Accounting and SEC Reporting Considerations for SPAC Transactions
This publication was updated on April 30,
2021, to reflect recent SEC statements. Note that it was
also updated on February 10, 2021, March 19, 2021, and March
25, 2021, to reflect additional interpretive guidance on
financial statement presentation for reverse
recapitalizations, accounting for shares and warrants issued
by a SPAC, classifying share-settleable earn-out
arrangements, share-based payment considerations, and the
availability of nonpublic review for registration statements
on Form S-4. It also includes considerations related to CF
Disclosure Guidance Topic 11 as well as recently adopted
amendments to Regulation S-K. Text that has been added or
amended since this publication’s initial issuance has been
marked with a boldface italic date in brackets.
Introduction
On the heels of a record-breaking year in 2020, special-purpose
acquisition company (SPAC) initial public offerings (IPOs) set a new record in
January 2021 by raising nearly $26 billion in proceeds in a single month.1 Given the continuing success of SPAC transactions, many private operating
companies have been merging with SPACs to raise capital rather than using
traditional IPOs or other financing activities (see Deloitte’s Private-Company CFO Considerations for SPAC
Transactions for further discussion of the growth and
lifecycle of SPACs). After a SPAC merges with a private operating company (the
“target”), the target’s financial statements become those of the combined public
company (the “combined company”). Therefore, a target will need to devote a
considerable amount of time and resources to technical accounting and reporting
matters.
Background
A SPAC is a newly formed company that raises cash in an IPO and uses that cash or
the equity of the SPAC, or both, to fund the acquisition of a target. After a
SPAC IPO, the SPAC’s management looks to complete an acquisition of a target
(the “transaction”) within the period specified in its governing documents
(e.g., 24 months). In many cases, the SPAC and target may need to secure
additional financing to facilitate the transaction. For example, they may
consider funding through a private investment in public equity (PIPE), which
will generally close contemporaneously with the consummation of the transaction.
If an acquisition cannot be completed within the required time frame, the cash
raised by the SPAC in the IPO must be returned to the investors and the SPAC is
dissolved (unless the SPAC extends its timeline via a proxy process).
Before completing an acquisition, SPACs hold no material assets
other than cash; therefore, they are nonoperating public “shell companies,” as
defined by the SEC (see paragraph 1160.2 of the SEC’s Financial Reporting Manual
[FRM]). Since a SPAC does not have substantive operations before an acquisition
has been completed, the target becomes the predecessor of the SPAC upon the
close of the transaction, and the operations of the target become those of a
public company. As a result, the target must be able to meet all the
public-company reporting requirements that apply to the combined company. Many
of the requirements discussed in this publication are related to the fact that
the target is considered the predecessor to an SEC registrant (i.e., the
SPAC).
Since a SPAC’s shareholders are required to vote on the
transaction, the SPAC may file either (1) a proxy statement on Schedule 14A or
(2) a combined proxy and registration statement on Form S-4 (note that (1) and
(2) are collectively referred to herein as a “proxy/registration statement”).
These documents must include the target’s financial statements, which are
expected to comply with public-company GAAP disclosure requirements as well as
SEC rules and requirements. For annual periods, the financial statements are
expected to be audited in accordance with PCAOB standards.
Once the SPAC's shareholders approve the transaction, the
acquisition will close, and the combined company has four business days to file
a special Form 8-K (“Super 8-K”) that includes all the information that would
have been required if the target were filing an initial registration statement
on Form 10. Accordingly, the SPAC and the target should take care to ensure that
the acquisition is not closed until all the financial information required for
the Super 8-K, including financial statements that comply with the SEC’s age
requirements, is available and audited in accordance with the standards of the
PCAOB.
