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Understanding SPACs

Updated: Apr 2, 2021

In this week's FinMail we crack down SPACs into simple English and we also understand why start-up companies are preferring this route over traditional IPO to go public.

The Story:

On Friday last week, US Securities and Exchange Commission (USA's SEBI) received an IPO filing request from a SPAC that is planning to raise $225 Million from the markets by listing on NASDAQ. The name of the SPAC is Think Elevation Capital Growth Opportunities and it is a joint venture between Think Investments and Elevation Capital.

An interesting thing here to note is that the SPAC has mentioned that it will focus specifically on acquiring Indian Tech Companies. Think Investments is a Silicon Valley based Investment Company invested in popular companies like Dream11, PharmEasy, NSE, and Bajaj Finance while Elevation Capital is a venture capital firm that has backed Indian Startups such as PayTM, Swiggy, Urban Company, Sharechat, etc.

No, the interesting part doesn't end here. The SPAC consists of reputed board members like Vijay Shekhar Sharma, (Founder: PayTM) Harsh Jain, (Co-Founder: Dream11) Kabir Misra (Former Managing Partner: Softbank) including Shashin Shah (Founder: Think Investments) and Ravi Adusumalli (Founder: Elevation Capital). But wait what are we talking about? What is a SPAC? We are just going to discuss the same in this FinMail. So let's not waste another moment and deep-dive right in.

Cracking SPAC:

SPACs - Special Purpose Acquisition Companies also known as Blank Cheque Companies are companies that are created with a single purpose of Acquiring Other Companies. It has no other objectives. At the time of its incorporation, it is a shell company which owns no asset or liabilities. Its only purpose is to raise money through an IPO and then acquire an already existing private company. The IPO of such companies is just as usual as regular IPOs but the only difference is that the Investor here doesn't know in which company they are putting their money.

But why would someone even do that?

For understanding the reason why an Investor trusts some shell company with their money, we need to understand the concept with an example. Let's say you are an active Investor who is eagerly looking for opportunities to invest your money in some good assets that have the potential to make money for you.

One of your friends is a Finance Enthusiast who is a Nerd in Analysis of various Companies. You are aware of his expertise and thus want to use this expertise to your benefit and for the benefit of your analyst friend as well. Duh! you are not selfish :) So you ask your friend to find a company for you which can make money for you and also sign him a cheque for a certain amount as well. If your friend isn't able to find a company within a predetermined period, he will return your money.

Now that's the same way a SPAC works. SPACs are created as shell companies with the purpose to acquire a company later on. The sponsors of these SPACs are usually reputed people in the Finance and Business arena so that the investors can trust them. Investors investing in SPACs invest in it because of the sponsor who is backing the SPAC and because of his/her reputation. The Investor has no information other than that. This is why they are often called Blank Cheque Company as the Investor doesn't know where his money will end up, and also the reason why is he even paying the money. He is just doing it because he trusts the sponsors.

How do SPACs acquire a company or what happens after a SPAC gets listed?

Usually, when a SPAC is incorporated, the sponsors have a company in mind to acquire it later on. If not a specific company, they have a particular sector in mind like FinTech, Automobile, Logistics, ESG, etc from which they will search out a company and then acquire it.

The company to be acquired is a private company before the acquisition and for acquiring the company, the funds that are received from the investors are used. If the funds collected are less, sponsors pair it up with a loan and complete the acquisition process. After the company is acquired, the shell company now has a running company and can then function as a regular company in the public markets. On the other hand, the then private company is now public without complications of listing through IPO.

Sounds interesting, right? SPACs have been gaining popularity lately while actually, it has been around for more than a decade. It was one of the most searched terms on Investopedia in 2020. This is because there are more and more SPACs being listed in the US Markets. In the last year, SPACs raised $82 Billion in the US which is an increase of 462% YoY.

Why companies are choosing SPACs over traditional IPO as a route to go public?

After understanding SPACs it might appear to you that they are a replacement to IPO and looking at the numbers it indeed feels that way. When a company lists in the market via Traditional IPO there is N number of regulations that a company needs to follow. It involves a lot of paperwork plus lots of compliance and also the cost is high. Listing via IPO also requires Underwriters that help the company get Investors and their fees are generally about 5% of the issue size which is a lot. So when all of these can be skipped when a company lists via SPACs route, it is obviously an attractive option.

So it is a good deal for the companies who takes this route of listing in the public markets. Now obviously there must be a win for the other party as well, right? So what must be the good side of the deal for the promoters/sponsors of the SPACs? The sponsors of the SPAC do not receive any fees or remuneration in the whole process but (yes there's a but) the sponsor gets 20% of the company (Boom!) and that too at a discounted price. (Boom!)

This discount is sometimes also as large as 99.98% (Boooom!). To be specific, you might be getting the shares of the newly formed company at $10 a piece while the sponsor could bargain the same for as low as 0.02 cents. It's a clear win for the sponsor.

What about the investors?

It's funny that we are even discussing it because, the way we looked at SPACs it really seems that the Investor is the one who is at maximum risk. It is not always a bad deal but the chances are high that it could be. This is because the Investor trusts the sponsors and doesn't know in which company his/her money would end up. The investor has little control over the selection of the company to be acquired in most of the cases. It is up to the Sponsors on which company to select. Also, the money can stay locked in for as long as 2 years or before if a suitable company is found out. If no company is found, the money would be returned with interest (no fixed rate). If the investor is not happy with the company that the SPAC is Acquiring there's no choice. Either go with it or either back out and get your shares (10$ each). The investor can also sell his shares in the secondary market but a study of 56 SPACs in US found that they underperform S&P500. The majority of SPACs listed in 2015-2019 are trading below the standard $10 price. Another study of 108 SPACs between 2017-2019 showed that their average return was just 2%. But what is the plus point that the investor is chasing and is ready to take up such risk for the same? Three possible reasons:-

  • Trust in the sponsors.

  • The profit potential after a suitable company is acquired by the SPAC.

  • A new option for investing money.

SPACs and Indian Startups:

Now that we have understood what SPACs mean, let us understand why Indian Startups are preferring SPACs over Traditional IPO Listing. The major reason behind this is to skip the regulatory process of IPO and decrease the time it takes to go public. As we discussed earlier that listing via IPO has lots of regulatory paperwork involved which is lesser in acquisition. Also, the time taken for this process is less as compared to IPO. Another reason is that many Indian Startups are not eligible to get listed in India via traditional IPO and thus prefer this route to raise extra capital from the markets.

Indian Startups that have raised money via SPAC include ReNew, Videocon D2H, Yatra. Startups in line to raise money via SPAC includes Flipkart and Grofers.

Why there are no SPACs listed in India?

When we looked and researched about SPACs we thought that there's no way that SEBI would ever allow this in India because of the high risk involved from the Investor's perspective. And also there aren't any as of now. But SEBI a few weeks ago has formed a group of experts that will examine the feasibility of SPACs in India. SEBI is indeed Har Investor ki Taqat. Will you ever invest in a SPAC that some Indian Investor sponsors? Tweet to us your answer @YourFinMan. Let's end this week's FinMail with a quote from Mark Cuban,

"Always look for the fool in the deal. If you don't find one, it's you."

That is it for this week's FinMail, keep learning, keep sharing. Wishing you a very Happy Holi and Dhuleti. We will see you next week!


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