[By Anumeha Agrawal]
The author is a student at the Symbiosis Law School, Pune
Introduction
A Special Purpose Acquisition Company (hereinafter referred to as “SPAC”) as the nomenclature suggests is a company incorporated with the sole aim to acquire another private company thus converting it into a public company.
The first step involved in the functioning of SPAC is the incorporation of the company with the promoters having expertise in the field of investment or the identified sector (if any). The second step is conducting an IPO where the public will invest in the company (without any business except for acquiring a private company), here the importance of reputed promoters arises as the investors are essentially banking on the technical know-how of the market and the identified sector for the acquisition.
Following the IPO is the identification of the private company for the proposed acquisition and once identified the shareholders’ approval is required. The SPAC can only proceed with the proposed transaction if the proposed transaction secures a certain percentage of votes (differing in different jurisdictions, mostly lies between 50-90%). In case the requisite majority is achieved the dissenting shareholders have a right to get their investment returned (subsequent to a nominal deduction). The target company is acquired and the company becomes public by virtue of reverse merger and has the capital raised by the SPAC.
In the event the requisite majority is not achieved then the SPAC can either identify another target company or liquidate depending on how much time has passed from its incorporation (differing in different jurisdictions, mostly lies between 18-36 months). Upon liquidation, the investors are paid back their investment with the interest accumulated in the escrow account (if any ) however the management is at the bottom of the sequence of payment, hence liquidation of SPAC is most detrimental to the interests of the promoters and the managerial personnel of SPACs.
Commercial Viability: The SPAC is a commercially viable investment vehicle as its structure is sustainable and there is a tangible need for the same in the market. There is a clear imbalance between the credit availability to small and medium corporations and the stringent eligibility criteria corporations are required to adhere to owing to the interest of the prospective equity investors. According to NASDAQ the year 2020 was the year of SPACs as their IPOs raised gross proceeds of 79.89 billion US dollars which was an increase of 462%. The Mckinsey Report of the year 2020 Asia can annually dispense 800 billion US dollars for funding midsized to large corporations, thus reinstating the commercial potential of SPACs[i]. Experts like Goldman Sachs have expected 2021 to be the year of SPACs in Asia.[ii] International Legal Scenario
SPACs are descendants of the blank check companies, which were companies in a development stage company that has no specific plan or purpose or has indicated their business plan is to engage in a merger/ acquisition with an unidentified company other person.[iii] These companies were common instruments of fraud in the 1980s and particularly issued penny stocks. Congress in 1990 enacted legislation requiring strict disclosures and management requirements on blank check companies, i.e., Securities Enforcement Remedies and Penny Stock Reform Act of 1990[iv]. In particular, Rule 419 accorded several protective measures to the investors when dealing with the blank check companies like a deposit of IPO funds raised and securities issued in an escrow account; an 18 month limit on the company’s right to retain investor funds without completing an acquisition; a prohibition on the trading of securities held in escrow; filing of a post-effective amendment upon the consummation of an acquisition; refund for investors disapproving a proposed acquisition; and a requirement that the acquisition must account for at least eighty percent of the funds held in escrow.
These rules significantly decreased the fraudulent activities associated with respect to blank check companies. By the mid-1990s US economy emerged from a deep recession and the small companies started to grow and then further companies initiated incorporation for the sole purpose of merging with a private entity however the shares were not penny stocks, therefore, the same was not governed by Rule 419, thus SPAC were formed. Few differences between blank check companies and SPACs were the former had 18months to complete an acquisition as compared to the latter which had 24 months.
The success of private equity in European countries led to the introduction of SPACs in several European countries around 2005, it is a more viable option due to less stringent requirements as compared to the NASDAQ and NYSE norms. For example, incorporating SPAC with specifically targeted company in mind is allowed and there is no requirement of the minimum fair accounting value of the target company to be 80% of the trust. The SPACs are also provided greater flexibility in the selection of target companies and multiple investment cycles for a SPAC. In Europe, multiple smaller acquisitions are executed in contrast to the single large transactions that are typical to US SPAC.
Despite the developed scenario of private equity in the Asian markets, there are only three jurisdictions that have noteworthy SPAC transactions, China, Malaysia and South Korea. Malaysia and South Korea officially recognize SPAC as an investment vehicle and are largely based on the US and UK laws, whereas China has several SPAC transactions owing to the need of Chinese companies to raise foreign investment and get listed on international stock exchanges like NYSE and NASDAQ however the jurisdiction lacks governing legislation.
Governing Indian Laws
There are no special legislations governing SPACs in India and the general corporate laws govern them including Companies Act, 2013[v], Securities Exchange Board of India Act, 1992[vi], Rules and Regulations and listing of corporate entities are SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018[vii] and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015[viii]. One of the requirements of commencement of business by a company within 180 days of incorporation[ix] will have to be amended for SPAC as the SPAC do not have their independent operations and SPACs has been given a longer timeline to acquire a target company than a year.
The recently introduced Gujarat International Tec-City SEZ International Financial Services Centre is proposed to list SPACS. A Consultation Paper on International Financial Services Authority (Issuance and Listing of Securities) Regulations, 2021[x] was proposed and Chapter VI provides the listing of SPACs including the proposed process of incorporation and the commercial transaction to be undertaken. It has the following provisions:
The offer document is required to provide various disclosures like the objects of the issue, the anticipates allocation of funds for the administrative capital, the basis of the issue price, the SPAC’s target business sector, limitations on the rights of the shareholders who vote against a business acquisition.
