Staff Statement on Accounting and Reporting Considerations for Warrants Sunil Jain

Byhaveyoursay

These restatements may involve revisions to the financial statements and notes, as well as restated quarterly financial information (Reg S-K Item 302) and revisions to MD&A (Reg S-K Item 303). The primary issue identified in the Statement is whether these warrants should be classified as equity or liability, which depends largely on the specific terms of the warrant and the entity’s specific facts and circumstances. As for materiality itself, some businesses supported the materiality of climate-related disclosures, while others encouraged the SEC to require company-specific assessments rather than a generic approach. The NYSE no longer requires shareholder approval for issuances to Related Parties in excess of 1% of a company’s common stock if that issuance is made for cash at a price no less than the “Minimum Price” threshold.

Private Placement Warrants

SPACs have almost universally accounted for both types of warrants as equity instruments, an approach that had been allowed by the Staff, all “Big-4” audit firms and the principal SPAC-focused audit firms. If your company is issuing or evaluating warrants, Windham Brannon’s professionals are here to help. Companies should adopt a proactive and structured approach to stay ahead with compliant accounting for warrants, particularly with the following key best practices. Accurate valuation of warrants may necessitate complex financial models, such as Black-Scholes or Monte Carlo simulations. Preferred stock warrants can be particularly tricky since their embedded rights (e.g., conversion features and redemption clauses) mean they often require detailed analysis, and, in many cases, third-party valuation reports to determine their fair value. However, with the right guidance and best practices, your organization can remain compliant and audit ready when it comes to accounting for warrants.

The Impact of the Recent SEC Staff Statement on Accounting and Reporting Considerations for Warrants Issued by SPACs

Especially in the case of preferred stock warrants and warrants issued with debt financing, correct classification and valuation is not only a compliance requirement, but it is essential to maintain stakeholder trust and avoid costly restatements. Companies may run into common pitfalls, such as treating liability-classified warrants as equity, failing to update valuations when terms change or lacking adequate documentation of management assumptions. Under GAAP, “if an event that is not within the entity’s control could require net cash settlement, then the contract should be classified as an asset or a liability rather than as equity.” One exception is that the warrant may be classified as equity if net cash settlement can be triggered only in circumstances in which the holders of the shares underlying the contract also would receive cash, such as in changes of control. To be classified as equity, the warrant must be considered “indexed” to the company’s own stock, for example, by providing for settlement of the warrant with a fixed number of shares. Warrants are frequently issued in connection with the formation and initial registered offerings of SPACs, but apparently there have been some problems with accounting for some of these warrants, or at least, so it appears from this Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”) from Acting Corp Fin Director John Coates and Acting Chief Accountant Paul Munter. On April 2, 2021, the SEC approved the New York Stock Exchange’s (the “NYSE”) proposed amendments to its shareholder approval requirements applicable to issuances to directors, officers and substantial security holders (“Related Parties”), and to private placements in excess of 20% of a listed company’s common stock by number of shares or by voting power.

Now that there is clarity about the changes to SPAC warrant agreements necessary to permit equity classification, we expect that sponsors of new SPACs that intend to offer units containing warrants in their IPOs will structure the warrants so they are classified as equity instruments. As indicated above, the definition of “Common Stock” was limited to shares of the issuer’s Class A common stock. Based on our discussions with these firms, we understand there is general consensus that the changes to the standard SPAC warrant agreement discussed below will allow the warrants to be classified as equity instruments. This Client Alert explains the current state of affairs and provides practical guidance to pre- and post-IPO SPACs seeking to implement changes to permit equity classification for their warrants. The consequence of the Statement will be that all SPACs with warrants in their structure, and their existing advisors, as well as newly engaged valuation firms, will likely be busy sorting out the accounting and disclosure ramifications for months.

Accordingly, if there is a change in accounting treatment, the SPAC financial statements will need to be corrected or restated, depending on materiality assessment, and the disclosure and the pro forma information in the Form S-4 and other disclosures (such as MD&A and risk factors) will need to be updated accordingly. If the table is removed, the post-business combination company will still have the ability to make a tender/exchange offer for the warrants for cash and/or stock (as many post-business combination companies have successfully done in the past), but there is no certainty that a sufficient number of warrantholders will accept the offer. Longtime SPAC market participants will recall that, on at least two prior occasions, SPACs and post-business combination companies faced the need to reclassify their SPAC warrants from equity instruments to contingent liabilities for different reasons.2 In those cases, even for post-business combination companies, the market shrugged it off, because the liabilities and non-cash charges do not affect the company’s revenue, operating expenses, operating income, taxes, cash flows or cash and cash equivalents, or any adjusted EBITDA results the company might report. Securities and Exchange Commission (“SEC”) requiring most warrants issued by special purpose acquisition companies (“SPACs”) to be accounted for as liabilities, SPACs scrambled to determine whether they needed to revise or restate their previously issued financial statements.

