Reading the Risks for Biotech SPAC IPOs
Published February 3, 2021
Despite the disruptions, in both everyday life and the financial markets, caused by the COVID-19 pandemic that began in early 2020, IPO activity has remained strong. During the early stages of the pandemic, we witnessed a halt to public deal flow, However, over the past several months, we have seen the market come back strong. For companies looking to go public, especially in the biotech and life sciences space, that has meant considering alternatives to the traditional path, specifically through a deSPAC transaction. A deSPAC transaction is where a company is acquired by a SPAC (Special Purpose Acquisition Company) and the combined company then trades on an exchange under the SPAC’s listing.
While there are several advantages to the deSPAC approach for life sciences companies, including locking in a valuation earlier in the process, an expedited timeline and avoiding day-of-offer market volatility, there also are some important legal considerations that companies should examine as they consider going public via a SPAC. These considerations should be weighed appropriately, and the company should look to insure they have the proper level of risk mitigation in place.
In a recent online discussion, two legal experts in the field examined some of these issues in detail. Moderated by Newfront’s Dereick Wood, SVP, National Claims Services and Client Engagement, attendees heard from Koji Fukumura, Partner and Chair, Securities Litigation Practice Group, Cooley LLP and Kristin VanderPas, a Partner in Cooley LLP.
One consideration for companies going public through a deSPAC process is the risk of pre-close merger litigation, filed in federal courts under Section 14(a) of the Exchange Act, arising out of alleged insufficient and/or misleading disclosures in the merger-related proxy statement. In most of these suits, the company will provide the additional disclosures thereby rendering the allegations “moot.” Then, Plaintiffs’ counsel will voluntarily dismiss the matter but look to be awarded a ‘mootness fee’ for the benefit they have obtained for the shareholders.
These mootness fee dismissals are a lower cost, less expensive version of the disclosure-only settlements we saw in Delaware Chancery Court before the Trulia ruling. A group of plaintiff attorneys have created an industry of sorts by sending demand letters to companies undergoing a merger, citing a lack of disclosures and processes. The intent is not to move forward with the suit, but rather to induce the company to make non-material changes, withdraw the suit and seek a fee.” Individual cases are not usually expensive”, Fukumara noted, but with the current valuations of most biotechs, “we’re seeing a lot of activity” in these type pre-close suits. SPACs are subject to these types of suits as their only purpose is to find a target company to acquire.
If the lawsuit survives post-close of the merger, companies are at greater risk for higher severity claims under Section 14(a). These cases have been slower to gain prevalence but, given the significant increase in SPAC IPOs and deSPAC transactions in 2020, we would anticipate a significant uptick in the number of Section 14(a) suits filed. Companies need to anticipate this environment when considering the D&O limits they are purchasing, especially if they are considering a deSPAC transaction or any merger. This litigation landscape, layered on top of the risks that biotech and life science companies face given the risk of a setback in a clinical trial or increased oversight by the FDA, lays the groundwork for an ever-increasing risk scenario; Fukumura expects 2021 will see “an uptick…and if the market goes down, there will be a lot of [lawsuit] activity.”
Books & Records Demands
Finally, another potentially expensive risk for Delaware incorporated companies relates to Delaware General Corporation Law’s Section 220. This provision allows shareholders to make a books and record demand, which can include everything from board minutes to bankers’ books and even email correspondence related to a SPAC transaction. Producing these documents can be costly, especially if email records are involved. Responding to these demands properly and efficiently requires sound legal counsel, and companies should be prepared from the beginning to deal with these potential requests. Further, Companies should be forewarned that many plaintiffs’ firms are using these Section 220 demands, as a means of discovery, to build stronger subsequent claims against companies by bolstering narratives in future complaints.
Changing Rules on Diversity
Companies going public – through a deSPAC transaction or by other means – also need to be mindful of the changing laws and regulations concerning environmental and social governance, especially the diversity of their boards, VanderPas notes. She called the issue “the biggest one our companies are worried about.”
In California, a series of laws passed in recent years, require companies incorporated there to have a minimum number of women on their boards, and beginning next year, a minimum number of members from “underrepresented” communities. The demand for qualified board members who meet those requirements has shot up, making it difficult to identify potential candidates and even more difficult to recruit them. And while some California companies are pondering incorporating in other states as a result, she cautioned against doing so – NASDAQ is in the process of enacting similar rules for companies on its exchange, and the NYSE is likely to follow suit.
These and other risks call for a careful review of a company’s registration or charter, as well as its D&O insurance coverage and other policies that potentially will cover a SPAC as it prepares to merge with a private firm. In many cases, Fukumura noted, policy limits these companies carry are too low compared to the potential risk. Given the changing landscape, companies who have historically purchased lower limits, will find themselves under insured and will be paying for these increasing lawsuits out of their own pockets.