On March 31, 2021, SEC Acting Chief Accountant Paul Munter
issued a public
statement regarding SPAC transactions. Mr. Munter stated
that such transactions are subject to the same review process by the SEC as
traditional IPOs. He also highlighted five key considerations, many of which are
further addressed in this publication:
- Market and timing — A SPAC target may have not begun preparing to become a public company and may need to evaluate “the status of various functions, including people, processes, and technology, that will need to be in place to meet SEC filing, audit, tax, governance, and investor relations needs” after the SPAC transaction.
- Financial reporting — SPAC transactions involve
several complex areas of financial accounting and reporting,
including:
-
Accounting for earn-out arrangements and complex financial instruments.
-
Public company disclosure requirements and adoption dates for new accounting standards.
- Internal control — SPAC targets must establish and maintain internal control over financial reporting and disclosure controls and procedures upon the close of the transaction, which may necessitate advanced planning.
- Corporate governance and audit committee — Mr. Munter stressed the importance of oversight by both the corporate board and the audit committee to ensure that a company provides high-quality financial reporting. He emphasized that an audit committee should be composed of “individuals with the appropriate skills and background” to oversee the SPAC transaction and combined company.
- Auditor considerations — SPAC transactions are generally subject to additional audit procedures to comply with SEC and PCAOB requirements for audit and independence standards.
On the same day Mr. Munter issued his statement, the SEC
Division of Corporation Finance issued a staff statement regarding SPACs. The statement addressed
(1) certain restrictions on SPACs and the combined company as a result of the
SPAC’s shell company status (e.g., ineligible issuer classification); (2) the
books and records and internal control requirements that apply to the SPAC,
target, and combined company; and (3) listing qualifications on national
securities exchanges that the combined company must meet to retain its publicly
listing. [Paragraph added April
30, 2021]
In addition, CF Disclosure Guidance Topic 11 (DG Topic 11), issued on
December 22, 2020, outlines disclosure considerations for both SPAC IPOs and the
subsequent transaction. The guidance includes a series of questions that
companies should consider when evaluating disclosures about (1) the financing
necessary to complete the transaction, (2) interests and incentives of the SPAC
sponsor and board of directors that may conflict with SPAC shareholders, and (3)
interests of any underwriters involved in the transaction. [Paragraph added February 10,
2021]
When planning for SPAC transactions, entities should also be
mindful of the following unique considerations:
-
The SEC's draft registration review process may be available for SPAC transactions in certain circumstances and only for the initial submission.
-
The SPAC and the target must work through the accounting for the transaction to determine (1) whether the SPAC or the target is the acquirer for accounting purposes (the “accounting acquirer”) and then (2) whether the nature of the transaction is an acquisition or recapitalization (as discussed in the Identifying the Accounting Acquirer section).
-
Pro forma financial information must be presented to reflect the accounting for the transaction.
-
While the SEC review process for a SPAC is as thorough and rigorous as that for a traditional IPO, after the SEC has completed its review of a SPAC’s proxy/registration statement, there is generally a period (e.g., 20 days) during which SPAC shareholders decide whether to approve the transaction. Separately, investors must also decide whether they wish to participate in the combined company or redeem their shares in the SPAC.
-
In addition to the SEC requirements discussed below, the target’s management may have other reporting considerations related to its support of the transaction, such as assisting in the marketing of PIPE financing and securing additional funding for the transaction.
Key Provisions for a SPAC Transaction
When conducting a SPAC transaction, the target should assess the following
technical accounting and SEC reporting considerations, which are discussed in
this publication:
The discussion herein applies to SPAC transactions in which (1)
a domestic SPAC merges with a domestic target and (2) the SPAC has identified
only one target for the transaction. SPAC transactions generate additional
complexity when foreign entities or multiple targets are involved or when the
target or a newly formed company legally acquires a SPAC. In such cases, we
recommend further consultation with accounting and legal advisers. Further,
views on the accounting and reporting requirements for SPAC transactions
continue to evolve. While the discussion below reflects our understanding as of
the date of this publication, because of the complexity involved in SPAC
transactions and evolving views, we recommend regular consultation with
accounting and legal advisers. This publication may be updated in the future as
views evolve.
