Will you invest in IPO of co. with no history? | Economic Times

By Varun RekhiThe year 2020 was extraordinary for IPOs in India, with 14 public issues raising nearly Rs 27,000 crore. It’s a big amount but pales before the estimated Rs 6,15,000 crore ($82 billion) raised by SPACs in the US during that year. A SPAC or a Special Purpose Acquisition Company is created with the sole purpose of raising capital through an IPO in order to deploy the funds in the acquisition or merger with a private company.How are SPACs different from regular companies?As opposed to a traditional company, there are no operations behind a SPAC, it is a shell company designed to hold capital until the management team is ready to deploy it. As with any company, the SPAC will hire an underwriter, an auditor, furnish its financials, price the stock and raise capital on the stock exchange. Securities laws would govern some key differences like how the IPO proceeds are held in an escrow, but the main difference lies in the publicly traded SPAC merging with a private company through shareholder approval while a regular IPO company would continue to function as an operating business.What is the main benefit of taking a company public via the SPAC route?Merging with a SPAC provides more certainty around the valuation of the business as it is negotiated between the SPAC sponsors and the target owners of the company. The valuation in a traditional IPO would depend largely on market demand, which can fluctuate greatly.What happens between forming a SPAC and announcing an acquisition?Once the SPAC is created with capital from the initial sponsors, it would get ready to raise capital through a public listing ($100m, $200m, $300m etc.) on the stock exchange by following relatively similar governance, regulatory, compliance and diligence requirements as is required for any company seeking an IPO. Following the IPO, the SPAC would be in diligence phase, or in the simplest terms, looking for an acquisition target across industry verticals or geographies or a mix of both.How are these investments different or same for investors?Theoretically, one can trade them as regular equity investments, but it is important to be cognizant of the risks. Initially, after the SPAC has priced its IPO, it may not show much trading volume and stock price movement. However, the prospect of a possible merger and the credibility of the sponsors provides a set up to be bullish with relatively high risk. If the announced merger and the subsequent completion of the deal is appealing to investors, the market will respond favourably and may push the stock up by a considerable amount. Alternatively, as with any M&A, the risk of a deal falling through or for the street to not view a transaction favourably can significantly impact the stock price and wipe out a chunk of the initial investment.Is it just a US phenomenon or does the SPAC market go beyond America?SPACs have been around since the 1990s. They are present in the UK and Europe although the lion’s share of volume is currently and has been coming from the US.In India, a company can launch an IPO only if it has a three-year profitability record. What does this mean for blank cheque companies that are SPACs?Sebi will have to consider exemption provisions to allow these entities to list publicly. It’s not that we don’t have competent managers or a plethora of high-growth private companies, it’s that the three-year profitability record requirement is difficult for a “shell company” to comply with. If we consider growth companies with significant OpEx that are rapidly scaling, they could be great candidates for a SPAC, but they may not turn net income positive for a few years. At that point, do they stop growing as capital dries up or investment timelines reach the exit stage? Do they consider becoming a fuel for the VC / growth equity supply or do our banks assist with more friendlier financing terms to keep these businesses running so that they reach an inflection point in their cash flows? Reconsidering the three-year rule will definitely be a landmark event for startup founders, investors, SPAC sponsors and the retail investors alike.What are the other legal hurdles that must be removed for SPACs to enter India?Firstly, the Company’s Act requires businesses to define an “objective” and typically the SPAC has no business objective but to make an acquisition. Secondly, you consider Section 248 of the Company’s Act where the registrar can remove the name of the company from the registrar of companies if the “company has failed to commence its business within one year of its incorporation”. SPACs could theoretically take anywhere between 0 months to 24 months to make an acquisition or even longer.Additionally, Sebi has its own regulations as well and both BSE and NSE require compliance with Sebi regulations before a listing can be achieved.A lot of listing rules in India do not favour liquidity events for our private companies. A special committee needs to be formed to understand the structure of SPACs, set specific exchange requirements that pertain to India, protect shareholder interest but enhance the depth of the capital markets in the country. When SPACs listing outside of India have been targeting Indian companies, why can’t our regulations create an environment such that we essentially become the market maker?(The writer is a Capital Markets Consultant based in New York)