Warrants are a standard part of how SPACs raise money, and they’re often classified on balance sheets as equity. But as part of the SEC’s ongoing scrutiny of these deals – and as a follow-up to statements issued in early April – Acting Corp Fin Director John Coates and Acting Chief Accountant Paul Munter issued a Joint Statement on Monday saying that these instruments might instead need to be classified as liabilities, which means that they need to be revalued every period and cause fluctuations in net income that are complicated to explain.
That’s a big issue, especially for SPACs that have been filing financials for many reporting periods that could now be considered erroneous, and also for SPACs that are trying to go effective with registration statements.
When it comes to accounting for warrants, the statement discusses fact patterns and specific warrant terms that can impact whether the warrants can be classified as equity or as an asset or liability that requires a fair value assessment each period. Equity classification requires that the instrument (or embedded feature) be indexed to the company’s own stock (e.g., the payoff can’t depend on who the holder is). Another common situation that GAAP treats as a liability is if an event not within the company’s control could require net cash settlement. There’s a big emphasis on this being a “facts & circumstances” analysis – for each entity and each contract. Here are a couple of examples from the statement:
We recently evaluated a fact pattern relating to the terms of warrants that were issued by a SPAC. In this 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. Because the holder of the instrument is not an input into the pricing of a fixed-for-fixed option on equity shares, OCA staff concluded that, in this fact pattern, such a provision would preclude the warrants from being indexed to the entity’s stock, and thus the warrants should be classified as a liability measured at fair value, with changes in fair value each period reported in earnings.
We recently evaluated a fact pattern involving warrants issued by a SPAC. The terms of those 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. In other words, in the event of a qualifying cash tender offer (which could be outside the control of the entity), all warrant holders would be entitled to cash, while only certain of the holders of the underlying shares of common stock would be entitled to cash. OCA staff concluded that, in this fact pattern, the tender offer provision would require the warrants to be classified as a liability measured at fair value, with changes in fair value reported each period in earnings.
Even though it may be painful, if you haven’t already talked with your auditors about this, it’s probably time to give them a call. If you determine there’s a material error in previously filed financial statements — such as a reclassification of warrants from equity to a liability that also experienced a material fluctuation in value — the statement includes a reminder about information to include in an amended Form 10-K and any subsequent Form 10-Qs. It also reminds companies of their need to maintain internal controls over financial reporting and disclosure controls and procedures to determine whether those controls are adequate.
This latest statement could have the effect of slowing the deluge of SPAC transactions, as companies will need to wrangle with their accountants and others over terms of any warrants. If you have questions about technical accounting matters involving SPAC warrants, you should contact the Office of the Chief Accountant – and for questions about restating financial statements, contact Corp Fin’s Chief Accountant’s Office.
-Lynn Jokela, TheCorporateCounsel.net April 14, 2021