SEC Filing Requirements
As discussed above, before consummating a transaction, a SPAC will be
required to file one of the following:
- Proxy statement on Schedule 14A — Generally required for the SPAC to solicit votes from its shareholders to consummate the transaction.
- Combined proxy and registration statement on Form S-4 — Generally required if the SPAC is registering additional securities as part of the transaction.
The reporting requirements for the proxy statement on
Schedule 14A and the combined proxy and registration statement on Form S-4
are substantially the same and are addressed in the Proxy/Registration
Statement Requirements section below.
A Super 8-K must be filed within four business days of the
consummation of a transaction, and the target will thereafter fulfill the
combined company’s ongoing reporting obligations. See the Super 8-K Requirements, Ongoing Reporting
Requirements, and Internal Control Over Financial Reporting and
Disclosure Controls and Procedures sections for further
information.
Proxy/Registration Statement Requirements
The SPAC’s shareholders are required to vote on the
transaction in which the SPAC merges with the target. Therefore, the
proxy/registration statement must include the information below related to
the target.
Financial Statement Requirements
The proxy/registration statement must include the target’s (1) annual
financial statements audited in accordance with PCAOB standards and (2)
unaudited interim financial statements, depending on the timing of the
transaction. Generally, the target must include annual audited financial
statements for three years. However, there are two scenarios in
which the financial statement requirements may be reduced from three
years to two years:
-
Smaller reporting companies (SRCs) — In a manner consistent with paragraphs 1140.3 and 5110.3 of the FRM, a target may provide two years of audited financial statements rather than three years if the target (1) is not an SEC reporting company and (2) would otherwise meet the definition of an SRC (i.e., it reported less than $100 million in annual revenues in its most recent fiscal year for which financial statements are available).
-
Emerging growth companies (EGCs) — In a manner consistent with paragraph 10220.7 of the FRM, a target may provide two years of audited financial statements rather than three years if all of the following apply: (1) the SPAC is an EGC, (2) the SPAC has not yet filed or been required to file its first Form 10-K, and (3) the target would qualify as an EGC if it were conducting its own IPO of common equity securities. A private company target would generally qualify as an EGC in its own IPO if it has total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year and has not issued more than $1 billion of nonconvertible debt over the past three years. The fact that an EGC SPAC has filed its first Form 10-K only affects the number of years of financial statements required and does not affect other EGC accommodations available to the combined company if it continues to qualify as an EGC after the transaction. [Paragraph amended February 10, 2021]
The decision tree below summarizes how entities can
determine the number of annual audited years to include in the
proxy/registration statement when a SPAC acquires a target. That
determination, as well as the determination of the age of the financial
statements, must be reassessed (1) each time an amendment to the
proxy/registration statement is filed and (2) when the Super 8-K is
filed or amended.
The audited annual financial statements must include (1)
balance sheets as of the end of the two most recent fiscal years and (2)
statements of comprehensive income, cash flows, and changes in
shareholders’ equity for the two or three most recent fiscal years (see
decision tree above). Depending on the timing of the transaction,
unaudited interim financial statements may be required. When needed,
interim financial statements must include (1) an interim balance sheet
as of the end of the most recent interim period after the latest fiscal
year-end (see the Age of Financial
Statements section) and (2) statements of comprehensive
income, cash flows, and changes in shareholders’ equity for the
year-to-date period from the latest fiscal year-end to the interim
balance sheet date and the corresponding period in the prior fiscal
year.