The minimum issue size permissible for a SPAC is 50 million US dollars of which a minimum of 20% of the post issue paid-up capital shall be held by the sponsors. The minimum subscription for any SPAC IPO to be successful is provided to be 75% instead of 90%. Furthermore, a minimum application size is 250,000 US dollars and the maximum percentage of a single allotment is 20%[xi].
Some protective measures for the investors include ensuring deposit of 90% of the IPO proceeds in the escrow account controlled by an independent custodian[xii], the mandatory requirement for the proposed acquisition to be approved by a majority of the shareholders[xiii] and the businesses acquisition shall have an aggregate fair market value which is a minimum of 80% of the aggregate amount deposited in the escrow account[xiv]. Lastly, SPAC is required to complete an acquisition within 3 years and this time limit may be extended by one year by special approval of 75% of total shareholders except for the sponsors[xv].
Securities Exchange Board of India has also formed Primary Market Advisory Committee on March 11, 2021 to examine the feasibility of the introduction of SPAC and similar investment structures in India. Critical Issues
The lack of awareness about the nature of investment proposed by the commercial vehicle. It is essential to spread awareness about the transaction involved in SPAC and the corresponding risk involved in the same as a result of which only investors having the corresponding risk appetite shall indulge in the same.
The requirement of the target company’s minimal fair accounting value to be 80% significantly restricts the ambit of prospective target companies for the SPAC. and ought to be dispensable. By permitting the acquisition of multiple target companies the sponsors shall not only be unburdened by the cumbersome process of incorporating a separate SPAC for each acquisition but also the credit availability and liquidity for small companies have a substantial increase.
Furthermore, there is no minimum eligibility criteria provided for the sponsors of SPAC and in particular no technical know-how is required, this renders an issue of lack of knowledge and experience in the target company sector a which shall be a problematic aspect in the amalgamated entity.
Lastly, there is no procedure laid down for the composition of the board and other managerial bodies in the amalgamated entity to prevent corporate disputes and ensure smooth functioning of the amalgamated entity.
Conclusion and Suggestions
SPAC is a highly sophisticated and high volume investment vehicle with a high risk associated with the same, therefore the target investors are seldom the retail investors. Since the target investors are accredited investors the level of protection available to them in the form of a majority approval of proposed transaction, depositing the IPO proceeds in an escrow account and the return of investment in cases of disapproval of the proposed acquisition are satisfactorily adequate. There needs to be a balance between the protection of interest of shareholders and the commercial viability of the investment vehicle itself.
The European measure of enabling SPACs to acquire more than one company ought to be allowed, this shall, in turn, widen the ambit of target companies SPACs can opt from, and further the cause of making the credit availability for the small companies. Additionally, by allowing SPACs to have multiple investment cycles the government shall also eliminate the exhaustive process of incorporating a separate company for the acquisition of a second target. Notably, the protection of the minimal fair accounting value of the target company to be 80% of the trust amount may continue as the total of the minimum fair accounting value of all the companies.
Secondly, there needs to be proper guidelines made for the process to be followed of change in control in the amalgamated entity, there should be some minimum representation provided to the erstwhile managerial personnel of the target company in the amalgamated company. This requirement gains further importance since the sponsors of the SPAC are not mandatorily required to have technical expertise in the target company’s sector then the need for technical expertise in the newly formed amalgamated entity shall be imperative.
Since the investors are investing in the expertise and prudence of the sponsors of SPAC instead of the performance of the target company itself the involvement (inevitably resulting in the liability) of sponsors ought to be of a longer duration, hence the proposed lock-in period of 180 days is not sufficient protection and caught to be increased to a minimum of a year.
Endnotes:
[i] Kurt Chauviere, Alastair Green, and Tao Tan, Earning the Premium: A recipe for long term SPAC success, (March 16, 2021L 15:04), https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/earning-the-premium-a-recipe-for-long-term-spac-success.
[ii] Kane Wu, Bankers say all aboard for great Asia SPAC merger lift-off, (March 10, 2021: 12:24 ), https://www.reuters.com/article/asia-ma/bankers-say-all-aboard-for-great-asia-spac-merger-lift-off-idUSL4N2LR2GY?edition-redirect=in.
[iii] SEC, Blank Check Company, (April 16, 2021: 20:02), http://www.sec.gov/answers/blankcheck.htm.
[iv] Securities Enforcement Remedies and Penny Stock Reform Act, 1990, (March 19, 2021; 14:49),https://www.govinfo.gov/content/pkg/STATUTE-104/pdf/STATUTE-104-Pg931.pdf.
[v] The Companies Act (Act No.18 of 2013).
[vi] Securities Exchange Board of India Act, ( Act No. 15 of 1992).
[vii] Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.
[viii] Securities Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
[ix] The Companies Act, Section 10A, (Act No.18 of 2013).
[x] Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021, Regulation 71.
[xi]Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021, Regulation 77.
[xii]Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021, Regulation 81.
[xiii]Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021, Regulation 82.
[xiv]Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021, Regulation 86.
[xv] Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021, Regulation 83.