How SPAC Organizers Can Manage Liability Exposures
Through September 2020, there have been over 100 Special Purpose Acquisition Company (SPAC) offerings year-to-date, for a combined capital raise of over $40 billion and an average offering size approaching $400 million1. This represents a nearly doubling of both nominal offerings and average offering size, and a tripling of capital raised year over year. There are several reasons for this significant growth and several considerations for SPAC organizers with respect to management liability exposures and the necessary solutions to address those exposures.
SPAC's Growth Drivers
Several factors have contributed to the increase in SPAC activity in 2020, among them:
Seeking an alternative to the traditional Initial Public Offering (“IPO”): Many investors believe the current IPO process to be inefficient, both in time invested, as well as, valuation realized by the listing companies at the time of offering. For years, SPACs were viewed as an alternative path to a public listing, and more recently direct listings have as well. The current SPAC growth rates may well be an indirect result of investors’ search for a more efficient public listing process.
Variation to alternative to traditional Mergers & Acquisition (“M&A”): SPACs can offer committed capital, experienced management teams, and a quick path to acquisition. These advantages allow SPACs to out-maneuver many competitors that are bidding on similar acquisition targets.
More attractive deal terms: Success often begets success, and as SPACs have raised more capital, the terms offered to investors have become more competitive. More attractive terms for investors entices more capital, and the virtuous cycle has repeated itself this year.
Successful headlines: Recent successes for high-profile SPACs, such as Virgin Galactic and Draft King’s merger with a SPAC, have raised awareness and made SPACs more of a mainstream option.
Potential Liability for Directors and Officers
Sponsors and management at SPACs must be mindful that many of the liabilities inherent to public companies also are applicable to SPACs. For example, Securities and Exchange Commission enforcement actions have occurred against SPACs. Allegations have included conflicts of interest, reporting and record-keeping violations, and fraudulent interstate transactions. Rule 144 violations are another potential source of exposure for SPACs, particularly given the growing size of SPAC targets and the possible need for SPACs to raise additional capital to complete their target acquisition.
Finally, SPACs can be subject to traditional securities class actions, with allegations including omissions/misstatements related to acquisition targets in the joint proxy/prospectus, traditional fraudulent accounting allegations such as revenue recognition, and valuation analyses in the acquisition process.
In sum, while SPACs as an asset class have been much lower risk than traditional publicly-traded companies, there is always some level of risk when companies are raising capital from third parties or subject to the Securities and Exchange Commission regulatory framework.
Three D&O Considerations for SPACs
Like any company accessing the public equity markets, SPACs are advised to purchase a carefully considered Directors’ & Officers’ (“D&O”) Liability program. The reasons for this arise out of the exposures inherent in SPACs, as well as the complexity and unique needs of SPACs given their organization and expected transaction activity. Some key considerations for SPACs with respect to D&O program architecture include:
1. Insurer Selection
Not all insurers have an appetite for the unique needs of SPACs, and therefore it is a smaller universe of insurers and underwriters that are viable candidates to write SPAC D&O coverage. Considerations include, for example: SPACs typically require a multi-year policy (to align with the expected lifespan), experience, and comfort with the target sector (for example, Life Science-focused SPACs entail much different exposures vs. Manufacturing-focused SPACs), and general willingness to consider creative approaches and solutions. Additionally, many SPACs are domiciled outside of the United States, and these foreign-domiciled SPACs often require placement in a market outside of the U.S. in order to comply with tax, regulatory, and insurance laws.
2. Certainty of Coverage
Inherent to SPACs is an amount of uncertainty with respect to, among other things, the target’s size, profile, and industry. With that uncertainty comes the need for SPAC D&O insurers to offer a significant amount of flexibility and creativity in order to meet insured and broker requirements with respect to coverage solutions. Some of these considerations include pre-agreed run-off rates in the event of a transaction, pre-agreed run-off rates in the event of a failed search process, and options to waive the “change in control” provision in certain scenarios. While some insurers may provide what is seemingly the lowest up-front cost with respect to SPAC D&O, in some cases insureds get what they pay for, and the inability to find creative solutions can be very costly in the long run.
3. Comprehensive Assessment and Comparative Analytics
While up-front premium costs are the most easily-quantified cost with respect to SPAC placements, the total cost of risk for SPACs must be measured through the life cycle and contemplate run-off, timing and other related premium outlays. Further, limits adequacy is a key question that Aon’s proprietary SPAC benchmarking can help to validate purchasing decisions. Finally, assessment of the S-1 and advice with respect to markets, program design, and process are inherent to Aon’s team given our breadth of experience in the sector.