We have recently observed new structures in which either the target or a
newly formed company acquires a SPAC. Such transactions may be viewed as
the IPO of the target and, thus, it may be appropriate to provide two
years of financial statements if the target qualifies as an EGC. We
recommend further consultation with accounting and legal advisers for
such structures. [Paragraph added April
30, 2021]
Financial Statement Presentation and Disclosure Requirements
The target’s financial statements must comply with
SEC rules and regulations, including SEC Regulation S-X and SEC
Staff Accounting Bulletins, both of which govern presentation and
disclosures in the financial statements. For example, in accordance
with Regulation S-X, Rule 5-03(b), a target is generally required to
state separately, on the face of the income statement, revenues (and
the associated costs of revenues) related to (1) product sales, (2)
rentals, (3) services, and (4) other revenue activities. In
addition, Regulation S-X, Rule 4-08(h), requires footnote disclosure
of an income tax rate reconciliation, and Regulation S-X, Article
12, requires certain financial statement schedules that should also
be considered. However, targets that would qualify as an SRC may
instead apply the scaled disclosure requirements for SRCs set forth
in Regulation S-X, Article 8. SRCs are generally not required to
apply the disclosure provisions of Regulation S-X in their entirety
unless Article 8 specifically indicates otherwise.
Regulation S-X, Article 10, outlines the financial statement
requirements for interim reporting. The interim financial statements
and related footnotes may be presented on a condensed basis in a
level of detail allowed by Article 10 but will always need to
contain disclosure of any material matters that were not disclosed
in the most recent annual financial statements.
Connecting the Dots
Because targets may not have historically
prepared interim financial statements, they should ensure
that they have established proper controls and procedures
for accurately preparing such information on a timely
basis.
The target’s financial statements must also comply
with public-company GAAP, which may trigger additional presentation
and disclosure requirements. Such requirements include, for example,
mezzanine equity classification (ASC 4802), segment- and entity-wide disclosures (ASC 280), earnings per
share (EPS) (ASC 260), disaggregation of revenues (ASC 606), and
incremental business combination disclosures (ASC 805). For further
discussion, see Chapter 5 of Deloitte’s Roadmap Initial Public
Offerings.
In addition, the target’s financial statements
cannot reflect Private Company Council accounting alternatives.
Therefore, if a target has elected such alternatives, such as
amortizing goodwill, the effects of these elections must be unwound
before the financial statements are included in the
proxy/registration statement.
The target’s financial statements generally must
reflect the adoption of new accounting standards on the basis of the
dates required for public companies. However, it is our
understanding that the SEC staff will not object if a target uses
private-company (non-public-business-entity) adoption dates if (1)
the SPAC is an EGC that has elected to defer the adoption of
accounting standards by applying private-company adoption dates, (2)
the target would qualify as an EGC if it were conducting its own IPO
of common equity securities, and (3) the combined company will
qualify as an EGC after the transaction (see paragraph
10120.2 of the FRM for a discussion of assessing EGC
eligibility after the transaction).
Financial Statements of Acquired or to Be Acquired Businesses
Under Regulation S-X, Rule 3-05, the target may be
required to provide separate audited preacquisition financial
statements for its significant acquired or to be acquired businesses
(acquirees) in the proxy/registration statement. Note that the
definition of a “business” for SEC reporting purposes, which differs
from the definition under ASC 805 for U.S. GAAP purposes, focuses
primarily on the continuity of revenue-producing activities. The
target must perform the significance tests in Regulation S-X, Rule
1-02(w) (i.e., the investment, asset, and income tests). If the
acquiree is determined to be significant (i.e., the significance
level exceeds 20 percent on any of the three tests), separate
audited preacquisition financial statements of the acquiree may be
required.
Changing Lanes
On May 20, 2020, the SEC issued a
final rule3 that amends the financial statement requirements for
acquisitions and dispositions of businesses, including real
estate operations, and related pro forma financial
information. The final rule applies to fiscal years
beginning after December 31, 2020; however, early
application is permitted. The final rule offers significant
relief for targets that are undertaking a transaction since,
among other changes, they will no longer be required to
evaluate acquisitions that occurred before the most recent
full fiscal year included in the proxy/registration
statement. The example below takes into account the
amendments in the final rule.