SPACs Poised to Enter into a Business Combination Agreement

Note that Form S-8 and Rule 144 are predicated on the company being current in its periodic reports (versus timely) while Form S-3 requires companies also be timely in their filing requirements. Rule 144 will also not be available until the company is current in its filings (for de-SPAC combined companies, Rule 144 is not available until 12 months after the Super 8-K filing). Companies that cannot file their periodic reports within the extended time period should issue a press release providing sufficient but not extraneous disclosure regarding the situation (e.g., be cautious if providing estimate of when the restatement will be complete, in case restatement process takes longer than anticipated and thus requiring another press release). What if the SPAC or post-de-SPAC combined company cannot file the periodic report by the extended deadline? Thus the Staff Statement likely impacts most if not all SPACs, but also post-de-SPAC combined companies, as well as transactions throughout the SPAC lifecycle, including formation, SPAC IPO, de-SPAC process, and post-de-SPAC operations. (As noted in the Staff Statement, the statement represents the view of the Division of Corporation Finance and the Office of the Chief Accountant, and is not a rule, regulation, or statement of the SEC.)

Each SPAC will need to evaluate the effect of this on its meeting materials to consider whether qualitative disclosure about the potential impact on the financial statements can be provided on a Form 8-K or the changes would require more significant amendments to the effective registration statement or definitive proxy statement. SPACs should anticipate that the process of confirming with the Staff the accounting treatment for alternative warrant structures to avoid classification of warrants as a liability may take some time, at least for the early movers. If so, the next steps may vary depending on where the SPAC is in its lifecycle and the materiality of the accounting error.

Arguably, the significance of the accounting treatment, and resulting financial statement impact, of SPAC-issued warrants is immaterial. For example, the staff has seen warrants providing 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. Parties should consider whether to delay the closing of the transaction to ensure that there is sufficient time to assess the materiality of the accounting error and prepare revised or restated financial statements, as necessary, so that accurate financial statements are filed with the Form 8-K. In addition to analyzing the materiality of the accounting error for the purposes of determining whether to restate previously-issued financials, the registrant will need to evaluate the materiality of the financial statement changes to the investment decision to vote with respect to the transaction.

  • Note, that if a SPAC determines the error is not material, it may provide the Staff with a written representation to that effect, with such written representation filed as correspondence on EDGAR.
  • The consequence of the Statement will be that all SPACs with warrants in their structure, and their existing advisors, as well as newly engaged valuation firms, will likely be busy sorting out the accounting and disclosure ramifications for months.
  • The SPAC should consult with its audit committee as part of the process described above and, once the above evaluation is complete, convene a meeting of the audit committee and its auditors to evaluate any errors to the financial statements and the results of management’s materiality analysis.
  • SPACs, their sponsors and deal professionals (particularly the accounting and auditing firms) are rushing to assess the impact of the Statement and evaluate an appropriate response.
  • #Audit #spac #valuation #askmarcum #marcumeverywhere Marcum LLP

SPACs should also review their risk factor disclosures and, if not already included, consider adding a risk factor that similar reclassifications based upon updated or revised accounting guidance or interpretations could occur in the future. SPACs should also review their risk factor disclosures and, if not https://natcomstore.com/notes-payable-vs-accounts-payable-whats-the/ already included, consider adding a risk factor that similar reclassifications, based upon updated or revised accounting guidance or interpretations, could occur in the future. Not for publication, email or dissemination

There are two alternatives to permit equity classification for the private placement warrants, each of which has commercial and other implications. Because the settlement amount of any private placement warrant containing any of the provisions described above would change if the warrant is transferred to a non-permitted transferee, such private placement warrant would be precluded from being indexed to the SPAC’s stock and would have to be classified as a liability.4 However, if the private placement warrants are transferred from their initial purchaser(s) to a non-permitted transferee, they become redeemable by the issuer https://lublinspp.citypg.pl/2023/11/28/operating-2/ and exercisable by the transferee holders on the same basis as the public warrants and become public warrants. In addition, under the Staff’s reading of the Fundamental Transaction Adjustment Provision, the private placement warrants may be entitled to a greater adjustment thereunder than the public warrants.

