What are Special Purpose Acquisition Companies (SPACs)?
SPACs are special purpose, non-operating companies that consist of a seasoned management team, called the sponsor, which raises capital through an IPO, then uses that capital to acquire and operate a business. It files an S-1 registration statement with the Securities and Exchange Commission to do so and then uses that capital to acquire and operate a business. The investors in a SPAC are looking to combine the skill and expertise of an experienced management team with an operating business that has the potential to grow and become a publicly traded entity, but does not have the funds or the expertise to do so on its own. Many private companies use the SPAC structure to become publicly traded entities.
The SPACs (special purpose acquisition companies) market has undergone a transformation over the last few years. SPAC IPOs make up an ever-increasing chunk of the overall US IPO market every year. SPACs have grown from a shunned fundraising vehicle to a sophisticated financing tool that now attracts billions of dollars in investment, sophisticated market players and advisers, and results in billion-dollar acquisitions.
SPACs and COVID-19
Recent COVID-19 driven market volatility and turmoil has slowed down numerous traditional IPO plans, but has proved incredibly beneficial to SPACs. SPACs have been touted as a safe asset class because they hold their IPO-raised funds in trust prior to entering into an investor-approved acquisition and allow the investors to redeem invested funds.
Getting a SPAC through an IPO and the De-SPAC
Like other sophisticated finance and acquisition vehicles, SPACs face many hurdles as they go through the IPO and the subsequent business combination. However, with some smart planning and the help of the right advisors, SPACs can take advantage of several insurance options that can help them achieve their goals while minimizing risk.
When thinking about insurance for a SPAC, it is helpful to think in terms of the SPAC’s life cycle. From an insurance perspective, there are three main phases:
Phase One: IPO
The main assets of SPACs as they go through the IPO process are their management team, the management team’s investment strategy, and the SEC’s approval of the SPAC Form S-1 registration statement.
Phase Two: SPAC Business Combination
After the IPO, SPACs have the funds to purchase or merge with another company. The SPAC’s management team must find an attractive target and complete the merger or acquisition, typically within 18 to 24 months after the IPO. When the management team approaches potential acquisition targets, which are typically private companies, M&A representations and warranties insurance (RWI) comes into play. However, the management team must also consider and plan for D&O insurance coverage of the post-business combination entity.
Phase Three: SPAC Operations
At this point the combined company is up and running—and carrying with it all the attendant risks of an operating public company. As such, the company needs to be ready for public company scrutiny, which calls not only for ongoing compliance with all necessary regulations, but for a review and usually an upgrade of the company’s overall insurance coverage. This can mean upgrading everything from the company’s property insurance to the company’s cyber liability insurance.
Woodruff Sawyer is a leading insurance broker in the SPAC market, protecting more than $18 billion in SPAC assets.
Woodruff Sawyer, a market leader for placing IPO Directors and Officers (D&O) insurance, has a dedicated SPAC IPO practice with an experienced team. We are also a nationally recognized leader when it comes to Representations and Warranties (RWI) insurance, a critical element of the SPAC M&A process.
RWI for SPAC M&A
RWI policies aren’t just for big deals anymore. The minimum limits for these policies have come down from $5 million to, in some cases, $1 million. Minimum premiums now range between $150,000 to $200,000 and fierce competition among 20+ insurers has significantly driven down the policy premiums from 4%–4.5% of the policy limit bought to 2.5%–3.0%, dipping even lower for larger deals. RWI insurance being placed for transactions with enterprise value as low as $20 million is no longer unheard of.
Insurance carriers are also more efficient in their diligence review process, which allows them to reduce the processing time of the policy to between one and two weeks. In addition, some of the policy exclusions that used to be standard a couple of years ago have been curtailed or even eliminated. The exclusion for COVID-19 related losses has been pared down substantially and can be narrowed significantly, depending on the target company’s particular situation.
The representations and warranties insurance coverage makes a lot of sense for SPAC management teams and their targets. SPAC sponsors can put forth a much more attractive offer when the offer is backed by an RWI policy, while the target entity can minimize escrow and indemnity. Because RWI is now almost a market standard in an auction process, is widely used by PE firms and is likely to be offered and used by the rest of the competition, excluding RWI from its offer effectively puts a SPAC buyer at a serious disadvantage.
For SPACs that are under extra pressure to close their acquisition transactions before their post-IPO 18- or 24-month deadline runs out spending management time and efforts on failed auction processes or extensive purchase agreement negotiations can be fatal.
Special Purpose Acquisition Companies Need D&O Coverage
Operating companies that go through an IPO process are sued frequently and for a variety of reasons. Given that SPACs are not operating companies, their IPOs see far less litigation than typical IPO companies. However, lawsuits—usually alleging material misstatements and omissions in the IPO registration statement—against a SPAC’s management team and its directors are still possible. The vulnerability brought on by public company exposure creates a need for directors and officers (D&O) liability insurance coverage for the SPAC’s management team and its existing board. Moreover, a majority of a SPAC’s board must consist of independent board members to satisfy stock exchange listing rules. Professionals who serve as independent board members typically do not accept a board appointment without a good D&O insurance already in place.
D&O Costs are Increasing
The litigation environment has gotten much worse recently as a consequence of a 2018 Supreme Court decision, Cyan v. Beaver County Employees Retirement Fund. Lawsuits are now brought in multiple jurisdictions, including federal and state courts. Plaintiff law firms have been quick to capitalize on the Supreme Court’s ruling, which in turn has driven up the cost of D&O insurance dramatically for new IPO companies compared to the cost for mature public companies.
How We Can Mitigate Your SPAC Risk
Our experts can lead you through the complexities of your exposures, with services in:
- Directors & Officers coverage for your management team before and after the IPO
- M&A Representations & Warranties Insurance for your business combination
- Risk management and claims support at all times
- Creative company and deal-specific solutions, including:
- Errors & Omissions Coverage
- Cyber Liability
- Tax Liability
- Contingent Liability
What Your D&O Insurance Broker Must Know
Given the quickly changing nature of the D&O insurance market, the peculiarities of SPAC IPO companies, and the high cost of D&O insurance for IPO companies, choosing the right insurance brokerage is a must. Working with an insurance broker who merely works with a lot of public companies will not optimize your outcome. To get the best D&O insurance coverage at the best possible price, it is critical that your D&O insurance broker has extensive and current experience working with IPO companies. In addition to having the expertise to recommend the best insurance policy placement options, it will benefit you if your broker also has extensive experience managing claims for IPO companies.
The coronavirus has halted many IPO plans but SPACs (special acquisition companies) are actually gaining speed. This edition of the D&O notebook discusses how more SPACs will likely lead to more SPAC litigation.
In the IPO market over the last couple of years, there has been a sharp rise of SPAC IPOs and the record-breaking amount of funds that they have raised. Raising money is one thing, but spending it is a whole different ballgame.