Example 1
Company A, a calendar-year-end
company, is a target in a SPAC transaction. The
proxy/registration statement includes its
historical (1) audited annual financial statements
as of December 31, 20X9, and December 31, 20Y0,
and for the three years ended December 31, 20Y0,
and (2) unaudited interim financial statements as
of September 30, 20Y1, and for the interim periods
ended September 30, 20Y1, and September 30,
20Y0.
Company A acquired Company B,
which also has a calendar year-end, in June 20X9.
Because the acquisition of B occurred before the
most recent full fiscal year presented by A, B’s
preacquisition financial statements are not
required. However, if B had been acquired in June
20Y0, A must evaluate the significance of the
acquisition of B. After performing the three
significance tests, A determines that the highest
level of significance was 41 percent. Therefore,
the proxy/registration statement would need to
include B’s audited annual financial statements as
of and for the years ended December 31, 20X9, and
December 31, 20X8, and as of March 31, 20Y0, and
for the three months ended March 31, 20Y0, and
March 31, 20X9. This is because B would not have
been included in A’s audited results for a
complete fiscal year.
For additional information, see Section 2.4
of Deloitte’s Roadmap Initial Public
Offerings.
Financial Statements and Summarized Financial Information for Equity Method Investments
Targets with investments that are accounted for
under the equity method (equity method investees or “EMIs”) should
consider the reporting and disclosure requirements in Regulation
S-X, Rules 3-09, 4-08(g), and 10-01(b).
In accordance with Rule 3-09, if the target holds an
interest in an EMI that is considered significant, the investee’s
separate financial statements must be included in the
proxy/registration statement. An interest in an EMI is considered
significant if the result of either the investment test or the
income test exceeds 20 percent for any annual period presented in
the target’s financial statements. If the EMI’s financial statements
are required in the proxy/registration statement, such financial
statements should be (1) as of the same dates and for the same
periods as those of the audited consolidated financial statements
that the target is required to file (if the EMI and the registrant
have the same year-end; otherwise, the separate financial statements
may be as of the EMI's year-end) and (2) audited for each year for
which the result of either significance test exceeds 20 percent. The
EMI’s comparative financial statements for any years for which
significance did not exceed 20 percent on the basis of either test
must still be presented, but they may be unaudited.
A target is not required to include separate interim
financial statements for significant EMIs. However, if the
individual significance of any EMI is greater than 20 percent, the
registrant must disclose summarized income statement information
under Rule 10-01(b) in its interim financial statements.
In accordance with Rule 4-08(g), a target must disclose summarized
financial information in the footnotes to its annual financial
statements for all EMIs whose significance, individually or in the
aggregate, exceeds 10 percent in accordance with the asset, income,
or investment test.
For additional information on the application of
significance tests and their relationship to transactions, see
Section
2.6 of Deloitte’s Roadmap Initial Public
Offerings.
Auditing and Review Standards
Audits for a private company are typically subject
to the auditing standards issued by the AICPA’s Auditing Standards
Board (i.e., U.S. generally accepted auditing standards [U.S.
GAAS]); however, for a SPAC transaction, the audit of the target
that becomes the predecessor of the SPAC must be performed in
accordance with the standards of the PCAOB. Therefore, even if the
target has previously been audited, the target’s auditor will
generally need to perform additional procedures and issue an
auditor’s report, which will be included in the proxy/registration
statement, that states that the audit was performed in accordance
with both (1) U.S. GAAS and (2) the standards of the PCAOB. In
addition, interim financial statements are generally reviewed by the
target’s auditors.
