On April 12, 2021, the SEC issued a statement on the accounting for certain warrants issued by special purpose acquisition (SPAC) companies. The statement called into question the widely accepted practice of classifying these warrants as equity on the balance sheet and identified common fact patterns that would require a shift to liability classification.
Due to the large volume of SPACs and the ubiquity of their capital structure, this issue is expected to impact hundreds of organizations in all phases of the SPAC lifecycle.
Background
A SPAC typically issues warrants to investors as part of its initial public offering. These “Public Warrants” are commonly bundled with shares of Common Stock as part of a unit structure. It is also common for the SPAC to issue “Private Warrants” to its sponsor and other related parties at the same time. The exercise period of both the Public and Private Warrants is generally tied to the completion of a de-SPAC transaction, which is a merger between the publicly traded SPAC and a private operating company. In most cases the Public and Private warrants survive the de-SPAC transaction and become part of the capital structure of the combined entity.
On April 12, 2021, the Acting Director of the Division of Corporation Finance and Acting Chief Accountant of the Securities and Exchange Commission together issued a statement regarding the accounting and reporting considerations for warrants issued by SPACs, entitled “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies.”
While the specific terms of the warrants issued by each SPAC will vary, the form of the warrants tend to be similar with certain terms being nearly ubiquitous. Historically, these warrants have been classified as equity on the balance sheet. The SEC Statement identified certain terms that would require the warrants to be liability classified, which would require that the warrants be recorded at fair value and subsequently remeasured with changes in value recognized in the Statement of Operations. A switch from equity to liability classification is required; the switch would be considered a misstatement and may result in the need to restate previously issued financial statements.
5 steps to assess and address the issue
Step 1: Determine if the issue applies to your organization
The issue applies to all SPACs that have issued or are in the process of planning offerings that include warrants. Further, as the warrants survive the de-SPAC process, the issue is applicable to all operating companies that are in the process of completing a merger, or have already merged, with a SPAC. The warrants must be classified and accounted for correctly on the historical and pre-merger financial statements of the SPAC, the post-merger financial statements of the combined entity, and registration and proxy filings with the SEC.
Step 2: Perform a technical accounting assessment
Although the SEC Statement has created a presumption that many SPAC warrants should be classified as liabilities, not all warrants are the same and not all will require liability classification. Organizations should engage their accounting advisors to perform a thorough review of the specific terms of their Public and Private Warrants and document their accounting position. This assessment should be grounded in the applicable FASB literature and take into consideration the SEC Statement. Further, it should consider all terms of the warrants, not just those addressed by the SEC, and the impact that the balance sheet classification will have on the treatment of issuance costs, subsequent accounting and other reporting requirements.
Step 3: Obtain a valuation of the warrants
If it is concluded that the Public and/or Private Warrants require liability classification, the warrants must be measured at fair value at the issuance date and at each reporting period that the warrants remain outstanding. Organizations should engage a third-party valuation firm to prepare the valuations in order to ensure that a consistent, industry-tested model is applied.
Step 4: Determine the impact on previously issued financial statements and public filings
The SEC Statement provided a view on the application of preexisting rules to the warrants; it did not represent a change in authoritative guidance. As such, for organizations that have taken a position that equity classification was appropriate and issued financial statements or other public filings with that position, a switch to liability classification would be treated as a misstatement. Organizations should engage their accounting advisors to assess the materiality of any misstatement under U.S. Securities and Exchange Commission Staff Accounting Bulletin No. 99, “Materiality.” This analysis should be documented in the form of a memo, which can be shared with the organization’s external auditors.
If the misstatement is determined to be material, the financial statements will be required to be restated (“Big R restatement”). The organization would be required to issue amended 10‑K or 10‑Qs, as applicable, to correct the misstatement. The organization may also be required to file a Form 8-K under Item 4.02 stating that previously issued financial statements should not be relied upon. If the misstatement is deemed immaterial, the error may be corrected in a future 10‑K or 10‑Q (“Little R restatement”).
SPACs that are in the de-SPAC process will also need to consider the impact that a misstatement may have on S-4, proxy and other SEC filings.
Step 5: Determine the impact on internal controls
The SEC Statement also highlighted an organization’s obligation to maintain internal controls over financial reporting. Organizations should assess whether prior disclosures on the evaluation of internal controls over finance reporting need to be revised in amended filings.
How CFGI can help
Throughout the development of this issue, CFGI has remained informed and prepared through our close collaboration with auditors, clients and other stakeholders. Before the issue broke, we had a dedicated team tasked with interpreting and applying the complex literature and developing practical deliverables to allow our clients to quickly and accurately comply with the SEC Statement. We are uniquely positioned to assist with technical accounting assessments, SAB 99 memos, valuation analysis and all reporting requirements.
Reach out to Josh Verni, Accounting Advisory Partner, (585-748-3687, jverni@cfgi.com) or Sean O’Reilly, Valuation Partner, (610-348-9519, soreilly@cfgi.com) for additional information on accounting advisory and valuation services.