July 15, 2021 (MLN): The Special Purpose Acquisition Companies (SPACs) are all the rage at the moment. SPACs raised nearly $100 billion dollars last year in the United States from more than 242 public offerings, whiplashed by a frenzy of interest for investing in smaller companies.
The SPACs have although existed since the 1990s, last few years have seen a fury of investor interest.
Keeping pace with the global trends, Pakistan’s Securities and Exchange Commission (SECP) also released draft rules on SPACs earlier this year.
The regulator defines SPAC as “a company registered with the commission [SECP] under these regulations for the sole purpose of performing the function of merger or acquisition transactions.”
So, how would a SPAC work?
SPACs are a way of raising money without the hassle of disclosures which are mandatory for companies listing on the stock market. If you have ever looked at the prospectus of a company applying for an initial public offering (IPO) at the Pakistan Stock Exchange (PSX), then you’d know how companies list down their partners, dealers, trade terms, past performance, future projections and where they plan to use the funds raised from the listing, etc.
These companies present a plan on how they will increase wealth for their future shareholders before asking them for money.
SPACs don’t have to go through all this. Simply put, SPACs can be set up and listed on the PSX to raise funds for the merger/acquisition of the company within a period of two years without actually sharing any exact purpose of that investment. A handful of sponsors with a reputation for good investments can basically orchestrate an entire SPAC.
It is an easy way of raising money without the need for prolonged due diligence which is required in traditional IPOs.
Then there is the time incentive. Stock listing usually takes around 8-12 months from the decision to actual listing. SPACs, due to their inherent lean process, can reduce that time to about three months.
Once the merger/acquisition is complete, the SPAC will then list the acquired company on the exchange within a period of two years.
The SECP defines SPAC obligates as such: raising funds for the sole purpose of merger or acquisition; list the acquired entity within two years; fund can only be used for merger or acquisition of companies; deposit at least 90% of the funds raised in an escrow account; and ensure at least 30% of its shares are held by sponsors for a period of at least three years from the date of listing.
As per the guidelines, SPACs can either be listed on the PSX or be placed privately in order to raise funds with an obligation to raise at least Rs200m from the offering.
SPACs can become a great tool for small and unorganized firms to become listed. SPACs, with their sponsors, can target companies and establish best practices during the proscribed time of two years. This will not only help SPAC sponsors and investors make money from listing their acquisition but can also help the acquired company to scale.
In addition, the country’s long-ignored small and medium enterprises (SMEs) can take advantage from SPACs to get listed on the exchange and learn best practices from SPAC sponsors or investors. The government has also announced its dedicated focus on SMEs through various incentives and interventions to spur growth in the small sector. Cheap loans, collateral-free financing is some of the steps taken by the government recently. With the SPACs, the private sector investors can also participate and increase their generated returns through identifying valuable companies.
However, on the flip side, there are a lot of caveats. Given the unclear disclosure requirements, SPACs can become a very tough job to value for retail investors. Imagine a SPAC selling its shares on the market for buying a technology startup in Pakistan without necessarily sharing what the startup does, its financials, obligations, and future outlook.
Even financial analysts will have trouble valuing SPACs without adequate disclosures, let alone the retail investors.
In the US, the SEC is currently investigating SPACs for their pump and dump nature of transactions.
What’s more worrying is that sponsors who set up SPACs can charge a huge chunk of fees which essentially incentivizes them to carry out mergers/acquisitions even if the acquired company is not profitable in the long run.
The SECP will need to revisit some of the caveats and ensure mechanisms are in place to insulate retail investors before allowing SPAC listings.
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