[Devanshi is a student at Gujarat National Law University.]
The concept of special purpose acquisition company (SPAC), pioneered by David Nussbaum in 1993, has become a prominent alternative to traditional initial public offerings (IPOs). While IPOs have long been the go-to method for established companies seeking capital and liquidity, they often present significant hurdles for startups with high growth potential but limited financial history. Traditionally, this gap has been bridged by angel investors, venture capital funds, and private equity investors, which has left the general public with limited access to investing in early-stage companies.
SPACs offer a solution by providing a streamlined path to public markets for startups, while also enabling retail investors to engage with promising firms from the outset. The allure of SPACs has grown, particularly in the wake of the COVID-19 pandemic, which led many companies to prefer this route over conventional IPOs due to market uncertainties.
In India, SPACs are generating increasing interest, exemplified by transactions such as Renew Power’s reverse triangular merger with a US-listed SPAC. However, India's current regulatory framework poses challenges for SPAC operations. This article explores the rise of SPACs, their potential advantages and challenges in the Indian context, and the current regulatory framework governing their operations. It also discusses the gaps in Indian regulations that hinder SPAC listings and acquisitions and propose ways to create a more supportive environment for these innovative financial vehicles.
The SPAC Model: A Flexible Alternative to Traditional IPOs
SPACs, as defined under Regulation 2(s) of the International Financial Services Centres Authority (Issuance and Listing of Securities) Regulations 2021 (IFSCA (IALS) Regulations 2021), have emerged as an innovative alternative to traditional IPOs, offering a distinct pathway for companies to go public. Unlike IPOs, which involve companies with established commercial operations seeking capital, SPACs are "blank-cheque" entities formed solely to raise funds for acquiring or merging with a private company. This unique structure allows SPACs to raise capital without an identified acquisition target, offering investors a chance to invest in a potential future acquisition.
The SPAC model involves a sponsor—a seasoned business professional or team—who, in exchange for their role in the SPAC's formation, receives a substantial share of the SPAC's equity, typically 20-25%, through shares and warrants. This initial capital typically amounts to 7-7.5% of the IPO proceeds, while the rest is held by public shareholders who invest in units offered during the SPAC IPO, with each unit comprising a share of stock and a portion of a warrant. Post-IPO, the SPAC holds public funds in a trust and has up to two years to identify and complete an acquisition, a process known as de-SPACing. If unsuccessful, the SPAC dissolves, and shareholders are refunded.
In contrast, traditional IPOs involve companies already operational, with a public offering process that can be lengthy and less flexible. SPACs, however, offer a quicker and more flexible route to public markets, though they come with their own set of challenges, such as the pressure to complete an acquisition within a fixed timeframe. Both methods aim to list a company's shares publicly, yet SPACs provide a more streamlined and potentially cost-effective alternative, reflecting their growing appeal in the financial landscape.
Regulatory Hurdles and Challenges for SPACs in India
India's regulatory framework currently presents several significant obstacles for SPACs, hindering their potential to transform the Indian capital markets. Although the IFSCA (IALS) Regulations 2021 partially address the SPAC model, these provisions have yet to facilitate a successful SPAC listing or reverse merger in India. A closer examination reveals key regulatory loopholes that undermine the feasibility and attractiveness of SPACs in the Indian context.
Companies Act 2013 : Timing and business objectives
The Companies Act 2013 (Companies Act) presents a major hurdle for SPACs, primarily through Section 248. This provision authorizes the Registrar of Companies to remove a company’s name from the register if it does not start a business within one year of its incorporation. This regulation is particularly problematic for SPACs, which typically operate with the sole objective of acquiring or merging with a target company within an 18-24 month window. This timeframe is crucial for SPAC sponsors to identify and negotiate with potential acquisition targets. The one-year limitation, therefore, creates a significant conflict, as it effectively jeopardizes the viability of SPACs under the current legal framework.
Additionally, the requirement for a Memorandum of Association (MoA) under Indian company laws compounds this issue. The MoA must specify the business objectives of the company. However, SPACs, by their nature, do not have a predefined business objective because their primary purpose is to seek out and acquire a suitable target. This requirement clashes with the SPAC model, as it is challenging to define a business objective when the SPAC’s core activity is contingent upon identifying and acquiring a target company.
