While the concept of a special-purpose acquisition company (SPAC) has been around since the early 2000s, recent governance changes, particularly in the United States (1), alongside several high-profile SPAC formations, has thrust SPACs into mainstream M&A practice. Utilising warranty & indemnity insurance in connection with the acquisition of a SPAC can provide SPAC investors with benefits that secure the investment value by replicating market terms for private company acquisitions. Currently the use of SPACs in Australia is under consideration by the ASX.
What is a SPAC?
A SPAC is a public investment vehicle created by a group of investors (or sponsors*) with the intent to merge with a private company in order to bring the entire entity public. One of the key advantages of SPAC IPOs is that companies can go public at a much faster rate than a traditional IPO. They are also referred to as “blank cheque companies” as funds can be raised up to 2 years in advance of sponsors identifying a target company to acquire.
SPACs in the Media
SPACs have been gaining popularity, raising over US$83 billion (AU$113 billion) with 248 IPOs last year, and setting a new record of nearly US$88 billion (AU$120 billion) with 298 SPAC IPOs in Q1 of 2021 alone (2). They have also gained traction in the US most notably for the enhanced return profiles that are created for the sponsors of the SPAC. The SPAC sponsor typically receives 20% of the total equity in the combined entity for an initial 3- 4% investment (3). In addition, a number of high-profile transactions were completed via SPAC IPOs in 2020, including, DraftKings, Nikola and Virgin Galactic in the US.
In Australia, more start-ups are being targeted by US SPACs. Recently the AFR reported that former Rich Lister and tech entrepreneur, Patrick Grove, was seeking an Australian or Asian tech company to buy and take public on the New York Stock Exchange, after an initial public offering set to raise more than US$300 million (AU$410 million) for a SPAC.
Deal Dynamics Creating Potential Exposures
Due to the unique nature of SPAC transactions, investors typically have limited or no recourse against the selling shareholder(s) for breaches of warranties and indemnities. This structure has become commonplace for several reasons, particularly since most selling shareholders maintain an active role and ownership in the target company post-closing through the purchase of equity in the target and may not have sufficient liquidity to backstop a robust indemnity obligation.
Even more compelling, most investors want to avoid the situation where their interests are in conflict with the interests of their management partners in the event that an indemnification claim arises. As a result, these dynamics leave investors exposed to the myriad of potential losses private company acquirers often face due to potential breaches of sellers’/management’s warranties & indemnities (whether innocent or malicious), including inaccuracies in the target’s financial statements, adverse tax or other regulatory proceedings, loss of material customers/relationships, cyber breaches, inadequate infrastructure, or insufficient disaster recovery plans (which is particularly relevant in the current COVID-19 environment).
Use of W&I Insurance on SPAC Transactions
Dealmakers typically navigate this equivalent potential conflict in private company transactions through the use of warranty & indemnity insurance. Such insurance affords an investor the benefit of a broad set of warranties and indemnities in the purchase agreement, which is backstopped by a separate insurance policy. In most SPAC transactions, where the publicly-listed SPAC moves to acquire a target company, the sale agreement will provide that the representations and warranties being made by the target company lapse at completion and so there is no recourse for the SPAC sponsors or investors when it comes to a target company’s warranty breaches.
At Aon we work with a select number of insurers to facilitate the development and availability of policies that address the unique risk transfer needs of parties to a SPAC transaction.
Essentially, in a SPAC placement a warranty & indemnity insurance policy is tethered to the warranties and indemnities negotiated between the SPAC and the seller(s). The policy reimburses the SPAC for any losses resulting from any breaches of any warranties & indemnities in the sale agreement which were not known by the SPAC at the time of the initial business combination, with the sellers’ warranties still lapsing at completion.
Accordingly, the dynamic from the seller’s perspective does not change, while the buyer receives the protection it expects in a non-SPAC deal (and avoids any potential partner conflicts). We structure a warranty & indemnity insurance policy at the de-SPAC** entity level (and such entity is the Named Insured under the policy) so that the de-SPAC entity is entitled to receive all reimbursements under the policy directly. In the US, the pricing of de-SPAC transactions are similar to private-operational style policies and de-SPAC companies can pay for such insurance as a transaction expense as part of completion, so all parties share in costs. There are also no current de-SPAC specific exclusions (4).