SPACs: Matchmaking in a new context

Would you ever invest in a company that doesn’t provide any service or sell any product? It seemed like a strange idea to us too, until we realized that there are people and institutions who have collectively invested billions of dollars in such companies in 2020 alone. All the questions that are now crossing your mind, crossed ours too, and we try to calm some nerves in this article.

Most of us understand what an Initial Public Offering is - companies that are willing to expand and are ready to open to retail investors to raise investment, offer an IPO which is essentially their first sale on the stock market exchange.

However, the process of IPO is arduous enough for not everyone to opt for that path. The process itself is expensive, involves auditing and underwriting through investment banks alongside marketing the IPO. But not only that, after the long ordeal, after D-day, with a constant public eye, IPOs come heavily under the eye of government regulators like the SEBI for India, SEC for the USA and so on and so forth.

It has been well established that a company’s journey to an IPO can be tiring, but what other options are left for companies willing to list themselves without going through the whole process. This is where Special Purpose Acquisition Companies (SPACs) enter.

SPACs enter the market as shell companies, selling absolutely nothing, but a prospect of a potential deal in the future. Also known as ‘Blank Cheque Companies’.

The companies do not reveal any potential deals or an acquisition target. They raise funds through private equity companies and the public and eventually acquire a company or merge with one. For companies wanting to go public, this presents a hassle-free approach. The deal essentially boils down to one to one merger-acquisition, instead of a process involving everyone from retail investors to bankers.

In simpler words, the process works in the following steps:

• A SPAC is formed, and the leadership has a potential acquisition, merger target, however it is open to changes by the time the deal finalizes.

• The SPAC undergoes its own IPO process, raising money for itself.

• Once the SPAC indulges in talks with an acquisition, merger target, both ends complete their due diligence. The talks could be initiated by any party, depending on the business targets.

• If the deal pulls through, the acquired/merged company becomes a part of the SPAC which is already listed, thus becoming a listed company by itself.

• If no acquisition is made within 2 years, or a deadline decided by law, the SPAC would face liquidation and the investors shall get back their investments.

Some major companies who opted for this route have been Virgin Galactic and Nikola. Talking about Nikola, a company, which has recently unfolded as just a huge marketing gimmick. To summarize, the concept was of trucks running on hydrogen-fuel cells, an electrical technology that could have rendered Tesla’s lithium-ion powered vehicles useless. Although, currently, hydrogen fuel cells are more expensive to produce and maintain, they are almost ten times as effective. And, producing vehicles made out of them was just the next big EV innovation to catch everyone’s eyes. However, they failed to keep their promise and what followed was just deceit. Nikola held large presentations, showcasing their trucks, claiming them to be falsely powered by hydrogen-fuel cells. In reality though, we have to give it to them for being excellent film-makers and presenters to have convinced everyone for long enough.

However, this story presents a glaring risk in the SPAC system. The investors lacking awareness of the company to be acquired, until the acquisition actually happens can put their investments at a crossroads with their expectations of a prospective acquisition. Consider a SPAC, the board of which has experts on the EV industry, and has identified itself as looking to operate in the EV industry. The industry can have multiple prospects, and Nikola might be one that some of the investors might be wary of, thus posing a significant risk if the stock tanks. Although, this risk is accompanied with traditional IPOs too, the uncertainty is less.

India has only seen a handful of SPAC deals over the years, and they have majorly been, foreign-based SPACs acquiring stakes in Indian companies and listing them in their markets. Formed with Indian board members/partners, some of the companies emerging in the scene have been: Trans-India Acquisition Corporation, Millennium India Acquisition Company, India Hospitality, Phoenix India, Globalization Capital. All of them represent India in their names, however, another striking similarity between them is that all of them are based out of the United States!

Specifically, in India, there are certain laws that restrict SPACs from originating in India. A SPAC by itself, cannot go for an IPO as it does not have past records, profits to showcase its credibility. Neither, do NSE or BSE allow a company to be listed without having a certain turnover over the previous few years.

For example, the SPAC to undergo an IPO, according to SEBI, it will have to have (quoted from laws),

• net tangible assets of at least three crore rupees in each of the preceding three full years (of twelve months each)

• a track record of distributable profits in terms of section 205 of the Companies Act, 1956, for at least three out of the immediately preceding five years

The SPAC can only be listed through the Bombay Stock Exchange as a large company, because listing as a small company requires The minimum income/turnover of the Company shall be Rs. 3 crore in each of the preceding three 12‐months period.

While the NSE does not have such a restriction, it requires the promoters and partners to have a track record of at least 3 years. Trans-India Acquisition Company mentioned above, was backed by then Chairman of the ICICI Bank. With such names involved, and large investment banks floating into the picture, this criterion is a fairly easier one to be met. However, norms laid out by SEBI will still be the major limiting factors for the operation of an Indian SPAC.

The laws are restrictive, but there are provisions that are made that can be used to bring out a sustainable model for SPACs.

The biggest apprehension is the lack of clarity and its perception as that of a black box model of operation.

To tackle this uncertainty, as we mentioned an example of a law by SEBI, it is required for the company to have a clear business objective while having assets and profits to show for a certain amount of time. These terms can be re-looked into, to find that the SPAC can state its business objective to be that of acquiring or merging with a company, specifically mentioning the industry it would belong to without identifying a specific target. This can definitely add color to the black box and possibly go past the authorities. Secondly, as per SEBI, to compensate for the lack of profits or assets, the SPAC can:

• Choose to allot at least fifty per cent. of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make allotment to the qualified institutional buyers,

OR,

• Ensure that, at least fifteen per cent. of the cost of the project is contributed by scheduled commercial banks or public financial institutions, of which not less than ten per cent. shall come from the appraisers and the issuer undertakes to allot at least ten per cent. of the net offer to the public to qualified institutional buyers and to refund full subscription monies if it fails to make the allotment to the qualified institutional buyers.

Coupled with such analysis into other norms, there can be a way for Indian SPACs to exist. However, then comes the question, whether they should even exist. We don’t see much that would be different in the SPAC method, as compared to an IPO, which could be reason enough for them to thrive. However, for the company, though SPAC offers a road with less potholes, its post Going-Public expenses and operations will become intensive irrespective of how it is going public. We suspect that could be a reason, the SPAC method is not dominant and that it will mostly be companies that are large enough to afford an IPO which would actually go through the SPAC route. The number SPAC deals, though, do not seem to decrease anyway.

Nevertheless, SPACs, we feel, are great instruments for smaller companies who have decided to tap into institutional and retail investments without the company having to go through all the ordeals of an IPO. If a sound business is in place, it can reduce the time for a company to go public by the company. A whole new kind of Indian Matchmaking will be in place bringing together companies looking for a SPAC option to go public and SPACs looking for a potential target before running out of time and having to liquidate.