SEBI regulations: Stringent listing requirements
The Securities and Exchange Board of India (SEBI) imposes rigorous listing requirements under the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018. These requirements include maintaining a net tangible asset value of INR 3 crores over the past 3 years, a minimum average consolidated pre-tax operating profit of INR 15 crores, and a net worth of at least INR 1 crore in each of the last three years. These criteria are intended for companies with established operations and financial stability.
SPACs, on the other hand, are essentially shell companies with no commercial operations until a target is acquired. They do not meet these asset and profitability criteria, as their entire purpose is to raise capital and use it to fund acquisitions. This regulatory mismatch highlights a critical gap in SEBI's framework, as it fails to accommodate the unique structure and operational timeline of SPACs, effectively barring them from listing on Indian exchanges.
Cross-border mergers: Regulatory and compliance challenges
Cross-border mergers, often considered a workaround for SPACs to list through foreign exchanges, introduce additional regulatory complexities. Section 234 of the Companies Act requires mandatory approval from the Reserve Bank of India for cross-border mergers. Furthermore, Sections 230 and 232 mandate approval from the National Company Law Tribunal (NCLT). These processes can be cumbersome and time-consuming, deterring potential SPAC transactions.
The Foreign Exchange Management (Cross Border Mergers) Regulations 2018 further complicate matters by imposing restrictions on foreign investments and requiring compliance with specific conditions for Indian entities involved in cross-border mergers. These regulations mandate that any Indian operations of the merged entity must adhere to the local regulatory framework, including repayment of debts as per the scheme approved by NCLT. The Liberalized Remittance Scheme’s cap of USD 250,000 per financial year, limiting foreign investments by Indian residents, adds another layer of complexity, making cross-border SPAC transactions even more challenging.
Stamp duty: Financial burden on reverse mergers
Stamp duty requirements pose another significant barrier for SPACs in India. SPAC transactions often involve reverse mergers, which attract heavy stamp duties. This financial burden undermines one of the primary advantages of SPACs—cost-effectiveness. The process of obtaining tribunal approval for mergers, coupled with substantial stamp duties, creates a complex and costly compliance environment. This discourages the use of SPACs as a viable method for companies seeking to go public in India.
Tax implications: Uncertainty and burden
The current tax framework presents further challenges for SPACs. While SPAC IPOs may not immediately incur tax liabilities due to their operational status, the tax implications of de-SPAC transactions are more complex. The Indian Income Tax Act 1961, does not explicitly provide tax neutrality for the transfer of shares in SPAC transactions, leading to potential capital gains tax liabilities. This creates uncertainty for both shareholders and SPAC sponsors. Additionally, if an Indian target company involved in a de-SPAC transaction experiences a significant change in shareholder voting rights, it could lose its ability to carry forward unabsorbed tax losses, further complicating the tax landscape for SPACs.
Risks Associated with Investing in SPACs
Investing in SPACs carries notable risks. One primary concern is the lack of industry-specific knowledge among SPAC sponsors, which can negatively impact both the target company and its shareholders. SPACs, essentially empty shells relying solely on raised funds, are susceptible to market fluctuations and future uncertainties, posing higher risks, especially for retail investors. Additionally, SPACs often provide limited information about potential targets, leading to greater investment uncertainty. Conflicts of interest among sponsors and directors can further complicate matters if not properly disclosed. In India, the regulatory framework presents additional hurdles, as SEBI regulations and the Companies Act do not accommodate the SPAC model effectively, complicating offshore transactions and de-SPAC processes. The pressure to meet acquisition deadlines may result in selecting suboptimal targets or overpaying, exacerbated by a less stringent due diligence process compared to traditional IPOs.
Conclusion and Way Forward
In conclusion, while SPACs present a novel and promising alternative to traditional IPOs, they also come with their unique set of challenges and risks. India’s vibrant start-up ecosystem has immense potential that could be further unlocked through a conducive SPAC regulatory framework. To harness this potential, India must draw insights from successful SPAC models in markets like the US and UK, which have effectively facilitated substantial capital inflows. Establishing robust guidelines for due diligence, auditing, and financial reporting will be crucial to ensure transparency and investor protection.
For SPACs to gain traction in India, regulatory reforms are essential. This includes addressing the limitations imposed by current regulations, such as those in the Companies Act and SEBI guidelines. By incorporating practices that prioritize the needs of retail investors and fostering an environment conducive to both domestic and international SPACs, India can enhance its global financial standing. A well-regulated SPAC framework not only offers a cost-effective pathway for start-ups to access public markets but also strengthens the overall economic landscape.
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