Are SPAC Investments Halal or Haram?

Guest Article by Mufti Faraz Adam and Rehan Ahmed

In recent months, whilst crypto-assets and in particular Bitcoin have been taking the headlines, another asset class has been making strides.

SPACs have gained tremendous momentum and popularity in 2020 with a 462% YoY increase in proceeds raised and look to continue their trajectory in 2021. This article first addresses what they are and thereafter delves into the Shariah issues regarding SPACs.

SPACs: What and Why?

“SPAC” stands for Special-Purpose Acquisition Company, which is a sophisticated way of saying “a mountain of cash raised for a merger”.

They are shell-like entities that go public in order to raise cash for acquisition of private companies. Private companies can then combine with a SPAC as an alternative route to the traditional IPO process.

One of the main reasons for the current hype around SPACs is that more companies are now turning to SPAC acquisition vs traditional IPO’s than ever before. SPAC’s accounted for more than 50% of IPO proceeds in 2020 meaning SPAC’s are the new black.

The Typical Lifecycle of a SPAC

1. Incorporation

A special purpose acquisition company is formed by a sponsor company to raise money through an Initial Public Offering in order to raise the capital required to merge with a private company. These are typically domiciled in Delaware or Cayman Islands.

2. IPO

The purpose of the IPO is to raise the funds necessary to fund the merger with a private company. The proceeds raised (and held in trust) by the SPAC IPO will equal to the number of units issued x the IPO price.

A SPAC will typically IPO at $10/Unit. Thus an IPO of 10 Million shares at $10/Unit will result in raising $100 million.

A Unit consists of: 1 common share + 1 warrant.

This also sets the $10 redemption value of all common shares. At $10/Unit, the warrant is obtained free of cost as an incentive for IPO participants.

A warrant is a bit like an option. It gives the holder the right to buy more shares of the company at a fixed price (regardless of what the market price may be at the time) until the expiry date of the warrant.

At the time of their IPOs, SPACs have no operating business and must not have a pre-determined target for acquisition. The investors in SPAC IPOs can range from hedge funds, private equity funds, VC funds to members of the general public.

SPACs usually have two years to complete an acquisition or they must return their $10/share redemption value to shareholders.

3. Post-IPO/Pre-merger

After a SPAC has raised the funds at IPO, the money is moved into a blind trust until the management team decides which company or companies it wants to merge with. Funds are typically placed in a trust account for which a separate trustee is appointed.

The raised funds cannot be disbursed except to complete an acquisition or to return the money to shareholders if the SPAC is liquidated.

Interest earned in the trust account can be used to offset some of the SPACs running costs, however at inception additional funds are set aside by the SPAC sponsor to cover the costs associated with running the SPAC.

During this phase, share prices typically hover around the IPO price of $10/share. This is because no material changes have occurred and no rumours have materialised on who the target company might be.

Typically, 52 days after IPO, the SPAC Units can be split into common shares and warrants to be traded independently.

As the SPAC moves closer to locking in a suitable merger target, it will go through a few distinct phases.

1. It will lodge a Letter of Intent (LOI) to merge with the target and begin negotiations.
2. It will raise PIPE funds to cover any additional capital required to complete the merger.
   A PIPE funding round is where institutional investors get to buy the publicly-traded shares in a company (in this case the SPAC) at a discount for a bulk-buy. 
3. A definitive agreement to merge will be lodged with the regulator.
4. The SPAC shareholders will vote to approve/reject the merger

4. Post Acquisition/post-merger

After the merger is approved by shareholders, the final step is for the stock ticker to change to reflect the new company. e.g. SPAC ticker IPOA changed to SPCE once the merger with Virgin Galactic finalised.

The common shares of the SPAC are converted to shares of the newly merged company.

Potential Shariah Review for Each Phase of the Lifecycle

1. IPO/pre-announcement Phase

A SPAC typically issues units in its IPO that consist of one share of common stock and a warrant.

Initially purchasing a unit/share

From a Shariah perspective, purchasing shares will only be permissible if:

1. The net assets are not 100% cash; or the net assets are 100% cash, but the unit is purchased at par value (e.g $10.00/share)
2. The SPAC passes the Shariah screening criteria as follows:

• Interest-bearing debts / market capitalisation (must be below 30%)
• Interest-bearing deposits/ market capitalisation (<30%)
• Haram income/total income (<5%)

The Warrant

The purchase of warrants and subsequent trading is problematic, similar to options trading.

However, from a Shariah perspective, the purchase of a Unit of a SPAC – which is composed of a share and a warrant – can be considered permissible based on the following:

1. The warrant is subordinate to the share.

The Fuqaha have mentioned the permissibility of selling land private easements such as irrigation rights, watercourse rights, drainage rights and rights of passage when such rights are subordinate to a valid asset. As such, the warrant can be considered as subordinate to the share.

