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Special Purpose Acquisition Companies (SPAC)

December 23, 2024

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This article has been written by Abhinandan Sah pursuing an Executive Certificate Course in Corporate Governance for Directors and CXOs from Skill Arbitrage and edited by Shashwat Kaushik.

This article has been published by Shashwat Kaushik.

Introduction

SPAC (Special Purpose Acquisition Companies) is a company with no business; it is specially formed for the acquisition of another company through an IPO. SPAC (Special Purpose Acquisition Companies) are structured as trusts with a face value of $10/- per share. The Companies Act does not approve SPAC directly but SEBI has issued guidelines only for foreign companies. It means an Indian company can list on foreign exchange boards through SPAC easily; however, its not available for listing on any exchange in Bharat.

Background

In an IPO, companies need to disclose all their financial operations, processes, compliance and many undertakings from the directors and promoters. Public disclosure of their business, while in the case of special purpose acquisition companies since there is no business at all, all this disclosure mechanism is not there in the process.

Also in the traditional IPO route, once the IPO is public for subscribers, if there is any volatility in the market at that time due to some temporary reasons, it leads to undersubscription of the IPOs. Oil, gas, and petroleum space sectors are such sectors that can be affected due to some temporary reasons; in this situation, IPOs can be undersubscribed.

When it comes to undersubscription it is very hard for companies since the overall process of an IPO is very hard. So SPAC is easier than an IPO.

How does Special Purpose Acquisition Companies (SPAC) work

IPO process: A Special Purpose Acquisition Company (SPAC) issues a standard price of $10 per share.
Funds are first kept in a trust account.
Acquisition/merger: After raising the fund, the Special Purpose Acquisition Companies (SPAC) has a time frame of 18-24 months for identifying and merging with the target company, resulting in a private company becoming public company
Shareholder approval: Both the company which is getting merged and SPAC shareholders should arrange for shareholders meeting where merger is approved by majority shareholders with special majority

Advantages of Special Purpose Acquisition Companies (SPAC)

Lower risk for companies: As informed above, the IPO route is very tedious; supposed the company has done all formalities and at the end, if there is a subscription, then the whole process needs to be done again if the company wants to raise funds from the public.
SPAC sponsors: Since Special Purpose Acquisition Companies are formed by experienced people in the market who have themselves established themselves as credible persons, in this case the threat of undersubscription is overruled.

Eligibility for Special Purpose Acquisition Companies (SPAC)

Special Purpose Acquisition Company issuer shall be eligible to raise capital through an initial public offer of specified securities on the recognised stock exchange(s) only if:
- the target business combination has not been identified prior to the IPO, and
- The Special Purpose Acquisition Companies (SPAC) have the provisions for redemption and liquidation in line with these Regulations.
A sponsor of the SPAC issuer shall have a good track record in SPAC transactions or business combinations or fund management or merchant banking activities, and the same shall be disclosed in the offer document.
For the purpose of these regulations, sponsor shall mean a person sponsoring the formation of the SPAC and shall include persons holding any specified securities of the SPAC prior to the !PO.
An issuer shall not be eligible to list securities under these regulations if the issuer or any of its sponsors is:
- debarred from accessing the capital market; or
- a wilful defaulter; or
- a fugitive economic offender.

IPO process for SPAC

The provisions relating to the appointment of the lead manager, in-principle approval from recognised stock exchange(s) and filing of an offer document provided for initial public offers under Part A of Chapter III “shall mutatis mutandis” apply to an initial public offer by a SPAC issuer.

International Financial Services Centres Authority (IFSCA) may consider the proposed listing of a Special Purpose Acquisition Companies (SPAC) issuer on a recognised stock exchange on a case-by-case basis.

Risks and considerations

Challenges and Considerations Surrounding Special Purpose Acquisition Companies (SPACs)

Conflicts of Interest: A potential risk with SPACs lies in the possibility that the interests of the SPAC’s sponsors or management team may not align with those of the public investors. This misalignment could lead to decisions that benefit the sponsors at the expense of the investors.
Uncertain Performance: The historical performance of SPACs is mixed. While some SPACs have achieved successful mergers and generated significant returns for investors, others have failed to find suitable target companies or have experienced poor post-merger performance. This variability makes it difficult to predict the success of any particular SPAC.
Market Dependence: Because SPACs themselves do not have underlying operating businesses, their performance can be heavily influenced by overall market conditions. Economic downturns, market volatility, or sector-specific challenges can all negatively impact the value of SPAC shares and the ability of the SPAC to complete a successful merger.
Dilution Risk: When a SPAC merges with a target company, existing SPAC shareholders often experience dilution of their ownership stake due to the issuance of new shares to the target company’s owners. This dilution can reduce the potential upside for SPAC investors.
Time Constraints: SPACs typically have a limited timeframe (often two years) to identify and complete a merger. This time pressure can lead to rushed or less-than-optimal deals, potentially resulting in lower returns for investors.
Regulatory and Legal Risks: SPACs are subject to various regulatory and legal requirements, and changes in these regulations or legal challenges could impact their operations and attractiveness to investors.

