants to make a purchase of the additional shares at a 15% premium to the $10 price of the IPO. 
• The shares of the sponsors/founders are subject to a specified lock-in agreement for 1 year following the business combination. Even if the stock price of the company falls after the business combination or post-business combination such that the warrants will have no value, the 20% ownership of the sponsor will (almost in most cases) exceed its initial contribution. 
• If the value of its portfolio companies increases above the annual hurdle rate which is usually 7%-8% owned by the investors, the private equity fund sponsor in such a case will realise the gain. 
• Another advantage of the SPACs is that they are capable of earning returns quickly as against a standard private equity fund. This advantage will only be applicable if the shares of SPACs are publicly traded.

Advantages to the investors

The following are the major advantages of SPACs to the Investors:

• Investors shall have access to investments in acquisitions and buy-outs which are otherwise restricted to Private Equity (“PE”) funds.
• Investors get an opportunity to invest with a SPAC sponsor and management team (often investing their capital up to 5% of IPO) who have maximum industry expertise.
• There are a structure and limited risk in a SPAC IPO transaction.
• Investors get various benefits from the liquidity of publicly traded securities and the ability to control the timing of an exit.
• There is no need for cash compensation to the sponsor or management team if there is a pending business combination.
• Warrants included in the Units offered in IPO enable the holder to invest more amount of capital at a predetermined price (premium to the IPO price) and leverage initial investment.
• Their SPAC IPO structure provides a minimum liquidation value per share to the investors in the event no business combination takes effect. 

SPACS as innovative structures for pe-exits

SPACS: private equity’s new exit strategy

The traditional IPO market structure has limited the exit strategies for the portfolio companies, which is a PE equity-backed firm. Apart from investor’s protection, the SPAC management team allows the investors to commit the capital in stages, i.e., to withhold the portion of the said investment if the managers/management underperforms and a route to exit. Therefore, SPACs have broken the traditional PE contract design by allowing their investors to exit. 

SPACs provide the investors with a highly meaningful form of exit, in contrast to traditional PE. As per SEC Rules (Rule 149), SPACs shall agree to hold 90% or more of the offering proceeds in the escrow account and these funds cannot be used for the company’s day-to-day operations as they shall be invested in government securities. If any SPAC fails to acquire a target or a shareholder approval to acquire the said target, then, each shareholder will receive a pro-rata share of the above escrow funds. Therefore, if more funds a SPAC can hold in the trust, the more it will be an attractive option to an investor. 

The SPAC boom of 2020

There following points highlight the Private Equity’s exit strategy amidst the SPAC boom of 2020:

• In 2020, there was a SPAC boom and it was beneficial for the PE funds looking for exits. Secondary Buy-outs (“SBO“), which is a leveraged buyout where both the parties (buyer and seller) are PE funds, were becoming less viable options. The primary reason for SBOs becoming a less viable option is that the other PE funds deleveraged amid the beginning of the Covid-19 pandemic which was a state of financial and economic shock. 
• Amidst the global pandemic, the timing of the rise of SPACs was not entirely coincidental because many PE firms decided and began sponsoring SPACs, thus, the SPAC boom of 2020 raised a level high.
• From the point of view of exiting PE funds, by selling to a SPAC, the General Partner (“GP”) of a PE firm could retain the equity upside that was liquid and then could perform a sale for a significant profit shortly after the SPAC merger was completed. 
• SPAC exits provide liquidity to the Limited Partners (“LP”), of a PE firm, at Interest Rate Risk (“IRR“) above the fund’s target IRR. This process could be completed in a shorter duration than a traditional IPO. 

Due to all this, SPAC IPOs raised $39.7 Billion in 2020, which was more than the total amount of money raised by SPACs between 2009 and 2019, and the number of SPAC IPOs was doubled in the first three quarters of 2020 as compared to 2019.  

57th Street General Acquisition Corp.

