The D&O risks of SPACs

The D&O risks of SPACs | Insurance Business

The D&O risks of SPACs

Although special purpose acquisition companies (SPACs) first entered the market in 1993, they really exploded on the scene in 2020. This revolution is due to the combination of recent market volatility, abundant investment funds and experienced investors with a stout appetite for risk. A growing list of companies has embraced this alternative route to going public – in 2020, roughly 200 SPACs raised close to $70 billion in total funding.

But what does it all mean? Now that SPACs are propelling into the mainstream market, it’s worth examining the differences between them and traditional initial public offerings (IPOs).

An IPO has long been the traditional route for a private company to offer its shares in a new stock issuance. On Wall Street, IPO has been a buzzword for decades, with the dot-com boom propelling shares in several industries. However, the IPO process isn’t effortless to navigate.

Companies must comply with the US Securities and Exchange Commission’s requirements to go public via an IPO and are subject to oversight and strict disclosure after the IPO. Although the results are often advantageous, including substantial profit margins, the IPO process is notoriously costly, complicated and time-consuming. Companies must hire investment bankers, lawyers, consultants, financial advisors and accountants, among others. As a result, IPO preparation alone can take a year or more.

Conversely, SPACs enjoy a much less stringent process. SPACs are shell companies, also known as ‘blank check companies,’ that intentionally raise capital through an IPO for the sole purpose of acquiring another company. Don Butler, managing director at Thomvest Ventures, summed up the contrast between IPOs and SPACs best when he said, “An IPO is basically a company looking for money, while a SPAC is money looking for a company.”

“Naturally, directors and officers of SPACs and soon-to-be-public companies face mass amounts of scrutiny from the open market”

However, it’s not effortless to bypass a traditional IPO and opt for the SPAC route. While SPACs aren’t required to withstand the same exhausting rules and regulations during the IPO process as conventional companies, they must weather other formalities. For example, SPACs usually have between 18 and 24 months to acquire a target company or face expiration. Plus, SPACs risk their shareholders rejecting a target company’s acquisition. Unfortunately, this guideline sometimes equates to settling for a workable deal rather than the best possible deal.

Additionally, amid a highly competitive environment, SPACs are poised to outperform their 2020 benchmark, raising $26 billion in January. With new SPAC structures surfacing regularly, the SEC is continually adjusting its rules and regulations for them. This boom means new threats and abundant liability risks for SPACs, making a reliable risk management framework crucial for success.

Typically, seasoned executives or elite former CEOs pilot SPACs – one of their unique intricacies. Naturally, directors and officers of SPACs and soon-to-be-public companies face mass amounts of scrutiny from the open market. Securities class action lawsuits have been hitting a record high, and settlements are also astronomical. What’s more, even when facing a hardening D&O insurance market, very few insurance carriers will cover SPACs.

A SPAC’s timeline and organic life cycle cause many challenges. Acquisitions can muddy up coverage details quickly, causing policies to expire or lapse. Tail coverage is critical for SPACs – even more so than traditional companies – to ensure an extended reporting period (ERP) of up to six years.

Directors and officers of SPACs and conventional companies put their personal assets at stake during an IPO. Shareholders, investors and competitors can sue, accusing leaders of wrongful acts in managing the business. With seasoned executives leading the charge, proper coverage is critical as they navigate an ever-changing regulatory environment and heightened headline risk.

With the powerful rise of SPACs, we’re all adjusting to new trends, exposures and challenges. Although traditional IPOs are far from obsolete, SPACs could be around for a while longer. We’ll likely experience plenty of ups and downs as the insurance industry responds to the fresh faces.

Wil Hamory is vice president of sales at Founder Shield, which specializes in creating tailored insurance solutions for innovative clients, with a focus on emerging and difficult-to-place risks.