Overall, while SPACs can offer potential benefits to both investors and target companies, they also come with a unique set of risks and challenges. Investors considering investing in a SPAC should carefully evaluate these factors and conduct thorough due diligence on the SPAC’s management team, target industry, and potential merger candidates.

Regulatory and legal aspects

Oversight:

The U.S. Securities and Exchange Commission (SEC) plays a crucial role in overseeing the activities of Special Purpose Acquisition Companies (SPACs).
This oversight involves monitoring SPACs to ensure they adhere to relevant regulations and guidelines.
The SEC’s involvement aims to protect investors and maintain market integrity.

Disclosure Requirements:

SPACs are subject to stringent disclosure requirements, particularly concerning the intended use of funds raised through their initial public offerings (IPOs).
These requirements mandate that SPACs provide clear and comprehensive information about their target industries, potential acquisition targets, and the risks associated with their investment strategies.
Adhering to these disclosure requirements ensures transparency and enables investors to make informed decisions.

Popularity and Growth:

Data sources indicate a significant surge in the popularity of SPACs around the fiscal year 2020.
This increased interest can be attributed to various factors, including the potential for faster access to public markets for private companies and the perceived efficiency of the SPAC model in facilitating mergers and acquisitions.
However, the rapid growth of the SPAC market has also raised concerns about potential risks and the need for enhanced regulatory scrutiny.

Special Purpose Acquisition Companies (SPAC) activity in Bharat

In Bharat, the SPAC market is still emerging compared to the U.S., but there have been notable developments and interest in this space. Some companies that go public on US exchanges through SPAc are listed below:

ReNew Power

SPAC Merger: ReNew Power, one of India’s largest renewable energy companies, went public in 2021 through a merger with RMG Acquisition Corporation II, a U.S.-based SPAC. resulted ReNew Power listing on the Nasdaq, which was the first successful listing of any Indian Company through SPAC route.

Videocon d2h

In 2015, Videocon d2h, a prominent Direct to Home (DTH) television provider in India, opted for a merger with Silver Eagle Acquisition Corp., a Special Purpose Acquisition Company (SPAC) based in the United States. This strategic move facilitated Videocon d2h’s listing on the Nasdaq stock exchange, granting the company enhanced access to capital and increased visibility in the global market.

The merger with Silver Eagle Acquisition Corp. marked a significant turning point for Videocon d2h, propelling its growth trajectory and paving the way for further expansion. Subsequently, Videocon d2h engaged in another merger, this time with Dish TV, a major player in the Indian DTH market. The consolidation of these two industry giants resulted in the formation of the largest DTH provider in India, commanding a substantial market share and establishing a dominant presence in the country’s television broadcasting landscape.

Eros International

SPAC Merger: Eros International decides to merge with a SPAC, 3iQ Corp. to form ErosSTX Global Corporation in 2020. This merger enhanced the capabilities of both and was a significant deal in the entertainment industry.

Key differences in regular IPO and SPAC

Aspect	Traditional IPO	Special Purpose Acquisition (SPAC)
Definition	A traditional IPO is when a company offers its shares to the public for the first time to raise capital.	A SPAC is a shell company formed to raise capital through an IPO with the sole purpose of acquiring or merging with an existing private company.
Process	The company going public must undergo a lengthy process, including financial disclosures, regulatory approvals, and roadshows.	The SPAC goes public first, raising funds without identifying a target. Once public, the SPAC has 18-24 months to find a target company to merge with.
Regulation	Regulated by SEBI.	SPACs are not authorised yet. Currently, they are mostly considered for overseas listings.
Time Frame	Traditional IPOs take months, sometimes years.	The SPAC itself can go public quickly. After that, it have 18-24 months to identify target and merge.
Risk Exposure for Investors	Investors buy into a company with a known business and financial history, so there is less risk.	Investors are investing in a company where they are mostly not knowing the exact business, adding more risk.
Valuation Certainty	The valuation is set through a pricing process set by SEBI.	The valuation of the target company is typically pre-negotiated with the SPAC sponsors.
Investor Type	It attracts a wide range of institutional and retail investors, especially in Indian capital markets.	SPACs often attract institutional investors, hedge funds, and high-net-worth individuals. Retail investor participation increases after the merger.
Costs and Fees	High costs due to underwriting fees, compliance, and marketing (roadshows).	SPAC sponsors usually take a significant stake and might charge additional fees. This could reduce value for post-merger shareholders.
Control and Governance	IPO investors buy shares and gain control as shareholders with existing management.	After the merger, the acquired company takes over the management.
Market Sentiment	Market sentiment at the time of the IPO plays a significant role in pricing and success.	SPACs can bypass short-term market volatility in pricing.
Transparency	High transparency, as the company must disclose detailed financials, business models, risks, and projections before going public.	Lower initial transparency since SPACs do not have operations.
Examples in India	Zomato, Paytm, LIC, and many other companies have followed the traditional IPO route in India.	Indian companies like ReNew Power and Videocon d2h have used U.S.-based SPACs to go public on foreign exchanges, but SPACs are still rare in India.