Similarly, the jurists such as Imam Abu Yusuf who considered the sale of silkworms independently as impermissible, permitted the sale when sold with silk. The Fiqh principles state:

At times, it is permissible to trade something subordinately when it cannot be sold independently.

Trading the unit

It is not permissible to trade the Unit except at par if the assets are 100% cash at this stage. Hence, if a person wanted to liquidate their position, they must do so at par. If any capital gain is made in the pre-announcement stage whilst the underlying assets are 100% cash, the capital gain must be purified.

The AAOIFI Shariah Standard states:

3/17 It is not permissible to undertake trading in the shares of a corporation,  when the assets of the corporation are cash exclusively, whether this is during the period of subscription or after that, prior to the commencement of the business of the company or at the time of liquidation, except at their nominal value and with the condition of delivery of possession.

Warrant:

Typically, after 52 days of the SPAC IPO, the unit is split into common shares and warrants with each being tradeable independently.

Any unit holder who purchased a unit of common shares with warrants cannot trade the warrants independently. Such trades will be Shariah non-compliant.

2. Post IPO/Post target announcement Phase

A SPAC is essentially a shell company that doesn’t have any business operations of its own. The stated purpose of the company is to identify and merge with a private company that’s consistent with the investment objectives of the SPAC.

Some SPACs limit themselves to particular industries, while others have free rein to make acquisitions in whatever type of company they wish.

From a Shariah perspective, the moment the target company is announced, a Muslim investor should consider the business activity and screen the business activity for Shariah compliance.

The target company cannot be from the following:

• Conventional Finance (non-Islamic Banking, Finance and Insurance etc.)
• Alcohol
• Pork related products and non-halal food production, packaging and processing or any other activity related to pork and non-halal food
• Unlawful Entertainment (Casinos, Gambling, Cinema, Music, Pornography and Hotels)
• Tobacco
• Weapons, arms and defence manufacturing

This list is not exhaustive and is provided as a basic guidance to the broad principles involved.

Post-merger target announcement, there can be two potential scenarios:

1. A Shariah non-compliant company is the target company

If the target company is not Shariah compliant, then it is not permitted to purchase the shares of such a SPAC. This is based on the following principle highlighted by the AAOIFI Shariah Standards:

The issuance of shares is permissible if the objectives for which the corporation was established are permissible according to the Shari’ah, thus, the objectives of its formation should not be transactions that are prohibited, like the manufacturing of liquor, trading in swine or transactions in Riba. If the objectives of the corporation are impermissible, the formation of the corporation is impermissible too, and consequentially so is the issuance of shares that constitute such a corporation.

Further, when investing in a SPAC, you become a shareholder of the SPAC. Being a shareholder of a project, whose focus is to acquire a non-Shariah compliant company and grow that company, will be a means of proliferating Shariah non-compliant activity.

As such, the SPAC investor will directly be assisting in the acquisition and growth of a non-compliant target company. This  I’anah ‘alal Ma’siyah (assisting in sin) considering the Qasd (intention) of the SPAC.

If an investor held a SPAC unit and the target company which is announced in Shariah non-compliant, then the investor should divest and liquidate their holdings. Any gain made from the moment the non-compliant target company is announced should be purified and disposed off.

2. Shariah compliant target company

If the target company is Shariah compliant, Units or common shares may be purchased and existing warrants can be used to purchase additional stocks. However, it will not be permitted to buy more warrants independently off the open market. It will only be permissible to invest in a unit or common shares of the SPAC – and that only under the following conditions:

1. The net assets are not 100% cash; or if the net assets are 100% cash, then the unit must be bought at par value.
2. The SPAC passes the Shariah screening criteria as follows:

• Interest-bearing debts / market capitalisation (must be below 30%)
• Interest-bearing deposits/ market capitalisation (<30%)
• Haram income/total income (<5%)

The important upshot of (1) above is that realistically a SPAC’s shares cannot be bought until after the acquisition has taken place, or until the SPAC has evolved and got at least something else on its balance sheet other than pure cash.

The reason is because a SPAC will largely remain 100% cash until after an acquisition – but the price of the shares of a SPAC will vary dramatically away from the par value of the cash it holds – especially once the target is announced.

3. Post-Acquisition/post-merger

Investing post-merger will be subject to the standard Shariah screening criteria as per the usual for equity investments.

Considerations for Investors

Whilst reviewing SPACs, three things became apparent which every Muslim investor should be extra cautious of:

1. If the underlying assets are 100% cash, then the unit must be bought at par value. It will not be permissible to buy/sell a unit when the price is not equivalent to the NAV (net asset value).
2. That any funds deposited or invested into Treasuries or interest-bearing accounts is less than 30% of the Market Capitalisation.
3. If a reputable Shariah stock screening app classifies a SPAC as Sharia-compliant and that screening provider has a known Sharia board, it will be permissible to follow the screening of the screening provider.

Author blurbs

Mufti Faraz Adam – see below blurb

Rehan Ahmed, CoFounder of HalalStocks.Co