What would you say if one were to tell you that in 2020 – a pandemic-hit year, one route to an IPO has managed to raise over USD 80 billion in about 237 listings in the US? Most likely, your immediate response will be to enquire about this route and how one could get in on this seemingly lucrative action.

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Such is the buzz around SPACs this year. After a noteworthy performance, especially in the US markets, last year, these “blank cheque companies”, as they are popularly called, have piqued investors’ interest across the globe. But how do SPACs work exactly?

How does a SPAC work?

SPAC stands for Special Purpose Acquisition Company. As the name suggests, it is a company specifically created with a view to acquire and list a target company. For example, let’s say company A wishes to create a SPAC, company A will now be called the Sponsor of this SPAC. A creates B, which is the SPAC, brings investors on board for B and goes ahead with a listing for B. Now, the sponsor, A, is an established player and thus, leverages its credibility, reputation, expertise and relationships to attract quality investors for B.

A, which typically owns about 20 percent of B, now has a period of 2 years to finalise a target company for B to acquire or merge within a business combination, which effectively achieves a de-SPAC and enables public listing of the target company. Suppose the investors agree on C, a young tech startup; then B proceeds to acquire C using the money raised from its IPO and any additional funding, typically through a PIPE (private investment in public equity) round. C now merges with B or is acquired by B and the combined or resultant entity trades on the stock exchanges.

Thus, SPACs can offer lucrative opportunities to investors looking to get a piece of the pie when it comes to acquiring and listing attractive smaller businesses.

India and SPACs: The Connection

India’s stringent rules on shell companies mean that no SPACs can be listed on the exchanges here. However, for Indian investors, SPACs are a window to participate in an attractive IPO on the Nasdaq; and for Indian tech startups, SPACs offer a sort of “short cut” to the big US market listing.

From an investor’s perspective, investing in SPACs also comes with certain advantages. Firstly, with a marquee investor with volumes of market know-how and experience acting as sponsor, investor confidence and sentiment remain high. The funds are placed in a trust and invested in US treasuries until the acquisition/merger, further boosting investor confidence and reassuring them of the security on their investment.

From the target company’s perspective, this route significantly cuts down the timeline for an IPO and limits the risk of being judged solely on its past performance, as is the case for traditional listings.

Usually, tech or younger startups typically seek high valuations based on projections rather than profit track record, which makes them unsuitable or unattractive candidates for an IPO on Indian stock exchanges. However, Nasdaq gives one access to a wider, more sophisticated investor base plus the ability to seek valuations based on projections because of the manner in which this process is run i.e., the SPAC sponsor finds the investors rather than target doing an extensive book-building exercise.

The recent USD 8 billion deal between India’s ReNew Power and Nasdaq listed SPAC RMG Acquisition Corporation II, for which Khaitan & Co acted as the Indian legal counsel to RMG II, is among the largest ever listings involving an Indian company in the US via this route. And if the growing buzz around SPACs is any indication, this deal may very well be followed by many more in the near future.

Recent media reports have indicated that SEBI, India’s market regulator, has asked its Primary Market Advisory Committee (PMAC) to examine the feasibility of SPACs in India and submit a report on the regulations required to successfully introduce the SPAC route here. This is a positive step and will surely bring cheer to India startups hoping to get listed.

What are the risks?

Like any investment opportunity, this too comes with some risks. While the amount of capital waiting to be invested in the hands of PE firms and other institutional investors is significant, the number of attractive and promising target companies are in limited supply across the globe. Hence, finding the right target is a major challenge and there is a risk of an acquisition/merger not happening at all.

There may be some concerns around valuations given that SPACs typically look for a target company that has a valuation of about 3 times the amount of money raised through the SPAC IPO.

Also, not every Indian target may be well-positioned to go down the SPAC route. De-SPAC transactions require offshoring or externalisation of the Indian target as a pre-condition and not all capitalisation tables would be easy to transition to an offshore model because of FEMA restrictions. Plus, the outbound merger route remains unviable, at least for now.

In a case where a target is not found in time, the sponsor loses their investment, and the SPAC has to return the investors’ money with interest.

With the number of SPACs being set up on the rise, regulators are now beginning to pay close attention to this space. Hence, tighter regulations and tweaks to certain rules so as to place greater checks and balances in the system, requirements for more disclosures and protections for investors could very well be on the cards.

The road ahead

According to some reports, SPACs have managed to raise USD 38 billion with 128 listings on US stock exchanges in just the first 40 days of 2021.

A Nasdaq report mentioned that in 2020, SPACs drove most of the growth in the US IPO market compared with the previous year. As mentioned earlier, SPACs reportedly raised close to USD 80 billion last year, surpassing the record USD 13.6 billion raised in 2019 (from 59 IPOs). The average IPO size was reported as USD 337 million.

As investors across the world look to hop onto the SPACs bandwagon, a flurry of investment activity in this space is likely over the rest of 2021 and all of FY22. We could see many Indian investors dip their toes in the US stock markets via SPAC listings and many Indian startups realising their US IPO dreams via the SPAC route.

—Haigreve Khaitan is Senior Partner at Khaitan & Co, one of India’s largest and leading full-service law firms. He has advised top global businesses and business leaders on a variety of corporate matters and worked on some of the largest M&A deals in India. The views expressed in this article are personal.