On April 12, 2021, the U.S. Securities and Exchange Commission (SEC) issued a staff statement regarding the financial reporting considerations for warrants issued by special-purpose acquisition companies (SPACs). This new guidance advises that warrants that lack an embedded feature (specifically, those that are options to purchase shares at a predetermined price within a defined time period) should be considered a liability on the balance sheet — a departure from the historical view and practice, which has treated them as equity instruments. Once categorized as liabilities, the warrants must also then be marked to market, which has potentially substantial implications for profit-and-loss statements. This new development can be attributed to documented patterns of inclusion of warrants within SPAC transactions and historical challenges in accounting for these complex financial instruments. SPACs are the focus of the new guidance, as a large majority of recent SPACs have included warrants wherein existing provisions entitle holders of the warrants to a cash settlement, qualifying the event as a “cash tender offer outside the control of the entity,” thus requiring the warrants to be classified as a liability. The new guidance is materially affecting many of the previously filed financial statements for SPACs, and now “de-SPAC” operating companies, and in many cases, is requiring formal restatements of already filed financial statements.
In the month since the new guidance was released, we’ve seen its effect create some turmoil in the SPAC market. Overall, the number of new SPACs decreased from nearly 100 in March 2021 to fewer than 20 in April 2021. A number of SPACs and subsequently acquired operating companies that have previously filed financial statements have been advised of a need for restatement or delayed annual reporting, depending on when the SPAC went public and how many filings the company had already made.
We are continuing to monitor this development, but beyond what we already know and are monitoring, there are a number of other implications that could pose challenges in the overall timeline for public-company readiness as it pertains to financial reporting, as well as internal controls and compliance.
- With a restatement, Form 8-K is due four business days after a restatement is declared. The restatement not only requires an adjustment on the face of the financial statements but also to the footnote disclosures, as well as Management’s Discussion and Analysis and perhaps a modification to the entity’s filed Risk Factors.
- Tax treatment may also be a consideration in this process, dependent on the warrant’s treatment (liability treatment versus prior equity accounting).
- Auditors and subject-matter experts should be engaged to evaluate the warrants themselves for appropriate accounting treatment, impact and considerations for the go-forward process. Investing the time necessary for early alignment is essential.
- Internal controls over financial reporting should be revisited to evaluate the severity of any potential deficiencies. This relates specifically to controls associated with appropriate disclosures and technical accounting guidance. Material weakness conclusions have been prevalent and almost the default outcome with those entities restating prior financial statements.
The SPAC market has exploded in popularity over the past year due to the relatively easy way for SPACs to raise public equity and fund future mergers-and-acquisitions activity (which results in the acquired entity becoming a public company). This has resulted in accelerated timelines and low-risk entry to an initial offering. Previously, SPACs saw a relaxation of standards and grace periods on accelerating timelines, but the new SEC guidance on accounting points to heightened risk and is slowing the typical cadence of activities to prepare for public offerings and S-4 issuances for SPACs.
It all comes down to timing. This latest development highlights the importance of securing consensus on accounting treatment for warrants early in order to mitigate costly disruption, avoid rework and not prolong the public-offering timeline. Organizations interested in either forming a SPAC or merging with one should take the time, as part of planning, to understand warrant terms and either structure those warrants differently or make certain to reassess their accounting considerations for warrants (or both). It is important for SPACs to know their target operating companies and for those companies to know and understand the structures of their SPAC partners so that they can incorporate these process considerations into their public-offering planning and timing.