A form of warrant that isn’t accounted for as a liability for special purpose acquisition companies (SPACs) is under development, but until that process is completed and gets an okay by the Securities and Exchange Commission, sponsors and others with an interest in the market face uncertain terrain, Gerry Spedale said in a Gibson, Dunn Crutcher webcast last week.
“You have accounting firms and law firms working together on that form, and that needs to get blessed by the SEC before everyone’s going to be comfortable moving forward with that approach,” said Spedale, a Gibson, Dunn & Crutcher partner.
The SEC earlier this year threw a wrench in the SPAC market when agency staff accountants released a memo challenging the longstanding view that the warrants that typically attach to SPAC shares should be treated as equity. Instead, the SEC said, they should be treated as liabilities for accounting purposes.
The liability treatment complicates deals because it requires sponsors to hire third-party accountants and auditors to value the warrants quarterly using a complex calculation, while equity treatment only requires a simpler, up-front valuation.
“It creates additional work that wasn’t there in SPAC-land prior to this guidance,” he said.
Because of the accounting question, the SEC in April approved only 13 SPACs — publicly traded shell companies that offer startups an alternative route to going public by merging with them. By contrast, 109 were approved just the month before.
It will be several weeks at least before the new form is completed and reviewed by the SEC, Spedale said. In the meantime, SPAC sponsors have options for moving forward, depending on where they are in the SPAC lifecycle.
For pre-IPO SPACs, there are three options. The first is simply waiting for the new form to get SEC approval, and then modifying the warrant agreement to meet the new terms. Given the SEC time frame, that could keep the deal on hold for weeks.
The second is treating the warrants as liabilities. In addition to the administrative burden that comes with that, it’s possible the deal will be at a competitive disadvantage in the market.
”Will startup target companies view the liability treatment as a negative of the process if you’re competing against other SPACs without that issue?” Spedale asked.
The third approach is either to do a warrantless SPAC or a SPAC with only one kind of warrant rather than the different public and private kinds of warrant that SPAC deals are typically offering.
“The different terms of the public and private warrants are at least one of the things causing some of the accounting issues,” Spedale said.
Offering the SPAC with no warrants doesn’t have a promising track record. Although there have been a couple of dozen SPACs that have made that work — clustered among technology and biotech firms — deals are hard to close without the warrants.
“The warrants are seen as valuable to investors,” he said. “Not every SPAC is going to be able to consummate their IPO without the warrants.”
SPACs that are post-IPO but haven’t yet completed their merger with a startup have no choice but to treat the warrants as liabilities until the new form is approved, Spedale said. Sponsors of these deals are in the process of hiring third parties to do valuations and to determine if the treatment of the warrants as liabilities is material and, if so, whether they’ll have to do restatements.
“That analysis is obviously requiring a lot of time and effort by the companies and the accounting firms and the auditors,” he said.
They also have to reassess their internal controls over financial reporting and whether or not they have a material weakness that needs to be disclosed.
SPACs in the merger process — known as the de-SPAC transaction — have a few more considerations, including if the merger agreement needs to be changed.
“You need to look at your de-SPAC transaction agreement and figure out if there are any issues there that are created by the fact that your financial statements, at least your historical financial statements, have this issue going forward,” he said.
Companies that have already completed their merger must go through a similar analysis of their financial statements.
“Hopefully they’ll have a little bit different perspective on the historical SPAC financials, given the relevance of that shell financial presentation once you’re actually in an operating entity,” he said.
They’ll need to go through other parts of the financial statements as well to see if the change in warrant accounting causes additional issues that might not be apparent at first.
“As you might imagine, all this focus on warrant accounting has led to accountants focusing on other parts of SPAC financial statements and other smaller accounting issues being raised that are contributing to the unresolved status of these issues,” he said.
Needless to say, SPAC sponsors are scrambling to sort through the accounting issues as quickly as possible. “People are worried about meeting deadlines for 10-Q filings, so you may see some people missing that filing coming up in a week or so,” he said.