The underlying structure of a middle-market private equity, growth equity, or de-SPAC transaction has specific implications on the correct method of implementing and managing the risk management and insurance profile pre-close, at close, and post-close. It is a fundamental mistake for members of a deal team to believe all transactions will simply require an updated name to the current insurance policies. This incorrect understanding of how insurance works can lead to problems post-close in the event of a loss or claim.
Here we will review the de-SPAC transaction process.
SPAC Market Update YTD 2021
In 2020, 248 SPACs were priced at a total value of $83.4 billion. According to SPACInsider, there have already been 246 SPAC IPOs valued at $78.8 billion as of March 11, 2021. Woodruff Sawyer is a market leader in placing Management Liability programs for SPAC IPOs, having advised and worked on more than 60 placements for our SPAC clients YTD in 2021. Read more about our expertise in the SPAC IPO process.
With almost 500 SPACs currently priced and in search mode, many SPAC clients are turning to the diligence phase of their investment life cycle, commonly known as the de-SPAC or business combination phase. This phase includes identification of a Target acquisition, gaining shareholder approval, acquiring of the Target, and the combined company begins life as an operating company with publicly traded shares. Similar to our previous Insights posts on various transaction types and the insurance implications, the de-SPAC diligence process from an insurance perspective is nuanced and a critical part of the process.
De-SPAC Business Combination – Insurance Due Diligence Process
Once a Target acquisition is identified, several workstreams should commence simultaneously: (1) RWI solicitation for the transaction; (2) customary due diligence for the Target company’s insurance program; and (3) go-forward and tail Management Liability solicitation. When managed appropriately, these three work streams work in tandem with one another with a single advisory team handling all aspects of insurance.
The primary goal of the insurance due diligence process is not dissimilar to the goal of a “normal” acquisition process by a traditional private equity buyout: identify underinsured, uninsured, deficiently insured, or acceptably insured risks that the Target faces and how the management team has historically retained, mitigated, or transferred those risks via insurance solutions. Put another way, the SPAC management team and board of directors wants to understand how the Target company fundamentally manages risk and protects EBITDA as a stand-alone entity. The nuance with SPAC transactions is two-fold: (1) the SPAC management team adds another layer of complexity into an acquisition process; and (2) the result of the transaction process is not a private-equity-owned entity. The Target becomes a publicly traded entity. Similar to traditional private equity deals, members of the SPAC deal team are not usually experts on insurance. The insurance advisor engaged to perform due diligence should be considered an offshoot of the deal team and a partner in EBITDA protection for the Target acquisition both pre and post-close, as well as in risk mitigation and long-term insurance strategy.
The result of the diligence process should be a comprehensive, clear, and concise memo or formal due diligence report outlining findings that will be delivered to both the SPAC BoD as well as investors and potential RWI insurance underwriters. This report should detail historical and go-forward cost implications as well as recommendations on how to improve the current program at close or moving forward post-close.
Key Findings During SPAC Due Diligence
Between traditional middle-market private equity transactions and de-SPAC combination processes, Woodruff Sawyer’s Private Equity / M&A Practice Group has worked on hundreds of transactions. In general, our main finding across most transactions is the Target’s underlying insurance program, while adequate, is not as sophisticated as it should be for a de-SPAC transaction, and both the management team and insurance broker have not developed or implemented a comprehensive approach to risk management and insurance for the Target.
Below are several key findings that arise on almost all de-SPAC transactions:
- Target has not implemented an adequate insurance foundation: With some de-SPAC Targets, the company is pre-revenue and/or the company has not established a foundation of Property, Casualty, or Management Liability insurance.
- Adequate foundation is set, and the core exposures are acceptably covered: Typically, the Target does have a form of foundational insurance program in place covering key exposures. Oftentimes, more nuanced coverages (such as cyber liability, product recall, etc.) have been overlooked or simply not purchased due to budgetary constraints.
- No thoughtful, strategic approach to insurance and long-term risk management: While a foundation has been established, no long-term insurance strategy for EBITDA protection has been developed or implemented. It sometimes appears the Target has historically been adding coverages as it has become necessary versus having a long-term, strategic approach to implementing the insurance program and protecting EBITDA.
- No (or little) Management Liability coverage in place: If the Target has obtained Management Liability coverage, it will typically be a small, private company D&O, EPL, Fiduciary, and Crime policy. This will be problematic if not tackled sooner rather than later in the transaction process.
- Limit adequacy of various coverage lines: In most cases, the decisions behind limits for various coverages on the underlying insurance program are driven by total annual cost. For example, if the exposure for Cyber Liability is $5 million but the policy is three times what a $1 million limit costs, the insurance buyer may accept the risk and opt for the $1 million limit. As the SPAC seeks to close the transaction, limit adequacy should be evaluated and the program improved to state-of-the-art terms, conditions, and pricing.
Change in Control and Run-Off Provisions
The de-SPAC Target acquisition will likely have several policies that are claims-made versus occurrence-based. This is an important distinction to make as claims-made policies include Change in Control provisions. It is critical to understand what, if any, policies include these provisions and the insurance advisor should identify actionable next-steps on handling those provisions for each policy. In some cases, the insurers will simply waive the Change in Control provisions and nothing needs to be done at close. For those policies where the provision cannot be waived, new coverage will need to be implemented at close and a tail (or extended reporting period) policy will need to be placed on the existing policy at close. The tail policy will protect against claims that arise post-merger for incidents that occurred pre-merger. The intent of any go-forward policy is to cover claims alleging incidents or actions taking place at or post-close versus pre-close.
Managing the Management Liability Due Diligence and Transaction Process
The Management Liability (D&O) diligence process is more nuanced in a de-SPAC transaction process as opposed to other transaction structures. There are three separate policies in play at any given time during the transaction process: (1) the SPAC’s own public-company D&O policy; (2) the existing private company D&O policy in place for the pre-close Target company’s Management Liability risks; and (3) the new, go-forward D&O program covering the combined entity, a publicly-traded operating company. The insurance advisor should be simultaneously performing due diligence on the existing Target D&O policy (as this policy’s coverage will matter for the tail) as well as engaging the Target’s management team to procure options for the post-close, publicly traded operating company D&O policy.
It is critical for both the SPAC and Target management teams to understand the difference between the Target’s existing Management Liability program and the public-company D&O policy that must be implemented at close. The pricing, terms, conditions, and limit for a publicly-traded company’s D&O exposures is significantly and critically different than the pre-close, private company.
As discussed in our Guide to Insuring SPACs in 2021, it is customary for the tail policies to have a six-year term. Carriers will charge a one-time premium to be paid at the closing of the business combination for each policy. Note that the cost of the D&O tail policy for the SPAC is typically negotiated when placing the initial D&O insurance policy for the SPAC IPO. Note further there may be situations in which no tail policy will be placed on the private company’s D&O insurance program. You will, of course, discuss this with your broker.
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