Timeline of Special Purpose Acquisition Companies (SPAC)

Here’s a timeline for a SPAC (Special Purpose Acquisition Company) to be listed and complete its business combination (merger or acquisition):

Formation of the SPAC

Time frame: 1-3 months

Sponsors (founders) create the SPAC, composed of experienced investors and industry professionals.
First, they file the necessary documents for the formation of the company’s.
Prepare the S-1 registration statement for filing with the Securities and Exchange Commission (SEC) (in the U.S.) or the appropriate regulatory body if it’s an international listing (for Indian companies, this could involve international exchanges like Nasdaq or NYSE).

Initial public offering (IPO) of the SPAC

Time frame: 1-3 months

After the formation of the companies, SPAC filed for an IPO at a standard price, often $10 per share.
Marketing includes a minimum as they have no operation and it is limited to institutional investors as the retail investor may not be interested due to the large risk involved in it.
SPAC is listed after successful completion of the IPO.
Funds raised from the IPO are held in a trust account, which can not be used until the target and merger are completed.

Target search period (De-SPAC Process)

Time Frame: 18-24 months

The SPAC management is given 18-24 months to find a suitable private company that is to be acquired; a period allotted for this is known as the target search period.
After identifying the target company, detailed due diligence is conducted to assess financials and legal issues to fit in the process.
Negotiation: this process is basically pre-decided but it may vary due to some current changes, including the valuation of the target.
If a target company is not found within the timeline, the SPAC is dissolved and all funds returned to the investors.

Announcing the business combination

Time frame: 1-2 months after identifying the target

This is the most critical area where investors can have ambiguity since the business combination is the combination that will make the resulting company a success or fail.
Once the combination is set, the merger agreement is prepared and filed with regulatory bodies for approval
In the US, companies need to file a Form S-4 or other relevant forms containing information about the merger, including the business of the target company, financial statements, and the terms of the transaction.

Shareholder vote

Time frame: 1-2 months after the announcement

SPAC shareholders and target companies must vote to approve the merger or acquisition.
If shareholders approve through special votes, the deal will move forward; in case of denial, SPAC continues to search for a new target (if time allows) or is forced to return the capital to investors.
Investors also have the option to redeem their shares for a pro-rata share of the trust account if they do not find a combination favourable for them.

Closing the business combination

Time frame: 1-3 months after shareholder approval

Upon successfully completing financial and legal provisions, the private company becomes public.
The SPAC’s ticker symbol is changed as per the new combined company.
So a new company starts trading with a new ticker and symbol while SPAC ceases to exist.

Post-merger operations

Time Frame: Ongoing

The management team of the target company takes over operations; former SPAC holders becomes shareholders and company operates normally as a public company for their day-to-day operations

Conclusion

Special Purpose Acquisition Companies (SPACs) are useful methods for raising funds when the promoters are decided about the targets. In this method, it is the easiest way for a company to get public who have any threat that their IPO may be undersubscribed due to some local instances.

Amidst the current global uncertainties, with conflicts arising in different regions such as the Russia-Ukraine war and the tensions in the Middle East, businesses involved in export, oil, gas, and other petroleum products are facing potential challenges. The fear of under-subscription looms large due to these geopolitical tensions. However, the SPAC (Special Purpose Acquisition Company) route emerges as a potential solution to mitigate such risks and prevent losses. This mechanism can be particularly beneficial for organizations operating in these sectors. Furthermore, insurance companies that provide coverage to marine companies can also directly benefit from this system.

Nevertheless, it is crucial to ensure that the entire SPAC system is robust and free from any loopholes. The integrity of the system must be maintained to prevent any misuse or exploitation that could lead to the loss of investor funds.

References

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