Accounting for warrants and other instruments issued by SPACs
On April 12, 2021, the SEC issued a Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), which highlighted a number of important financial reporting considerations for SPACs. Most notably, the statement describes two fact patterns that are common in warrants issued in connection with a SPAC’s formation and initial registered offering. These fact patterns led the staff of the Office of the Chief Accountant (OCA) to conclude that the warrants did not meet the requirements for equity classification and as such should be classified as a liability.
In the first fact pattern, the warrants included provisions that provided for potential changes to the settlement amounts dependent upon the characteristics of the holder of the warrant. We understand these provisions generally exist in the context of private placement warrants issued to the SPAC sponsor or its affiliates and that the changes to the settlement amount are dependent upon whether the sponsor or its affiliates continue to hold the warrants. Because the holder of the instrument is not an input to the fair value of a fixed-for-fixed option on equity shares, OCA staff concluded that the warrants are precluded from being indexed to the entity’s stock under ASC 815-40-15-7F, and thus equity classification would not be appropriate.
In the second fact pattern, which may exist in the context of both private placement warrants and warrants issued in the registered offering, the warrants included a provision that, 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 OCA staff concluded (with reference to the guidance in ASC 815-40-25-7 and 25-8 and related implementation guidance in ASC 815-40-55-2 through 55-6) that, in this fact pattern also, equity classification is not appropriate given that a tender offer is outside the control of the entity and, while all warrant holders would be entitled to cash, only certain of the holders of the underlying shares of common stock would be entitled to cash.
As pointed out in the statement, the evaluation of the accounting for contracts such as warrants issued by a SPAC requires careful consideration of the specific facts and circumstances for each entity and each contract. As such, it would not be appropriate to assume all warrants require liability treatment; nor would it be appropriate to assume that these are the only features in a warrant agreement that trigger liability treatment. In the event liability classification is required, the warrants should be measured at fair value, with changes in fair value each period reported in earnings.
We believe there are a few other accounting and financial reporting considerations to keep in mind:
- The warrants commonly are issued contemporaneously with shares or other freestanding financial instruments, including in the initial public offering, whereby warrants typically are issued with shares that are redeemable if a business combination doesn’t occur by a specific date or redeemable at the election of the holder upon the occurrence of a business combination. The classification of the warrants as liabilities versus equity impacts the initial allocation of proceeds amongst the instruments, given that instruments like liability-classified warrants that are subsequently measured at fair value are allocated proceeds equal to their issuance-date fair value, with the residual proceeds allocated to other instruments, such as the redeemable shares, that are not subsequently measured at fair value. On the other hand, equity-classified warrants are allocated proceeds based on their proportionate fair value to the total fair value of instruments not subsequently measured at fair value. Thus, the initial carrying amount of the warrants and any freestanding instruments with which they were issued would be expected to change as a consequence of reallocating proceeds in the event the balance sheet classification of the warrants changes. Furthermore, the redeemable shares are subject to the temporary equity classification guidance in ASC 480-10-S99-3A, including the subsequent measurement provisions that begin at paragraph 13 and the earnings per share guidance in paragraph 21. As such, a re-allocation of proceeds will impact the adjustments that are necessary to the carrying amount of the redeemable shares, as well as earnings per share.
- Fair value should be determined in accordance with the provisions of ASC 820, Fair Value Measurement, including the general provisions for financial liabilities and equity that begin at ASC 820-10-35-16. The fair value measurement should maximize the use of relevant observable inputs while minimizing the use of unobservable inputs, with the objective of estimating the price at which an orderly transaction would take place between market participants at the measurement date under current market conditions.
- Companies may contemplate modifying the warrant agreements in order to be able to account for them as equity post-modification. It is important to keep in mind that the accounting analysis is complex and there may be other features (in addition to those described by OCA) that trigger liability treatment.
SPACs that have issued or are contemplating issuing warrant agreements should work with technical accounting advisers and legal counsel to understand the contractual provisions and carefully evaluate (or reevaluate) the accounting treatment for each warrant agreement. If a conclusion is reached that there is an error in previously filed financial statements, the materiality of the error would need to be evaluated as well as internal control ramifications and filing requirements, as further discussed in the statement. Lastly, while the emphasis of the statement was on warrant issues, financial reporting complexities extend to other areas of SPAC financial statements, including earn-out or compensation arrangements and other complex financial instruments. These and other matters are discussed in the March 31, 2021 OCA release, Financial Reporting and Auditing Considerations of Companies Merging with SPACs.
Contact information is provided in the statement for companies that wish to direct questions to the SEC. Generally, a company’s auditor and legal counsel would participate in a discussion with the SEC.