Dear PM Modi, Don’t Let ‘Babus’ Kill SPACs... And Startup Dreams

SPACs or Special Purpose Acquisition Companies, are the new gleam in first-generation entrepreneurs’ eyes. In one shot, SPACs could get them billions of dollars, a clutch of pedigreed investors, and a quick listing on American exchanges, thereby unlocking wealth and rocketing into the next phase of growth. Sounds like a dream come true, right? Unfortunately, as has happened before with India’s first-gen founders, it could spiral into a nightmare. But let’s keep the bad stuff for later and begin with the good news.

SPACs are colourfully called ‘blank check companies’ In fact, it’s literally a pool of cash parked in a listed vehicle, say on Nasdaq or NYSE. SPACs have got no business, no operations or employees, no nothing. They prowl to acquire valuable assets via a stock swap. As soon as they come across a ‘prey’ – for example, a fast-growing newbie in the SaaS or e-commerce or renewable energy space in Israel or India - they pounce on it by issuing new stock to existing shareholders, and before you can say “S.E.C.”, the SPAC has disappeared and the acquired asset is listed!

You Sexy Thing On A Trapdoor

Today, SPACs are the sexy thing on Wall Street. In the first two months of 2021, $90 billion of SPACs have been raised, compared to $83 billion through all of 2020. Investors are excited at replicating some outstanding deals – eg, Nikola Corp, an EV start-up, gobbled up at over $3 billion; Virgin Galactic, scooped up for $800 million; DraftKings, a digital gaming company, lassoed for $2.7 billion.

Understandably, this has ignited the gleam for India’s startups, wanting to be similarly ensnared. Remember, nearly $135 billion of cash is lying in trust waiting to pounce (in a nice way, of course), and India’s unicorns must surely be prime ‘prey’.

But – unfortunately, there always is a ‘but’ in our great country – India’s regulatory trapdoors could imprison and kill so many young dreams.

The problem is an old one. India’s regulations fail to evolve with swift innovations in the architecture of global finance. On top of that, our regulators (or should I call them ‘inspectors’, given their capacity and mental make-up?) apply outdated laws extremely narrowly and with brute force. The aggrieved victim has to undertake expensive litigation to win any argument. Meanwhile, the ‘inspectorate’ gets coercive and extractive, freezing bank accounts, arresting hapless professionals, and impounding assets, even pre-emptively selling them before a legal charge has crystallised. If you don’t believe me, Google search a company called Cairn Energy.

Crashing And Burning SPACs

So, how could our regulators/inspectors crash and burn the SPAC opportunity? Let me simplify the most egregious impediments:

Under the Liberalised Remittance Scheme, resident Indians are allowed a maximum investment of $250,000 per annum in foreign assets. So, if this rule, which is meant for ordinary citizens, is applied to a first-gen founder, then her cross-border share swap will be impossible. For example, if she owns 10% of a company d at $1 billion, she is entitled to get shares worth $100 million. But if LRS is unthinkingly/brutishly applied to her, she can get only 0.25% of the wealth she has worked all her life to create. Just imagine the monstrous unfairness of this ruling!
Even if you overcome the LRS problem, you run into a Capital Gains obstacle. If the merger were happening within India, it could be tax neutral. But since it will be a cross-border event, the share swap will be treated as a sale-and-fresh-purchase contract. So, our poor founder will have to cough up almost $20 million in capital gains taxes. A simple tweak that would deem a SPAC-swap to be a domestic merger, for tax computation, could be the remedy. But when did you last see our regulatory inspectorate agree to do anything that is a simple tweak?
Finally, the ‘criminal’ action of Round Tripping. Since our disarmed founder would have ‘sold’ a local asset to ‘purchase’ a foreign share which is ‘invested back’ in an Indian business (yes, a simple cross-border share swap can be so horrendously interpreted by our lawmakers), she will be guilty of round-tripping, and under extreme conditions, could go to jail.

Enough! Several such infirmities could get invoked if existing laws, meant for domestic transactions, are narrowly, brutishly, without a proper context, applied to this new-fangled financial innovation of a cross-border SPAC-swap. Net-net, this gleam gets snuffed out.

Why Am I So Pessimistic? Look What They Did To Superior Rights Shares

Why can’t I cut some slack for Prime Minister Modi’s unalloyed commitment to Startup India, Standup India, Digital India, Atmanirbhar (self-reliant) India? Because I’ve seen this horror flick before, how the bureaucracy comes up with rules that kill the soul of every prime ministerial invocation. Allow me to rewind to recent history.

A few years back, I had described the policy pitfalls that had condemned our first-gen entrepreneurs as DACOIT-Y, that is, Digital America and China were Obliterating Indian Tech. In response to that scathing criticism, several IAS officers had reached out and promised change. In fact, our bureaucrats were chuffed when, finally and I believe in response to the charge of DACOIT-y, Superior Rights shares were “permitted”. The government believed it had put India’s first-gen founders on an even keel with their American and Chinese peers. Unfortunately, these grand-sounding “incentives” were grudging, half-hearted, squeamish, and too tiny to make a substantial difference on the ground:

While you can get 10x voting on your equity, ‘a la Mark Zuckerberg’ as a regulator gleefully explained to me, a bunch of government secretaries (!) will have to certify that you are a ‘genuinely tech-savvy’ outfit that deserves all the policy concessions.
If, God forbid, your estranged wife or brother or stepmother is wealthy, you could be barred since your net-worth could become “more than Rs 500 crore”; unfortunately, that’s how a “promoter group” is legally defined, including “spouse, siblings, and parents”.
You can only keep your SR shares while working “full time” in the company – if you quit, your shares automatically convert to ordinary shares with 1x voting rights. Likewise, if you acquire or merge with other companies or lose control.
There are several ‘coat tail’ provisions under which your SR shares will have only one vote, not the 10x that you think you have. And there is a sunset clause – five years after listing, your SR shares shall compulsorily become ordinary shares. unless other shareholders vote to extend your privilege
You can’t sell SR shares. The minute you transfer them, they become ordinary shares, ab initio. Also, it sounds cruel, but when you die, your family cannot inherit SR shares. These extra voting rights die with you…

Unfortunately, as I wrote in July, that’s how babus killed Superior Rights shares. Now, don’t let them snuff the SPAC gleam.

Raghav Bahl is Co-Founder – The Quint Group including BloombergQuint. He is the author of three books, viz ‘Superpower?: The Amazing Race Between China’s Hare and India’s Tortoise’, ‘Super Economies: America, India, China & The Future Of The World’, and ‘Super Century: What India Must Do to Rise by 2050’.