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Inside the SPAC Frenzy

It seems like every time you turn around there is another SPAC announcement making headline news. A SPAC – “special purpose acquisition company” – is a shell corporation listed on a stock exchange with the intent of buying a private business and taking it public. It’s a way of doing an initial public offering (IPO) without all the time, expense, and regulatory oversight traditional acquisitions require.

Everyone from Jay Z to Shaquille O’Neal, Serena Williams to former Speaker of the House Paul Ryan and family offices has jumped on the SPAC bandwagon in addition to the traditional investment banking industry. In fact, in 2020, a record 248 SPACs were listed compared to 209 traditional IPOs. And, in the first six weeks of 2021, SPACs had already raised $42.7 billion, according to the Financial Times.

How Do SPACs Work?

Also known as “blank-check companies,” SPACs have been around since the 1990s. A SPAC gets listed on an exchange such as the New York Stock Exchange (NYSE) and typically has up to 24 months to acquire a target company. Since a SPAC doesn’t make anything or own any assets, the founders are its main draw. Investors may bank on founders having the right connections to close a deal with a hot tech startup, for example, and bring it to market.

Once the SPAC raises capital (typically at $10 per share) the funds go into an interest-bearing trust account until its founders or management team find a private company looking to go public through an acquisition. Once an acquisition is completed, the SPAC’s investors can either swap their shares for shares of the merged company or redeem their SPAC shares to get back their original investment, plus the interest accrued while that money was in trust. The SPAC sponsors typically get about a 20% stake in the final, merged company.

If a deal isn’t made by the two-year mark, the SPAC must dissolve and return the gross proceeds to shareholders.

Why Are SPACs So Popular Now?

For one, a SPAC doesn’t require the regulatory hoops traditional IPOs have to go through to get listed on an exchange. Traditional IPOs can be costly and time-intensive, taking up to two to three years to close. A SPAC can be completed in as little as two to three months.

SPACs require fewer disclosures, with deal points limited to its founder(s) and chief executive of the target company. There is therefore no need for investor roadshows, perhaps, in part, explaining the SPAC boom in 2020 when the pandemic basically shut down travel and stymied in-person meetings.

What the SEC Is Saying About SPACs

Over the past six months, shareholder advocates as well as business journalists and legal and banking practitioners have sounded alarms over the SPAC surge. Concerns include risks from fees, conflicts, and sponsor compensation, from celebrity sponsorship and the potential for retail participation drawn by baseless hype, and the sheer amount of capital pouring into the SPACs.

The Securities and Exchange Commission (SEC) as a result is eyeing potentially misleading earnings projections made by SPAC sponsors and is seeking clearer disclosures. The SEC, in fact, over the last couple of months, has issued several public statements highlighting concerns and issues related to SPACs and private operating companies that are going public through business combinations (known as “de-SPACs”) with SPACs.

D&O Liability Insurance for SPACs

The SPAC boom has overwhelmed the Directors & Officers (D&O) Liability market, with carriers that write coverage for SPACs flooded by listings this year. The premiums for SPACs and de-SPACs are high and should be budgeted and planned for early on. D&O coverage is needed to cover the SPAC between the time of the IPO and the merger. A Representations and Warranties Insurance (RWI) policy is recommended to protect the SPAC and the de-SPAC entity from breaches of representation in the merger agreement and from fraud. Tail coverage added to the original IPO D&O policy should also be considered to protect the SPAC team for six years after the IPO policy terminates. A D&O policy will then be required for the post-merger entity. And, finally, the SPAC’s insurance needs revolve around the coverage of the target company’s directors and officers. One can opt to obtain tail coverage on the target’s private company D&O policy. An insurance broker who specializes in providing D&O insurance to SPACs is the smart route to take to properly structure each policy.

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