57th Street General Corp. (“company” or “57th Street”), was a US-based blank check company (SPAC) formed on October 29, 2009, for the sole purpose of acquiring assets or operating businesses, through a process of merger, or capital stock exchange, or reorganisation, or other similar transactions/deals. 

In May 2010, the company completed its IPO. The details of the IPO transaction are as follows:

• IPO of 5,456,300 units,
• Each unit consisted of one share of common stock,
• Per value of a share was $0.001, 
• One warrant, each to purchase one share of the company,
• Units were sold at an offering price of $10.00 per unit, thereby, bringing the company’s total gross proceeds to $54,563,000.

This new SPAC brought several changes to the traditional SPAC structure which was designed to address the concerns of potential companies. Therefore, it may offer a desirable exit strategy for PE funds considering exit alternatives for their portfolio companies.

The PE firms may want to look at the following improvements in this new structure which may offer an attractive exit opportunity:

• Traditional SPACs provided their pubic shareholders with an opportunity to convert their shares into cash during the timeline of acquisition, provided that there is a favourable vote on the acquisition by majority SPAC’ shares during a special meeting of shareholders.
• The vote was not required by any SEC rules in most of the cases, and thus, resulted in significant delays. It also imposed an artificial threshold that could be exploited.

AMENDMENT: This was eliminated when 57th Street SPAC took place. 

• The structure allowed the public shareholders an opportunity to redeem their shares at the time of acquisition through a tender offer.
• In a traditional SPAC structure, there was a minimum value required for the target company provided that no acquisition could be closed if more than a minority of public shareholders, between 20-40%, requested conversion of their shares into cash. 

AMENDMENT: The minimum value was then eliminated in the 57th Street transaction and the conversion threshold was increased to 88%.

• In the traditional SPAC IPO, SPACs offered units that consisted of one share of common stock and one warrant to purchase a share of common stock. During this structure, the warrant strike price was usually set below the IPO price of the units. This ultimately puts downward pressure on the trading price of the common stock. 

AMENDMENT: in 57th Street, the strike prices of warrants were set above the IPO price per unit. 

SPAC listing in gift city

Talking about India, the Gujarat International Finance Tec-city (“Gift City“) is one of India’s first operational greenfield smart city and international financial service centre, which is an under-construction business near Gandhinagar, Gujarat, India. 

Recently, Injeti Srinivas, chairman of International Finance Services Centres Authority (“IFSCA”) said that IFSCA will soon be coming up with the SPAC regulatory framework which shall facilitate startups to raise capital through the sale of equity. IFSCA was established on April 27, 2020, with the sole aim to regulate and develop financial activities in IFCS in India. 

Sh. Nirmala Sitharam, Finance Minister during Budget 2021-22 has announced that the Government will support the development of the Fintech hub at the GIFT-IFSC. 

IFSCA is looking to facilitate the listing of SPACs in the stock exchanges and promote several innovative methods for raising capital under the supervision of the regulator, and make GIFT City a worldwide financial platform. The framework provided by IFSCA for the listing of SPACs on stock exchanges in International Financial Services Centres (“IFSCs”) has the following features:

• Offer Size: should not be less than USD 50 million or any other amount as may be provided by the Authority. The sponsors shall hold at least 20% of the post issue paid-up capital.
• Minimum Application: an IPO of SPAC should be USD 250,000.
• Minimum Subscription: at least 75% of the offered size.
• SPAC specific obligation: 

• requirements concerning the maintenance of escrow account,
• eligible investments pending utilisation, 
• acquisition timeline of 3 years extendable up to 1 year,
• right of dissenting shareholders,
• liquidation provisions, etc. 

Therefore, a foreign company can set up a SPAC in the Gift City which can list its securities on the stock exchange with the primary objective to effect a merger or an amalgamation of a target company that may be situated in India. This is a new regime, and thus, several benefits have been provided to the investors for establishing presents in the Gift City. From the Indian perspective, the entities or units which shall be set up in the Gift City would be treated as foreign persons, but, from a tax perspective, they shall be treated as tax residents of India, as per the provisions of the Income Tax Act, 1956 (“ITA”). 

