On Thursday, April 12th, the Securities and Exchange Commission (“SEC”) published Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”) and stated its views related to the accounting treatment of the private and public warrants in a SPAC.
Based on the SEC staff statement, certain features of both the public and private warrants issued in many, but not all SPAC transactions, should be accounted for as liabilities. The staff statement is having a significant impact on the SPAC industry since these warrants had historically been classified as equity by the SPACs and their auditors.
A SPAC typically issues units to third-party investors at $10.00 per unit, which includes one ordinary share and a fraction of a warrant to purchase one share at an exercise price of $11.50 (a “public warrant”). SPAC sponsors usually purchase private units at $10.00 per unit, which includes one ordinary share and a fraction of a warrant to purchase one share (a “private warrant”). Although the terms of private warrants are often substantially the same as the terms of public warrants, there are differences. SPACs should consider whether there are other features in the private warrants that require an analysis that was unnecessary for the public warrants.
U.S. Generally Accepted Accounting Principles include guidance that entities must consider in determining whether warrants that settle in an entity’s own stock should be classified as equity of the entity or as an asset or liability.
Warrants generally contain multiple provisions that adjust the settlement amount to compensate the holders of warrants for lost time value upon an early exercise or settlement. The entity must conclude that the adjustment (e.g., the increase in the number of additional Shares issuable) represents a reasonable amount of compensation to the holder for lost time value; otherwise, such provisions will preclude the warrant from being considered indexed to the SPAC’s stock. If the SPAC determines that the warrant is not considered indexed to the company’s stock, the warrant must be classified as a liability.
As discussed in the SEC statement, the SEC staff evaluated a fact pattern where the warrants issued by a SPAC included provisions that provided for potential changes to the settlement amounts depending “upon the characteristics of the holder of the warrant” (for example, settlement amounts differed for warrants held by the SPAC’s sponsor or its related parties compared to warrants held by public holders). The SEC staff concluded that since "the holder of the instrument is not an input into the pricing of a fixed-for-fixed option on equity shares," such a provision would preclude the warrants from being indexed to the entity’s stock.” Consequently, the SEC staff concluded that "the warrants should be classified as a liability.”
Tender offer provisions
The staff statement also drew attention to warrants that provided "in the event of a tender or exchange offer made to and accepted by holders of more than 50% of the outstanding shares of a single class of common stock, all holders of the warrants would be entitled to receive cash for their warrants."
The SEC staff concluded, in this fact pattern, that 1) the tender offer is an event not within the entity's control and 2) only warrant holders would be entitled to cash, not necessarily holders of the underlying shares, and thus these warrants should “be classified as a liability.”
While SPACs have typically classified warrants on their balance sheets as equity, the SEC has highlighted that certain warrants that do not meet the criteria must be classified as a liability and measured at fair value every quarter, with changes in fair value reported in earnings.
Reporting considerations to SPAC management
- Accounting for the warrants will need to be reevaluated, based upon the specific provisions in the warrant agreements, to determine whether the warrants should be accounted for as debt or equity. The warrant agreement should be analyzed in its entirety using the applicable literature.
- If the warrants should be accounted for as liabilities, the warrants will need to be fair valued at each reporting date, going back to the post-closing balance sheet included in the Form 8-K filing. The valuation should be performed by a valuation specialist.
- SPAC management should assess (1) the materiality of the error and (2) whether they are required to file a report under Item 4.02 of Form 8-K indicating that the previously filed financial statements impacted should not be relied upon and to restate those financial statements.
- When a material financial statement error is identified, registrants are generally required to amend reports previously filed under the Securities Exchange Act of 1934. The errors in accounting for warrants described above may affect several fiscal quarters and years of a registrant’s previously filed reports. The SEC statement indicates a registrant may correct material errors related to the accounting issues described above by amending its most recent Form 10-K and any subsequently filed Forms 10-Q, and including in such amended filings:
• restated financial statements and applicable footnote disclosures, including the disclosures required by ASC 250, Accounting Changes and Error Corrections;
• restated quarterly financial information in response to Regulation S-K Item 302; and
• revisions to information provided in response to Regulation S-K Item 303, Management’s Discussion and Analysis, based on the restated financial information, explaining the company’s operating results, trends and liquidity during each period presented and other pertinent information, as necessary.
- The SPAC’s internal control over financial reporting and disclosure controls and procedures will need to be reassessed.
- An audit committee meeting will need to be held.
If you have any questions about SPAC-related reporting, contact us today.