[Poojita Saxena is a 4th year law student at the National Law Institute University, Bhopal]
One of India’s leading renewable energy companies, ReNew Power, recently announced the execution of a definitive business combination agreement with RMG Acquisition Corporation II. The USD 8-billion transaction enables the combined power generation company to get listed on NASDAQ by the second quarter of 2021. This transaction marks the first major overseas listing of an Indian company by means of a Special Purpose Acquisition Company (“SPAC”) vehicle in recent times. This post seeks to highlight various considerations on the roadmap to such listings that may end up influencing the decision of companies to choose SPACs as against the traditional route of initial public offering (“IPO”).
Growth of SPACs in 2020-21
Amidst the Covid-19 pandemic, SPACs witnessed explosive growth in a disrupted world economy. In 2020, a total of 248 SPACs raised a record USD 83 billion through their IPOs. This figure is projected to grow in 2021, with a massive USD 73.2 billion already raised by 228 SPACs within the first three months.
SPACs have been in global markets since David Nussbaum, then CEO of GKN Securities, invented a modified blank check company in 1993 after capitalising on the new regulatory environment that offered greater investor protections against penny stock frauds. Since then, there has been a resurgence of SPACs due to the evolution of their structure, better governance by the Securities and Exchange Commission (“SEC”), and the recent market volatility partly attributed to the global pandemic. Despite substantial volatility in the first half of 2020, the capital markets continued to thrive, especially in the US, and several private companies were interested in the benefits of a public listing. During the pandemic, however, taking on the cost and time pressures of a conventional IPO, along with the inherent pricing and valuation risk, was perceived as less appealing. Against this backdrop, the path emerged for a more flexible, less burdensome, and quicker alternative of raising capital through SPACs. From the billionaire fund manager Bill Ackman’s largest SPAC ever to tech-investor Chamath Palihapitiya with his dozen SPACs to former NFL player Colin Kaepernick, several investors have jumped on the SPAC bandwagon.
A SPAC is a type of blank check company, which is formed specifically to raise funds through an IPO to finance a merger or acquisition of an unidentified target within a set timeframe. Subsequent to such merger or acquisition by the SPAC, known as a De-SPAC transaction, the target company becomes a listed company in lieu of executing its own IPO.
Generally, a SPAC is established by experienced sponsors or managers with nominal invested capital of about 20% interest in the SPAC. By leveraging their expertise, they raise the remaining funds via public shareholders through the shares offered in the SPAC IPO. These funds are held in an interest-bearing trust account until a suitable target is found within a typical timeframe of 18-24 months. If the SPAC does not conclude a merger or acquisition within that period, it will be liquidated and the IPO proceeds will be returned to the SPAC’s public shareholders.
What makes this route a viable and attractive option for private companies is the fast-track IPO process, easier access to capital while retaining control of the company, flexible deal terms with liberty to negotiate the valuation and share price, easy exits for the shareholders, potential for private investment in public equity (“PIPE”), and ability to partner with experienced managers. With increasing recognition of these significant advantages, the SPAC boom is no longer limited to the US economy. The growth of this model in Asia is evident from tycoons and money managers from Hong Kong and Singapore launching their own SPACs with the intention of acquiring the increasing number of Asian businesses in the technology, media, and e-commerce industries. Further, with big Indian companies like Flipkart and Grofers looking to go public via SPACs, India is not short of joining the new wave of SPAC transactions.
SPACs in India
While overseas listing is not a new phenomenon in India, with companies like Videocon d2h and Yatra Online Inc. already listed on the NASDAQ, new investment opportunities in Indian companies have resurfaced and have set the ball rolling for SPAC transactions. However, since India does not have a specific regulatory framework guarding these transactions, the implementation of SPACs might face certain challenges.
A De-SPAC transaction, where SPAC is merged with an Indian target entity, requires outbound merger compliances under the Foreign Exchange Management (Cross Border Merger) Regulations, 2018. As per the regulations, pursuant to the NCLT’s sanction of the scheme of the cross-border merger, the Indian office of the target company shall be deemed to be the branch office of the combined entity. The shareholders of the Indian target will receive shares of the combined entity, either as a consideration for the merger or as a share swap. Such transaction is deemed to have RBI approval if, amongst other conditions, the fair market value of the shares is within the limits prescribed under the Liberalized Remittance Scheme (USD 250,000/financial year) and the Foreign Exchange Management (Transfer or issue of any Foreign Security) Regulations, 2004 are complied with. Moreover, the guarantees or outstanding borrowings of the Indian target that have been converted into liabilities of the combined entity must be repaid to the lenders along with a no-objection certificate.
While almost all of the above qualifications can potentially be fulfilled over time, in cases where the Indian shareholders are individuals having higher stakes in the target company, the fair market value of shares to be acquired by such shareholder is likely to exceed the limit of USD 250,000.
Moreover, from a taxation point of view, acquisition of shares of the combined entity would be a taxable transaction in an outbound merger with no specific relief available for De-SPAC transactions in India. If the Indian shareholder acquires shares of the combined entity as a result of the SPAC purchasing shares for money consideration, then the shareholders would be subject to a heavy capital gains tax and pricing guidelines. In order to make this merger tax-neutral and for Indian shareholders to have no tax incidence, a new provision granting exemptions would be required. Furthermore, the value of the Indian target shares that the shareholders will exchange for the shares of the combined entity, must be equal to or greater than the fair market value of SPAC shares in order to avoid tax under the anti-abuse provision of the Income Tax Act, 1961.
Apart from the above compliances, the Indian target must also prepare for the accounting and reporting considerations applicable in the jurisdiction of the SPAC. The target entity must plan to become a public company within a few months, which is a shorter timeframe than a conventional IPO with substantially the same planning, due diligence, and auditing, along with SEC disclosures and scrutiny in the case of American SPACs.
Criticism and Viability of SPACs
Although the capital that SPACs raised in 2020 was as much as they had raised over the entire preceding decade, critics are of the opinion that the SPAC bubble is bound to burst soon since people have misunderstood the real economics behind it. They reckon that SPACs tend to display poor post-merger performance because of the dilution that is in-built in the SPAC structure. After the IPO it is typical for a significant number of SPAC shares to be redeemed. To make up for this loss the SPAC issues shares to third parties or investors through PIPE. As a result, the shareholding of the SPAC sponsors, public shareholders, private investors, and the shareholders of the target entity would be highly diluted. Thus, for retail investors who invest in a company with no existing business operations, the average return from a post-SPAC merger is predicted to be less than post-market returns in an IPO.
Keeping in mind the pros and cons of the SPAC route, as of now, it is the best fit for Indian companies with a foreign holding company, i.e. companies that have externalised in a jurisdiction that allows cross-border mergers. This allows for easier compliance with cross-border merger regulations but would still attract heavy tax implications. Several Indian companies like Flipkart, Zomato, Delhivery, and Grofers, who have not reported profits in recent years, are planning to go public this year. The costs and benefits of an indirect overseas listing through SPACs must be compared to a direct listing in India through an IPO, which is supported by a favourable regulatory structure but at the cost of a risky valuation.
With careful structuring and possible innovation in a traditional SPAC transaction, such that it is tailored to meet the obligations under the Indian regulatory regime, SPACs could be an attractive alternative to IPOs for Indian companies.
– Poojita Saxena