How Young India’s Dreams are Being Killed By Regulatory Trapdoors

Here’s how our regulators could crash & burn the billion dollar ‘SPAC’ dreams of India’s first-gen entrepreneurs.

SPACs, that is, 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 SEC (Securities Exchange Commission of America), the SPAC has disappeared and the acquired asset is listed!

‘SPACS’: You Sexy Thing On A Trapdoor!

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

Understandably, this has ignited the gleam for India’s start-ups, wanting to be similarly ensnared. Remember, nearly USD 135 bn 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 apply outdated laws extremely narrowly and with brute force.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 a company called Cairn Energy.

Crashing & 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 (LRS), resident Indians are allowed a maximum investment of USD 250,000 per annum in foreign assets. So, if this rule, which is meant for ordinary citizens, is applied to a first-generation founder, then her cross-border share swap will be impossible. For example, if she owns 10 percent of a company valued at USD 1 bn, she is entitled to get shares worth USD 100 mn. But if LRS is unthinkingly/brutishly applied to her, she can get only 0.25 percent 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 USD 20 mn 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! There are several such infirmities that 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 (SR) Shares

Why can’t I cut some slack for Prime Minister Modi’s unalloyed commitment to Start-up India, Stand-up 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-generation entrepreneurs to DACOITY, 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 (SR) 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, ‘à 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 which 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 cr’; 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, that’s how ‘babus’ killed Superior Rights (SR) shares. Now, don’t let them snuff out the SPAC gleam.