Author: Shasank Konger
Final Year Student from AMITY LAW SCHOOL, AMITY UNIVERSITY, KOLKATA
As the world resumes activities resembling the pre-pandemic era, learning to adapt and live alongside the SARS-CoV-2 virus, reservations have ebbed away as an increased number of investment opportunities present themselves for investors to make good on lost time. This accounts for a far more engaged market, as businesses re-establish themselves, bolstered by increasing volumes of customer demand, contrary to inflation woes. With the economy returning to this new state of normalcy, private equity and venture capital firms look to take on new challenges and address struggling industries, in an effort to expand their portfolios. In 2021, over 60 businesses in India found themselves seeking public investment, in an attempt to ensure stable funds, through ‘Initial Public Offerings’ or ‘IPOs’. Listing pre-requisites on the Indian markets, including IPO qualifications, are regulated by a combination of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, amongst others. However, contrary to this traditional method of raising capital, these troubled times witnessed the emergence of the ‘Special Purpose Acquisition Companies’ or ‘SPACs’, which turned out to be a lucrative alternative but not to the benefit of the participants in the Indian capital markets.
The acquisition of WeWork, an American company offering flexible office spaces for self-employed workforces, by BowX Acquisition Corp, was what caught the public’s eye in the last quarter of the previous year. This came on the back of an unsuccessful attempt at an IPO that WeWork tried to file back in 2019, due to overvaluation. Soon after, Buzzfeed, the digital media giant, announced its intention to secure public funding and followed through with a public listing in December 2021. What set these transactions apart from regular announcements was the fact that they were the latest addition to a long list of notable names to have gone public through SPAC IPOs over the past year and a half.
Several prominent Asian names have also been under the radar, undergoing negotiations and deliberating interest, which includes the likes of Grab, a Singapore based ride-hailing, and food delivery start-up, valued at about $40 billion, India’s homegrown e-commerce giants Flipkart, and Byju’s, an edTech platform that happens to be India’s most valuable startup. SPAC IPOs in the US were reported to have raised nearly $83 billion in the whole of 2020, and closing over $100 billion announced in the first quarter of 2021 alone and just under $3 trillion worldwide.
What are SPACs and why are they relevant?
A Special Purpose Acquisition Company or SPAC is also known as a ‘blank cheque’ company, which are basically shell companies (without any commercial purpose), constituted ‘specially’ for acquiring a ‘target’ company, with the intention of the ‘target’ going public. Traditional IPOs have often been expressed as tediously time-consuming and expensive processes, and the alternative SPAC route provides relief for companies to avoid the incessant stress involved. The founders, also known as the ‘sponsors’ along with the management team of the SPAC are responsible for raising capital before they identify and pursue the acquisition of a target. The capital raised is usually deposited and held in a trust until the whole process is completed, similar to the functioning of an escrow account.
After the acquisition, the majority of the business control is escorted by the target, with the target’s shareholders holding the majority stake of the company. This is of course, for a specified period of time, after which a process is known as the ‘de-SPAC’ is carried out, upon which a demerger is facilitated and the target is successfully able to list its own share on the exchange of its choice. The SPAC contributes in the form of its experienced personnel and management expertise towards the target. However, if the target is unable to undergo the de-SPAC process within the specified period of time (generally 18-24 months), the capital raised is returned to the investors and the company undergoes dissolution.
How has the pandemic facilitated IPOs through SPACs?
Albeit out of the general public’s eye until quite recently, SPACs have been around since the 1980s and 90s. The earlier years were plagued with links to fraudulent activities, and hence, did not gain much traction, often serving as the last resort for a desperate failing effort to raise capital. This was until regulatory authorities were able to intervene for a secure marketplace and a fairer flow.
