SPACs are Dead! Long Live SPACs!

On April 12, 2021, the Securities and Exchange Commission (“SEC”) issued a Public Statement on accounting and reporting considerations for warrants issued by special purpose acquisition companies, or SPACs. In the public statement, the staff of the SEC expressed their view that the warrants typically issued in connection with a SPAC’s initial public offering should be treated as a liability, rather than equity as has been the long-standing practice. Because the statement was framed as an interpretation of existing Generally Accepted Accounting Principles (“GAAP”), it impacted both SPACs that had not yet finalized their IPOs, and also all SPACs that had issued warrants with the warrant structure outlined in the Public Statement (which was virtually every SPAC). The result was that from mid-April until mid-June SPAC IPOs came to a grinding halt. By mid-June, however, a number of solutions to address the concerns raised by the Public Statement had been developed and SPAC IPOs returned to the market.

Equity Versus Liability Accounting
While the technical aspects of the liability accounting issue are complex, a brief overview of the accounting issue is sufficient to understand the issues raised by the Public Statement. The Public Statement explains that pursuant to GAAP, an “equity-linked financial instrument…must be considered indexed to an entity’s own stock” to be classified as equity on the entity’s financial statements. In the Public Statement, the staff of the SEC identified two classes of provisions typical to SPAC warrant agreements that preclude equity treatment for the warrants: (i) provisions that allow for changes to settlement amounts because these provisions do not meet the “indexation” requirements under GAAP; and (ii) tender offer provisions that could require net cash settlement outside of the SPACs’ control while certain holders of the underlying equity would not be entitled to the cash settlement. These terms typically are the result of the insider warrants having different terms than the public warrants.

The Issue
The economics of a SPAC structure don’t really change based on whether the warrants are treated as equity or a liability. However, there are some practical consequences of treating the warrants as a liability versus as equity, including added costs associated with valuing the liability at each quarterly reporting period, and the resulting changes to the balance sheet and income statement of the SPAC, which may skew the SPAC’s results of operations after its initial business combination. Also, if you are an existing SPAC or a company that has completed a business combination with a SPAC, you will need to do an analysis of whether this change from equity to liability will require a restatement of your prior financial statements (with all the attendant consequences).

The Emerging Solutions

            Companies with Existing Liability Warrants

Companies with existing SPAC warrants that require liability accounting are developing a number of approaches to address the issue. For SPACs that have not completed a business combination, the consensus appears to be to leave the warrants alone (and report the warrants as a liability) until it comes time to complete a business combination, at which time there will be a number of options to amend the warrant, including exchange offers, consent solicitations to amend the warrants, etc. For companies that have already completed an initial business combination with a SPAC, these same options are available, but considerations about the remaining life of the warrants and the materiality of the liability on the company’s balance sheet may result in these companies electing not to change the warrant structure. Because the changes mostly impact the rights of the insider warrants, it seems likely that these changes will be made without much objection from existing warrant holders.

For registrants that “misclassified” warrants as equity in their financial statements, the SEC suggested “evaluating the materiality of the error” and provided a path for correcting it. Registrants with a material error should restate their financial statements and file an 8-K disclosing the restatement in Item 4.02 (Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review). Registrants that have made the error in prior quarters or years should also amend their most recent Form 10-K and any Form 10-Qs filed thereafter.

SPAC Warrants Moving Forward

There are a number of paths forward for SPACs that have not yet completed their initial public offering. The simplest, and the one adopted by SPACs near the finish line when the Public Statement came out, is to simply account for the warrants as a liability. Another approach is to get rid of the warrants entirely, but this approach is typically only available to management teams with prior SPAC successes where investors are eager to sign up to see if the team can hit another home run.

Two other alternatives have come to the fore: converting the warrants to rights and stripping out the offending provisions from the warrant agreement. The conversion to rights is an interesting solution in that rather than having a 50%-200% warrant “over-hang” the company simply grants rights to acquire 10% of the SPAC shares at the time of the business combination. The implications of this new structure are many, and if this structure continues to gain acceptance, we will be discussing it more in future articles. The other straightforward approach for new SPACs is to omit the offending provisions in its warrants. Because these provisions typically only impact the insider warrants, the result is that insider warrants and public warrants will now be essentially identical.

A Point of Divergence
The Public Statement represents a point of divergence in SPAC structures. As a result, it will be interesting to see how pre-Statement SPACs adapt to the liability accounting, as well as how post-Statement SPACs develop in the face of the warrant liability accounting. What is clear is that the news of the death of SPACs was an exaggeration.

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