Episode #21: SPAC Trends, Advantages and Obstacles (Davina Kaile)

Accounting for warrants, especially those linked to preferred stock, can be a challenge due to evolving standards and the need for careful analysis under U.S. However, some warrants issued by SPACs include provisions that could preclude use of the exception. Warrants may also include variables that could affect the settlement amount, which, depending on the nature of the variable, could preclude a determination that the warrant is indexed to the company’s own stock. If warrants are classified as a liability, according to the Statement, they should be “measured at fair value, with changes in fair value reported each period in earnings.” Real-time financial performance reports, empower you to make informed decisions for your business. The Staff Statement states that if the warrants provide that the settlement amount may change based on the characteristics of its holder, the warrants should be classified as liabilities measured at fair value rather than being indexed to the entity’s stock.

As noted above, a post-de-SPAC combined company will also need to file an Item 4.02 disclosure on Form 8-K regarding the restatement (and potentially staff statement on accounting and reporting considerations for warrants an Item 3.01 disclosure on Form 8-K if it is unable to timely file any required periodic reports and receives a delisting notice as a result thereof). The same considerations would also apply where an S-4 is not required to be filed and the SPAC has filed a preliminary proxy statement with respect to the business combination. Note that the Form S-4 will not be declared effective by the SEC until the warrant accounting issue is resolved. Note, that if a SPAC determines the error is not material, it may provide the Staff with a written representation to that effect, with such written representation filed as correspondence on EDGAR.

If the company determines that the accounting error is not material to the required financial statements and disclosures included in pending submissions and filings, the company “may provide the staff with a written representation to that effect in correspondence” on EDGAR. 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.” The staff determined that, in those circumstances, the warrants should be classified “as a liability measured at fair value, with changes in fair value reported each period in earnings.” Pre-IPO SPACs may choose to revise the terms of their warrants to ensure that such warrants may be classified as equity, whereas parties to a de-SPAC transaction may wish to consider delaying closing to ensure that there is sufficient time to assess materiality and prepare revised financial statements, if necessary. We are issuing this statement to highlight the potential accounting implications of certain terms that may be common in warrants included in SPAC transactions and to discuss the financial reporting considerations that apply if a registrant and its auditors determine there is an error in any previously-filed financial statements. If the post-business combination company will have a dual class structure (e.g., where certain former owners of the target company receive super-voting stock in the business combination), then the public warrants also will need to be addressed.

GAAP, in which case previously filed financial statements may need to be revised or restated. If the business combination has already closed, the post-de-SPAC combined company must undertake the same analysis as that of an already public SPAC, including as described under “Why is this creating such an issue? If the meeting has already occurred, the restated financial statements and updated disclosures should be filed on Form 8-K and under Rule 425. If a SPAC has filed a Form S-4 registration statement (the Form S-4) in connection with a business combination but the Form S-4 is not yet effective, then the SPAC should follow the steps outlined above regarding a SPAC that is already public and is in the de-SPAC process (whether looking for a merger partner or in discussions regarding a BCA).

  • Arguably, the significance of the accounting treatment, and resulting financial statement impact, of SPAC-issued warrants is immaterial.
  • The consequence is that de-SPAC’d companies may have to (1) pause the use of resale registration statements, (2) postpone the filing, or pause the use of, other registration statements and (3) notify investors of non-reliance on previously issued financial statements under Item 4.02 of Form 8-K.
  • The comments reflected a range of views, with some parties suggesting that the SEC should or must limit itself to financially material disclosures, and others raising First  Amendment concerns.
  • The Securities Exchange Act of 1934 requires a registrant to file materially complete and accurate reports with the Commission.
  • In addition, as registrants and their advisors evaluate the effects of any possible changes to their public disclosure, they are reminded of their obligations under Regulation FD not to selectively disclose material nonpublic information.
  • There are potential scenarios where additional disclosure would require a re-mailing of the materials.

In other words, if a qualifying cash tender offer (which could be outside the control of the entity) occurs, in the SEC’s view of the agreement 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. The Statement challenges long-held views about equity treatment for SPAC-issued warrants, suggesting that certain nearly ubiquitous features in SPAC warrants require the warrants to be recorded as “liabilities” on the SPAC’s balance sheet rather than as “equity.” It also highlights financial reporting considerations if a SPAC determines it has misclassified its warrants. The Staff’s observations will have ramifications for almost every SPAC with warrants in its structure — whether in formation/registration, newly public, approaching a business combination, or post-initial business combination (even years ago).

Registrant Filing Considerations

Existing SPACs and companies that have completed a business combination with a SPAC should consult with their advisors about amending their warrant agreements to make the changes suggested above to avoid future liability accounting. To state the obvious, any modifications to the terms of the warrants for purposes of achieving an accounting result should be reviewed by the SPAC’s accountants and verified with its auditors as they may have different or additional views on the actions required to be taken to maintain equity treatment. The need to restate previously issued financial statements often leads to an inability to file timely periodic reports.

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