Blog Post 04.19.21
What are SPAC warrants?
Virtually all SPACs have both public warrants (issued as part of the units sold in the IPO) and private warrants issued to the SPAC sponsors. The terms of the public warrants and the private warrants are substantially similar, except that the private warrants typically do not have redemption provisions as long as the warrants are held by the SPAC sponsor or by a permitted transferee and provide for both cash and cashless exercise. In contrast, public warrants typically can only be exercised for cash, except in the case of specified redemption scenarios, and are typically subject to redemption by the SPAC.
What did the statement from the SEC say?
On April 12, 2021, the Staff of the U.S. Securities and Exchange Commission (the SEC) issued a Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”) (the Staff Statement). The Staff Statement expressed the view that certain terms that may be common in warrants issued in connection with a SPAC transaction should be analyzed to determine if such warrants should be accounted for as liabilities rather than equity and if so, whether the impact of the change in accounting treatment is material and thus require a restatement of previously issued financial statements. (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.)
The Staff Statement cited two types of provisions that would indicate the warrants should be classified as liabilities versus equity:
Why is this creating such an issue?
Virtually all SPACs have historically accounted for private and public warrants as equity, and virtually all such warrants contain provisions similar to those cited in the Staff Statement which provisions, in the Staff’s view, would cause such warrants to be more appropriately classified as liabilities versus equity, and therefore measured at fair value, with changes in the fair value of the warrants reported in earnings in each period. 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. Further, if an entity were required to restate previously issued financial statements, it could be subject to several additional consequences, including, among others:
What if the SPAC or post-de-SPAC combined company cannot file the periodic report by the extended deadline?
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).
The NYSE or Nasdaq may issue a notice that the company’s shares are subject to delisting, which would trigger another Form 8-K filing under Item 3.01 and the need to work with the stock exchange to resolve the delisting issue.
Companies must also suspend use of any registration statement where the use of such form is dependent on the timely filing of periodic reports, until such reports have been timely filed for the required time period (e.g., Form S-3, to the extent a post-de-SPAC combined company is otherwise eligible to use Form S-3, and Form S-8, which cannot be used until the late periodic report is filed). 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). 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.
Companies should also review existing agreements to determine whether a late filing will constitute a breach or event of default under any agreements, including any credit facilities.
What if you are forming a SPAC or are in the IPO process but not yet effective?
If forming a SPAC, you should consider drafting or revising the terms of the warrants to:
Alternatively, if retaining language or provisions similar to those cited in the Staff Statement, the SPAC and its auditors should analyze whether the warrants should be classified as liabilities and apply the appropriate accounting treatment in the financial statements.
What if the SPAC S-1 has gone effective but the IPO has not yet closed or the green shoe has not yet been exercised?
There are several considerations here, including relating to the underwriting agreement and deliverables thereunder, such as comfort letters and legal opinions. Where an S-1 has gone effective but the IPO has not yet closed (or the green shoe has not yet closed), the parties should consider, among other things, whether:
What if the SPAC is already public and is looking at a business combination, or has entered into a business combination agreement (BCA)?
A SPAC that is already public should undertake the following steps, whether or not it is in the process of evaluating potential merger partners or has entered into a BCA:
What if the change is immaterial?
If the change is deemed to be immaterial and the SPAC has not yet filed its Form 10-K, the SPAC should reflect the appropriate accounting treatment in its financial statements to be filed with its Form 10-K. If the SPAC has filed its Form 10-K, the SPAC may reflect the new accounting treatment in its next Form 10-Q and update its prior year audited financial statements and include footnote disclosure regarding the change in accounting treatment and the impact thereof on historical and future reporting periods.
It is possible that the change in accounting treatment may not be viewed as qualitatively material, as investors most likely understand the warrant terms and the impact of the accounting change may not impact their investment decision with respect to the securities of the SPAC or the post-de-SPAC combined company. However, the materiality analysis is both a qualitative and quantitative analysis.
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 Staff may, however, disagree with that determination.
What if the change is material?
If the change is deemed to be material, thus requiring a restatement of previously issued financial statements, and the SPAC has filed its Form 10-K and/or subsequent Forms 10-Q, the SPAC should amend the filed 10-K and/or Forms 10-Q, which would include amending and filing the restated financial statements and updating Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), disclosures regarding sufficiency of internal controls, and risk factors, among other areas. The SPAC will also have to consider the need to file an Item 4.02 Form 8-K.
If a SPAC has not filed a Form 10-K, it should:
What if the SPAC has already entered into a BCA and has filed a Form S-4 registration statement that has not been declared effective?
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). Note that the Form S-4 will not be declared effective by the SEC until the warrant accounting issue is resolved. 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. 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.
What if the Form S-4 is already effective but the business combination is not yet closed?
If the Form S-4 is effective but the required shareholder meetings have not yet occurred, the restated financial statements and updated disclosures, including the pro formas and updates to MD&A and risk factors, should be provided in the form of a filing under Rule 425. The SPAC may also need to consider whether the shareholder meeting should be postponed to provide holders with sufficient time to consider the new information.
If the meeting has already occurred, the restated financial statements and updated disclosures should be filed on Form 8-K and under Rule 425.
Further, as the combined company will need to file the Super 8-K within four business days of closing, the parties must ensure that the restated financial statements and related disclosures will be prepared in time to meet the filing deadline (or postpone the closing until such time as the disclosure will be ready for inclusion in the Super 8-K).
What if the business combination has already closed?
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?” and “What if the SPAC or post-de-SPAC combined company cannot file the periodic report by the extended deadline?” From a materiality perspective, it is possible that the post-de-SPAC combined company could conclude the error is immaterial, given that the post-de-SPAC combined company is typically larger than the SPAC and as such, the threshold for materiality may be higher. However, this may vary for historical versus future periods and thus a post-de-SPAC combined company may nonetheless need to restate financial statements for periods prior to the de-SPAC. If a restatement is required, a post-de-SPAC combined company may also need to postpone the filing of resale registration statements or suspend the use of currently effective resale registration statements or amend effective resale registration statements by filing a prospectus supplement (or if necessary, a post-effective amendment, assuming the post-de-SPAC combined company does not qualify as a smaller reporting company and thus is not able to forward incorporate by reference its subsequent periodic reports.). 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 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). Further, the post-de-SPAC combined company should review its obligations and representations under existing agreements, including under any registration rights and debt facility agreements, to determine if there is any technical breach of any representations or covenants under those agreements.
Will this have a significant dampening effect on SPAC deals?
The volume and market value of SPAC transactions (including de-SPAC business combinations) have been significantly impacted in the immediate aftermath of the Staff Statement. In addition, companies are beginning to file Form 8-Ks to announce they are undergoing the analysis to determine the appropriate warrant accounting treatment and the magnitude of any changes required and/or are going to restate their financial statements in light of the Staff Statement (and, in some cases, to announce they will be unable to file an upcoming periodic report in a timely manner and receipt of a delisting notice). However, the longer term impact on the SPAC market is difficult to predict. There is some sentiment that while it will cause people to hit “pause” on SPAC transactions and result in restatements and transaction delays, it may not have a long-term significant dampening effect on the SPAC market generally. Again, however, the ultimate impact remains to be seen.