Special Purpose Acquisition Companies (SPACs)

Introduction

The Special Purpose Acquisition Companies (SPACs)have been since 2003 in US but have been growing in popularity throughout the world due to number of reasons like growth potential of target businesses, time consuming process of traditional IPO, credibility of sponsor and availability of liquid securities in the post COVID-19 times. Since the substantial funds have been already raised by SPACs in the recent past and a significant portion of these funds remain to be deployed in target across the globe, it is expected that many more SPAC transactions being consummated in the near-future.

What is SPAC?

SPAC is company with no commercial operations or any specific business plan or has indicated that its business plan is to engage in a business combination (i.e. a merger or acquisition). In other words, a SPAC is formed strictly for the purpose of raising capital through an IPO and using those funds to acquire an operating business.These types of companies are popularly known as ‘Blank Check Companies’ which are raising blind pool of cash through IPO to acquire a private operating company.

SPACs bring together experienced management teams, often comprising industry veterans, private equity sponsors who can leverage their expertise to raise capital to acquire, then operate, a new public company.

The IPO of a large private company is facilitated, in effect through a merger with SPAC, enabling a private business to avoid the inherent costs and risks associated with the traditional IPO process.

Evolution of SPAC

• The first SPACs that appeared in 1990’s could not qualify for listing on any U.S. exchange and were often quoted on the OTC Bulletin Board and were made to comply with the onerous rules for “blank check” offerings.
• In 2003, SPAC went public for the first time in US.
• In 2005, the American Stock Exchange (NYSE Amex) began allowing SPACs to list under generic listing standards that did not require companies to have operating histories.
• In 2008, as the financial crisis reached its peak, the IPO market for SPACs closed, the number of acquisitions completed by SPACs dropped significantly.
• In 2010 listing rules were altered to remove the requirement of majority voting to initiate a business combination. Instead the investors opposing business combination can redeem their shares. In 2010, private equity firms frequently emerged as sponsors of SPAC.
• In the next ten years SPAC started gaining momentum. In 2020, $83.36 Bn was raised through SPAC IPOs.
• In 2021, till the end of June month, record breaking 362 SPACs have been formed raising in total $ 111.12 Bn.

Summary of SPACs in US since 2003

Source: SPACs analytics

Elements of SPAC IPO

• Affiliatemeans any person that directly or indirectly controls, is controlled by, or is under common control with, the issuer.
• Business combination– De-SPAC transaction that will combine the SPAC and target business into a single publicly traded company.
• Warrant means redeemable warrant which entitles the holder thereof to purchase one share of a common stock post business combination.
• Sponsor is the entity or management that funds the SPAC. It is often a new limited liability company formed solely for the purpose of sponsoring the SPAC. IPO expenses, underwriting commission, and a minimum amount of working capital will be funded by the sponsor. Typically sponsors own 20% of outstanding common stock of SPAC post-IPO.
• Trust Account – Account in which the IPO proceeds are placed. The funds are not permitted to be released from the trust account until the closing of a business combination or the redemption of public shares. The interest generated can be used to pay taxes until business combination.
• Target Business– The business to be acquired post closure of offering. Normally the business is chosen from a specific industry in which the management or the sponsor possesses expertise.
• Unitsmeans units of SPAC consisting of common stock (class A or class B shares) and in most case redeemable warrants.

