Over the past two years, special purpose acquisition companies ("SPACs") have become a popular means of taking private companies public. SPACs accounted for 247 public listings in 2020 (52% of all initial public offerings ("IPOs") for that year) and 613 in 2021 (59% of all IPOs that year).1 While the SPAC craze has cooled somewhat in recent months, SPACs are likely to account for a significant number of public listings in 2022 as well.

As one would expect, the eruption in SPAC transactions over the last two years has given rise to a corresponding uptick in SPAC-related lawsuits. These include securities class actions, shareholder derivative lawsuits, and breach of fiduciary duty actions. SPACs have also been in the crosshairs of the SEC.

This article analyzes SPAC-related litigation and regulatory risks from the perspective of the private equity firms that increasingly sponsor SPACs, as well as the insurance coverage implications associated with such risks.

Overview of SPACs

SPACs, also known as "blank check" companies, are shell companies without any operations or revenue, which serve as investment vehicles through which retail investors partner with the SPACs' "sponsors" to invest in private companies seeking to go public.2 Generally, SPAC transactions proceed as follows:

  • The sponsor takes the SPAC public on the promise that the SPAC will use the capital raised in the IPO to seek out and acquire an unspecified target.3
  • Following a SPAC's IPO, investors' capital is held in trust while the SPAC's management team searches for a suitable target to acquire. SPACs are given a limited timeframe (typically 18-24 months) to locate a target and close a deal.
  • SPACs that fail to make an acquisition within the pre-set timeframe must return the money raised in the IPO to its investors.
  • However, if a SPAC does identify a target that it believes would make for a lucrative investment and the target is amenable to being acquired on the terms proposed by the SPAC, the SPAC and the target will merge to produce a single public company, with the SPAC investors' shares being converted into shares of the post-acquisition company. The merger of the SPAC and the target is referred to as the "de-SPAC" transaction.

In exchange for their investments, retail SPAC investors are given shares in the SPAC, which are converted into shares of the go-forward entity at a set price (usually $10/share) should the SPAC succeed in making a deal. As an added incentive to invest, investors are also given warrants to purchase additional shares in the post-acquisition company. Meanwhile, the SPAC sponsor generally receives a 20 percent ownership stake in the go-forward entity if they succeed in accomplishing a deal.

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Footnotes

1. Phil Mackintosh, A Record Pace for SPACs in 2021, NASDAQ (Jan. 6, 2022 5:55 PM) https://www.nasdaq.com/articles/a-record-pace-for-spacs-in-2021.

2. SPACS are distinguishable from the shell companies that had been used to perpetrate penny stock and pump-and-dump scams in the 1980s, which were also occasionally referred to as "blank check" companies.

3. Ramey Layne & Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, HARV. LAW SCHOOL FORUM ON CORP. GOV. (July 6, 2018), https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.