From Company’s law perspective and an Indian tax perspective, the Gift Company will be regarded to be an Indian person and covered under the Companies Act, 2013 and ITA for tax benefits, and the merger would be subject to a merger between two domestic companies, hence, there shall be no complications either under the Companies Act or ITA. However, since this is regarded as a person resident outside India, the approval of the Reserve Bank of India (“RBI”) shall be required depending upon the transaction. 

Another benefit that shall be provided is that the trading of shares of securities issued by a Gift SPAC on a stock exchange of the Gift City would be completely tax-exempt, and thus, there would be no tax payable once the Indian entity is folded up into the Gift SPAC. 

SPAC mergers adding to an already bussing exit market

In January 2021, the blank-check companies (SPACs) announced five (05) billion-dollar merger which indicates that the SPAC management team/sponsors are not wasting to find the target companies. 

Some prominent examples include:

• Alight Solutions, which is a US situated business process outsourcing multinational company is backed by Blackstone Group, a PE firm based in the US too, was valued at $7.3 billion its merger with investor Bill Foley’s Trasimene Acquisition. This was said to be the largest tie-up.
• Taboola, which is a private advertising company in the US is expecting to raise $545 million in a merger with Ion Acquisition at a $2.6 billion valuation.
• The Hillman Group, a US-based company that makes home building and hardware is owned by CCMP Capital Advisors, an American PE firm that was valued at $2.6 billion in a SPAC combination with Landcadia Holdings III.
• Sunlight Financial, which is a US-based residential solar financing platform, has performed an agreement with Spartan Acquisition Corporation II backed by Apollo Global Management, a US-based investment management firm. 

Conclusion

During the global pandemic, the PE funds were not spent as expected, therefore, there is an unspent PE Dry Powder of around $2 Trillion, and the PE portfolio companies are seeking exits totalling $2 Trillion. However, the current SPAC capital searching for targets is only $67 Billion and thus, the SPAC market will continue to grow shortly. According to a PitchBook report (see here), more than 250 SPACs went public in North America in 2020. And as of 2021, nearly 67 blank-check companies have raised $17.5 billion in the US IPO markets. The blank-check (SPACs) deals have added opportunities to an already healthy exit market for PE-backed companies. There are several characteristics of SPACs that are attractive to a PE firm such as flexible acquisition terms, increased earning potential, greater certainty on pricing & financing, etc. Although SPACs acts as an appealing investment vehicle for PE firms, certain features should be taken into account when performing a SPAC IPO transaction. 

References

1. https://pitchbook.com/news/articles/spac-glut-powers-exit-spree-for-pe-and-vc-backed-companies
2. https://ifsca.gov.in/Viewer/ReportandPublication/9
3. https://ifsca.gov.in/PublicConsultation
4. https://bfsi.economictimes.indiatimes.com/news/industry/indias-gift-city-regulator-ifsca-is-looking-to-facilitate-the-listing-of-spacs/81444779 
5. https://www.prnewswire.com/news-releases/57th-street-general-acquisition-corp-announces-closing-of-over-allotment-option-95306004.html
6. https://breakoutpoint.com/blog/2020/12/wolf-pack-on-spac-pack/
7. https://www.blankrome.com/publications/spacs-emerging-exit-strategy
8. https://www.djcl.org/wp-content/uploads/2014/07/EXIT-VOICE-AND-REPUTATION-THE-EVOLUTION-OF-SPACS.pdf
9. https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin
10. https://www.pehub.com/new-spac-structure-holds-promise-for-private-equity-exits/
11. https://the-ken.com/story/renew-power-spac-rmg-merger-ipo/
12. https://www.mondaq.com/unitedstates/private-equity-mbos/64420/the-spac-as-an-alternative-exit-opportunity-for-private-equity-firms

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