Process of SPAC IPO

• Founders – A SPAC is formed by experienced business executives who are confident that their reputation and experience will help them to identify a profitable company to acquire. Since SPAC is only a shell company, the founders become the selling point when the sourcing funds from investors. The founders provide the starting capital for the company and they stand to benefit from a sizeable stake in the acquired company. The founders often hold an interest in a specific industry when starting a special purpose acquisition company.
• Registration – Filing registration statement (Form S-1) with the U.S. Securities and Exchange Commission (“SEC”),
• ClearingSEC comments and conducting roadshow for attracting investors.
• Identification– of Stock Market for listing (majority of SPACs list on NASDAQ and NYSE)
• Issuing the IPO – When issuing IPO, the management team of the SPAC contracts an investment bank to handle the IPO. The investment bank and the management team of the company agree on a free to be charged for a service, usually about 10% of the IPO proceeds. The securities sold during an IPO are offered at a unit price, which represents one or more shares of common stock. The prospectus of the SPAC mainly focuses on the sponsors, and less on company history and revenues since the SPAC lacks performance history or revenue reports. All proceeds from the IPO are held in a trust account until a private company is identified as an acquisition target.
• Acquiring a target company – After the SPAC has raised the required capital through an IPO, the management team has normally 24 months to identify a target and complete the acquisition. The period may vary depending on the company and industry. The fair market value of the target company must be 80% or more of the SPAC’s trust asset.
• Negotiating – for merger or purchase agreement to acquire a business or assets within 24 months.
• Redemption option – Shareholders who do not approve of the business combination are given back their full investment via a tender process.
• Raising additional finance, in case of substantial redemption by shareholders. For this purpose,forward purchase agreements are entered in advance with affiliates and sponsors. Debt and Equity may be raised through other modes like PIPE (Private investment in Public Equity). PIPE involves issuing shares of a public company in a private arrangement with a select investor / group of investors. PIPE investment happen only after a target is identified.
• Consummation of business combination–The SPAC and the target business will combine into a publicly traded operating company. It is also referred as De-SPAC transaction.
• Where the SPAC fails to achieve business combination within 24 months, it will be obliged to liquidate and redeem 100% of the shares offered subject to certain exemptions. When running the SPAC, the management team is not allowed to collect salaries until deal is completed.

Other important points in the process of SPAC IPO

• SPACs are not allowed to decide upon its target business at the time of listing in order to avoid compliance and disclosure requirements.
• The IPO proceeds will be held in a trust account and can be used only to fund the business combination or to redeem shares sold in the IPO in case SPAC is unable to complete a business combination within 24 months.
• The target business must have an aggregate fair market value of at least 80% of the assets held in the Trust Account.

Capital Structure of SPAC

1. Public units

A SPAC floats an IPO to raise the required capital to complete an acquisition of a private company. The capital is sourced from retail and institutional investors, and 100% of the money raised in the IPO is held in a trust account. In return for the capital, investors get to won units, with each unit comprising a share of common stock and a warrant to purchase more stock at a later date.

The purchase price per unit of the securities is usually $10.00. After the IPO, the units become separable into shares of common stock and warrants, which can be traded in the public market. The purpose of the warrant is to provide investors with additional compensation for investing in the SPAC.

1. Founder Shares

The founders of the SPAC will purchase founder shares at the onset of the SPAC registration, and pay nominal consideration for the number of shares that results in a 20% ownership stake in the outstanding shares after the completion of the IPO. The shares are intended to compensate the management team, who are not allowed to receive any salary or commission from the company until an acquisition transaction is completed.

• Warrants

The units sold to the public comprise a fraction of warrant, which allows the investors to purchase a whole share of common stock. Depending on the bank issuing the IPO and the size of the SPAC, one warrant may be exercisable for a fraction of share (either half, one-third or two-third) or a full share of stock.

For example, if a price per unit in the IPO is $10, the warrant may be exercisable either 30 days after the De-SPAC transaction or twelve months after the SPAC IPO. The public warrants are cash-settled, meaning that the investor must pay the full cost of the warrant in cash to receive a full share of stock.

Founder warrants, on the other hand, may be net settled, meaning that they are not required to deliver cash to receive a full share of stock. Instead, they are issued shares of stock with a fair market value equal to the difference between the stock trading price and warrant strike price.

Where India stands in SPAC race?

