Such is the growing appeal of special purpose acquisition companies (SPACs), that the Securities Exchange Commission took the unusual step in March of warning that it is “never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment”.
In the United States, 274 SPACs were launched in 2020, and so far in 2021 $47.2 bn has been raised, according to the Financial Times. Despite the SEC’s concern with celebrity endorsements, the typical profile of sponsors to date has been investment banks or successful professional investors and executives. This trend is clearly on a rapid upward trajectory and, as with other areas of the mergers and acquisitions market, the use of representations and warranties (R&W) insurance can offer real benefits to both buyers and sellers.
Managing the risks
The use of R&W insurance has become a standard feature for deals in the PE space in the last several years and a valued tool to facilitate deals, with a myriad of benefits for both sides of the transaction. Participants in SPAC transactions will also want to consider the product once a target has been identified and work is underway to complete the de-SPAC merger.
The risks to be insured on a SPAC transaction are not radically different from a PE deal – for the buyers the exposures are largely the same. However, there is one issue that the insurance market is concerned may drive risky behaviors: deals are being done against the clock.
One of the key attributes of SPACs is that deals must be completed within a two-year time frame, which imposes considerable pressure on the founders to find the target and close the merger. This aggressive timeline means that some parties may be tempted to cut corners in the due diligence process, and SPAC sponsors will be aware that discovering bad news that might derail the deal. This time pressure can also mean that SPAC sponsors may make concessions during the negotiation of the purchase agreement, because they have an incentive to close the business combination and don’t have a fiduciary duty to the investors. In most cases, sponsors are able to sell their shares soon after the deal is done, so they are less interested than other investors in the target’s long-term performance. This last issue can, and in some cases has, been resolved by making sponsors hold shares in the SPAC longer so that their interests are more aligned with other investors. The more interest the sponsor has post-deal, the deeper they may dig to understand the target, and the more invested they may be in the due diligence process.
How R&W can make it happen
The global team of underwriters at Liberty GTS is experienced in executing deals under tight time constraints, which can give SPAC acquirers certainty that they will have insurance in place when they sign a deal. Further, with our depth and breadth of experience across sectors, Liberty’s deep bench of underwriters can highlight any soft spots in the diligence that need to be addressed to ensure meaningful coverage.
There is also competitive pressure for targets and having R&W insurance can be an advantage in an auction process, helping the investors to secure an attractive target. For the target company it removes the requirement to have an escrow and the sellers can realize the entire proceeds of the deal on closing. For a purchase in hundreds of millions of dollars, the ability to liberate a 10% escrow with an insurance policy is very attractive.
While the risk profile for a SPAC target is not critically different from that of any other business requiring R&W insurance, the somewhat abbreviated timelines involved on SPAC deals and their shorter track record makes it harder to predict outcomes. However, with the level of activity we are seeing, it is clear that SPACs are set for more than five minutes of fame.