Special Purpose Acquisition Companies (SPACs)

What’s the connection between NBA legend Shaquille O Neal, tennis star Serena Williams, former Facebook executive and Silicon Valley investor Chamath Palihapitiya, and Indian media veteran Uday Shankar? SPACs!

What are SPACs and how do they work? 

SPAC or Special Purpose Acquisition Company is a company without commercial operations listed on a stock exchange by an experienced management team or an individual with an investment pedigree (known as the Sponsor) with the sole purpose of acquiring or buying out a private company, thus making it public without going through traditional IPO. At times, SPACs are also referred to as blank check companies.

The private company being targeted is not known at the start, although the Sponsors could indicate the geography/sector they are interested in investing.

For the purpose of this acquisition, the SPAC needs money which is raised through the process of IPO. The IPO’s success solely depends on the faith that the investors have in the Sponsors, since the company has no business / financial performance to speak of. SPACs seek underwriters and institutional investors before offering shares to the public. During IPO, investors are allotted units which comprise of shares along with fractional warrants (SPAC warrants are options given to the warrant holder to buy the shares of the company at a predetermined price on a future date, subject to certain terms and conditions relating to the exercising) that offer them an upside and act as a deal sweetener. The capital raised through the IPO is placed in an interest-bearing trust account until the target company is identified.

A SPAC has about two years to discover this target and complete a reverse merger. If the SPAC fails to find a suitable target and complete the process, it gets delisted, liquidated and the entire money kept in the escrow account (along with interest less any taxes/bank fees) is refunded to all the investors. If the target is identified within 2 years, then post the approval of the proposed acquisition by SPAC investors, the SPAC and the target combine to form a publicly traded operating company, leading to an automatic listing of the acquired private company.

Note – If the SPAC investor is not comfortable with a planned purchase, he/she has the option to sell the shares and exit, but can keep the warrants. These warrants give you an additional upside if the SPAC is successful and goes better than expected.

The deal value of the acquisition could be four to five times higher than funds raised by the SPAC. The difference is met through fresh investments, mainly in the form of Private Investment in Public Equity (PIPE) deals. At the time of a public listing, large private equity and hedge funds can directly invest in and acquire shares of a company at share price or at a discount without going through the stock markets. The funds get access to non-public information on the potential target company from the SPAC after signing a NDA and get the option to invest at the time of the merger.

SPACs – why prefer them over traditional IPOs?

SPACs are considered a safe bet during choppy markets and the global outbreak of COVID-19 has played a major role in its popularity.

Traditional IPOs are seen to be expensive and far more time consuming in terms of registrations, disclosures and processes. SPACs involve lesser parties, lesser negotiations and are perceived to offer a faster and flexible route for venture capital funds and private equity majors to take their private companies public.

A regular IPO involves a list of procedures prior to actual listing – doing roadshows, convincing a wide variety of investors regarding future business prospects, deriving optimum valuation for the business etc. All these activities take time and are fraught with uncertainties. This is where SPAC has an advantage. With SPAC already listed, half the work is done. Also, the negotiation works faster since only one party has to be convinced.

SPACs work even better for startups – since most successful SPACs are run by experienced business investors, young companies can benefit from that investment expertise and not have to worry too much about swinging investment amounts or shifting negotiations. Broader market sentiment matters less since the SPAC investors commit to the purchase, sometimes allowing companies to remain truer to their original mission statement or purpose than if they were purchased by a larger board of investors.

Off late a majority of the SPACs have sponsored startups and companies that are pushing the boundaries of tech and are innovative. Being an investor in a SPAC gives funds and individuals the opportunity to potentially become an investor in such cutting-edge companies

What’s in it for the Sponsors and Investors?

For the sponsor, though they are not entitled to any remuneration during the process of raising funds and acquiring the target company, the substantial Founder shares and warrants are incredibly valuable. It is not every day that you get to own 20% of a company for $25,000.

For investors, SPACs make for a safe bet because their funds are parked in an interest bearing trust account until the merger. In many cases, the investors in a SPAC sell their shares before the merger or at the time of the merger and are able to make good profits

SPACs – Picking up steam

It is the sheer volume of dry powder sitting with investors – $2.5 trillion globally – that’s making SPACs quite popular. Also, SPACs offer a simplified path to taking a company public and to access the public markets for both investors and private companies.

Over the last 10 years, SPAC has been gradually gaining traction in the US markets. In 2020, SPAC was used as a listing option for every alternate transaction, i.e. 50 per cent of the transactions were done through SPACs. As much as $83 billion was raised.

In India, SPAC structure deals are not entirely new. For instance, in 2015, Silver Eagle Acquisition, a SPAC acquired a 30 percent stake in Videocon d2h for around $200 Mn. In 2016, Yatra Online, the parent company of Yatra India, listed on NASDAQ, by way of a reverse-merger with another US-based SPAC, Terrapin 3 Acquisition. The deal size was around $219 million.

Due to the increased scrutiny of US SPACs by the US SEC, companies are running low on targets in North America and as a result Asia is getting attention.

SPACs for Indian Investors

SPACs cannot be listed in India due to various rules and regulations around shell companies and the general myth that these companies are formed for money laundering activities

However, considering India’s large and mature IPO market and the fact that India is the third largest startup ecosystem in the world, regulators should consider allowing SPAC listing in India – with the necessary regulatory oversight in place. It is understandable that there may be some skepticism around the risks associated with SPACs, but the advantages that they bring to the table are priceless for investors.

Current Indian laws will have to be modified to bifurcate a shell company from a SPAC. Since SPACs are increasingly getting noticed by Indian investors they will hopefully also get noticed by lawmakers and regulators and they will make the required amendments in laws to gain from this SPAC boom.

Recent developments in India:

To keep with pace with the evolving market environment, International Financial Services Centres Authority (IFSCA), the unified regulator of IFSC at GIFT city, India, is now proposing a suitable framework for capital raising and listing of SPAC on the recognised stock exchanges in International Financial Services Centres (IFSCs).

The proposed salient features of the IFSCA framework for listing of SPACs are as follows:

• Offer size of not less than $50 million or any other amount as may be specified by the Authority from time to time.
• The sponsor would have to hold at least 20% of the post issue, paid-up capital
• The minimum application size in an initial public offer of SPAC shall be $250,000
• A minimum subscription of at least 75% of the offer size has been stipulated

SEBI has told the Parliamentary Standing Committee on Finance that it was deliberating on the framework of SPACs in Indian capital markets and a committee, which was set-up to look into it, is in the process of finalising its report.

What’s the bottom line? 

Fancy packaging does not make it less risky to write out blank cheques. The magnitude of costs and risks involved around SPACs is high.

The SPAC structure lends itself to heavy dilution of share value, through shares allocated to the Sponsor, the options investors have to redeem shares without surrendering warrants, and the underwriting fees based on IPO proceeds. This in effect impacts the actual value of the SPAC shares at the time of the merger, further affecting the deal value and could result in lower share prices post-merger.

Considering a large number of SPACs being launched and allegations against some of them, there is rising scrutiny. There are calls for better disclosures and greater checks on Sponsors so they have more responsibility towards investors. The increased competition among SPAC Sponsors for investor money is also resulting in more equitable structuring, ensuring Sponsors do not have an extraordinary advantage over late investors.

With elements of high risk and the potential for spectacular windfalls, investors should be very mindful while giving in to the SPAC buzz.