The pandemic resulted in a lot of businesses closing down, downsizing, or losing out on substantial revenue due to working remotely, especially affecting the restaurant and hospitality sector. A lot of the privately-owned businesses therein turned to secure public funds, less as a business strategy, but more as a means for survival. However, these ran a great risk for traditional IPOs, as most businesses had either stagnated or were on the decline. This was when such private companies were graciously greeted by SPACs, where sponsors were eagerly looking to invest in prospective business models and subsequently banking on multiplied results. The mutual need of the hour arising out of the crisis was the driving factor for SPACs to surge to the forefront. SPACs usually tend to target businesses in the emerging arena, whose potential has not fully been tapped into and is unapparent to public investors. Moreover, in a much more volatile market, as compared to the pre-pandemic era, the safer bet for both targets and sponsors was to adopt the non-traditional route, enabling them to avoid general market risks involved in IPOs. This was enabled by the fact that valuations involved were pre-determined, unlike traditional IPOs, where even underwriting fees of a transaction amounted to nearly 7% of the total proceeds. Such costs remain relative to the size of the entire transaction in a SPAC IPO, making it a pocket-friendly option.
Are there any downsides?
If the SPAC model was a much safer and cheaper route, why has it been dormant for so long? Why have the major players not stuck to this instead of going through lengthier, costlier, and immensely strenuous IPOs? Although it may be a safer bet, the focus of the alternative to traditional IPOs has less to do with the past performance of a target but emphasizes the potential and future prospects of a business. On top of that, it became much more difficult to reassure investors that the time required after the acquisition would justify the results that they might be expecting. Fewer risks would also inadvertently result in lower returns, which might be a key factor for businesses to facilitate IPOs, regardless of the risks involved, expecting more handsome returns upon their listing. A school of thought among many skeptics of the non-traditional route persists that the SPAC era would eventually be quite short-lived, as we put distance between us and the volatile market.
As with any new form of market activity, regulatory scrutiny increases proportionately to its popularity, as participants increase, alongside chances of fraudulent manipulations and securities fraud. Many notable SPACs have come under the purview of their respective regulators in recent times, that includes the likes of DraftKings, the online betting company, and Nikola, a promising autonomous vehicle manufacturer. Greater regulatory scrutiny, clubbed together with the inability to identify target companies to the satisfaction of investors, has been amongst the leading reasons for a comparative slowdown in SPAC activity in recent months.
How has Asia fared?
Asia, in general, has been left behind in the ‘SPAC’ race. Most Asian unicorns (a term used for private startups valued at over $1 billion) have turned to the west, in hopes of more lucrative options available in the US exchange markets. Only a handful of the stock exchanges in Asia (Hong Kong, Singapore, South Korea, and Malaysia) have warmed up to the idea of private companies adopting this route to go public. Given the impact and the potential of Asian businesses on the global market, the over-contemplation and hesitancy around SPACs have driven entrepreneurs beyond the Asian sub-continent. Hong Kong and Singapore, two of the most lively markets in Asia have remained on the fence with the idea of SPAC listings for a while, the latter listing its first SPAC as recently as January 2022. Although under consideration, rather stringent regulatory norms proposed have already driven the hearts of most prospects to the West. The pace and certainty invoked by western sponsors tend to reassure target companies.
India, in particular, has no means for companies to follow this route at the moment. As a consequence, it forces businesses and companies to look for listing in alternative markets. For example, Flipkart, one of India’s earliest unicorns, has been deliberating to go public through a US-based SPAC in the NASDAQ (National Association of Securities Dealers Automated Quotation), following other Indian counterparts such as Grofers, an online grocery venture. SPAC enthusiasts in the country believe that the non-accommodating nature of the Indian markets has essentially driven profitable businesses to look for listings abroad. Major regulatory roadblocks to domestic investors exuberant about overseas SPACs stem from restrictive approval policies and blurry tax implications imposed by the Securities and Exchange Board of India (SEBI). Under the Companies Act, 2013, any company in India must possess a commercial objective to be registered. Since a SPAC’s only objective is to acquire a target, it fails to fall under the head of a business objective. This measure has been imperative to check shell companies built only for the purpose of tax evasion and money laundering. However, all hope is not lost for the Indian markets and investors. SEBI, which is the market regulatory authority in India, has been closely monitoring the developments of SPACs in foreign forums. The International Financial Services Centres Authority (IFSCA) had recently released a consultation paper proposing the facilitation of the listing of SPACs in the domestic market. Although India must keep up with the rest of the world to make sure it does not lose out to global markets due to its dissent, it must not jump the bandwagon only for it to tumble eventually. Patiently waiting out the erratic market trends, and making a safe and sound assessment thereafter to weigh the scales of pros and cons, might sound conservative, but is the most rational option, at present.