SPAC deals in India are still at a nascent stage, the number of SPAC related conversations in the Indian transactions space is swiftly growing. Credit Suisse estimates that India is home to at least 100 highly valued, as-yet unlisted unicorns – startups worth more than $1 billion each, with a combined market capitalization of $240 billion. During the budget speech of 2020, Finance Minister Smt. Nirmala Sitaraman promised to relax foreign investment rules.

To keep the pace with the evolving market environment, International Financial Services Centres Authority (IFSCA) in the Gujrat International Finance Tec-City (GIFT City), has recently released a consultation paper where IFSCA is exploring to facilitate listing of SPACs in the GIFT City. The proposed framework by IFSCA is expected to provide an ecosystem for capital raising and listing by Fintech and other start-up companies. The proposed framework will also facilitate issuers from across the jurisdictions to raise the capital for variety of needs.

The salient features of the IFSCAs framework for listing of SPACs is as under:

1. Offer Size: Not less than USD 50 million or any other amount as may be specified by the Authority from time to time. Further sponsor shall hold at least 20% of the post issue paid up capital.
2. Minimum application:The minimum applicationsize in an initial public offering of SPAC shall be USD 250,000.

• Minimum subscription: At least 75% of the offer size.

1. SPAC specific obligation: Requirement have also been prescribed with respect to maintenance of escrow account, eligible investments pending utilization, acquisition timeline of 3 years extendable up to 1 year, right of dissenting shareholders, liquidation provisions, etc.
2. Post Business acquisition:The issuer resulting from the completion of the business acquisition by the SPAC shall be required to meet the listing eligibility criteria set out in these regulations within 180 days, in order to continue the listing on the recognized stock exchange(s).The shareholding of the sponsors in the target company shall be locked up for a period of 180 days from the date of closing of the business acquisition.

Can Indian resident individuals invest in a SPAC?

Yes, Indian resident individuals can invest in an overseas SPAC within the prescribed annual limits (Currently, USD 250,000). As per current regime, the Indian shareholders are liable to pay the taxes on their investment after de-SPACing even without having monetized their investments. Depending on the mechanism adopted for de-SPACing, Indian investors may have to seek regulatory approvals at the de-SPACing stage besides initial approval at the time of investment.

Tax implications for Indian Investors

Tax implications on the future sale of SPAC shares/resultant company’s share shall depend on various factors such as residential status of the investor and the nature / type of investor involved.

Tax implications for resident Indian individual is as under:

Benefits of SPAC

• It is considerably quicker IPO process which can be completed within a period of 3 to 4 months
• SPAC acts as a tool to raise funds for the purpose of an acquisition of target company
• It is relatively easier to prepare financials and prospectus of SPAC due to no commercial operations in company
• The approval process by SEC is comparatively less cumbersome
• There is no upper limit for raising capital
• Option to the investor to redeem the shares purchased, if they disagree with the identified business combination.
• Relatively low cost of due diligence
• Lower underwriting commission (5.5% as against 7%-8% in case of normal IPO)
• Experienced Senior Management

Flip side of SPAC

• The success of SPAC depends on the sponsor’s experience and “know-how” and so the investor is blindly depending on the sponsor to identify successful business and negotiate a good deal.
• Twenty-four-month deadline (36 months as per IFSCA framework) imposed for making a business combination, while protecting investors by forcing a return of their investment, puts management under severe time pressure.
• Unlike investors, the sponsor is not entitled to get any of this interest back if the acquiring transaction does not occur.
• The requirement that management must spend at least 80% of the SPAC’s assets on a transaction could result in the SPAC’s management overpaying for the target company to satisfy the condition.

Conclusion

In todays globalized business world, Global capital acts as an important driver of economic growth and development. The unprecedented rise of the SPAC market is transforming and reshaping the global capital markets. India is one of the most buoyant start-up ecosystems after Silicon Valley and there is huge potential for foreign direct investment by SPAC.A comprehensive SPAC framework in India will help to attract the global capital to meet India’s development needsand provide international issuers a globally competitive financial platform.