For audits of fiscal years ending on or after
December 15, 2020, critical audit matters (CAMs) must be included in
auditors’ reports that refer to PCAOB standards, except when the
registrant qualifies as an EGC. Although the target is not a
registrant, we believe that it would be appropriate to omit CAMs
from the auditor's report on the financial statements of a target in
the proxy/registration statement if (1) the SPAC is an EGC, (2) the
target would qualify as an EGC if it were conducting its own IPO of
common equity securities, and (3) the combined company will qualify
as an EGC after the transaction. [Paragraph added February 10, 2021]
In addition, the registered accounting firm must
also meet the independence requirements in Regulation S-X, Article
2. Because the SEC’s and PCAOB’s independence rules are generally
more restrictive than those of the AICPA, both the auditor and those
charged with governance need to determine (1) whether there is
possible noncompliance with the SEC’s and PCAOB’s independence
rules, (2) whether there are any conflicts of interest before the
entity undertakes the transaction, or (3) both. For example, because
certain nonattest services that the auditor is permitted to provide
under AICPA rules may be prohibited under SEC independence rules,
the auditor and those charged with governance need to evaluate
whether the nonattest services provided during the financial
statement periods to be included in the proxy/registration statement
are permitted under the SEC’s and PCAOB’s independence rules. In
certain cases, the target may be required to change its independent
auditor to move forward with the transaction. This could be the case
because, for example, the audit firm is not registered with the
PCAOB or is not in compliance with the SEC’s independence rules for
its audits of the years for which SEC independence is required.
Changing Lanes
[Added February 10,
2021]
On October 16, 2020, the SEC issued a final rule4 that amends certain auditor independence requirements.
Among other changes, the amendments generally reduce the
look-back period for which the target’s auditor must be
independent in accordance with SEC rules. Companies are
encouraged to consult with their auditor on the appropriate
application of these requirements.
Age of Financial Statements
Audited Annual Financial Statements
If the filing date, the effective date of a
registration statement, or the mailing date of the proxy statement
(hereafter “the filing or effective/mailing date”) is on or before
the 45th day after the target’s fiscal year-end, Regulation S-X,
Rules 3-01 and 3-12, permit the SPAC to include audited financial
statements of the target for the fiscal year preceding the target’s
most recently completed fiscal year. In such cases, the target must
also provide interim financial information through the third quarter
of the most recently completed fiscal year. However, if the audited
financial statements for the most recently completed fiscal year are
available or become available before the filing or effective/mailing
date, the filing should be updated to include them.
Example 2
SPAC A, a nonaccelerated
filer, enters into an agreement to acquire Target
B. Both A and B have calendar year-ends. On March
1, 20Y0 (i.e., more than 45 days after the
year-end), A files its proxy/registration
statement, which must include B’s audited annual
financial statements for the two or three fiscal
years ended December 31, 20X9 (see the Financial
Statement Requirements section). No
interim financial statements would be
required.
Unaudited Interim Financial Statements
If the audited year-end balance sheet is as of a date that is no more
than 134 days from the filing or effective/mailing date, the
target’s interim financial information is not required. If, however,
the year-end balance sheet is as of a date that is 135 days or more
from the filing or effective/mailing date, a registrant must provide
the target’s financial information as of an interim date that is no
more than 134 days from the filing or effective/mailing date in
addition to the audited year-end financial statements.
Example 3
SPAC A, a nonaccelerated
filer, enters into an agreement to acquire Target
B. Both A and B have calendar year-ends. SPAC A
files its proxy/registration statement on
September 1, 20Y0 (i.e., more than 134 days after
year-end). To meet the age of financial statement
requirements, the proxy/registration statement
must include B’s (1) annual audited financial
statements for the two or three fiscal years ended
December 31, 20X9 (see the Financial
Statement Requirements section), and
(2) interim financial statements as of June 30,
20Y0, and for the six months ended June 30, 20Y0,
and June 30, 20X9.
“Updating” Requirements for Proxy/Registration Statements
The financial statements in the proxy/registration
statement must meet the requirements for the age of financial
statements on both (1) the filing date and (2) either the effective
date of the registration statement or the mailing date of a proxy
statement. Because the effective or mailing date may be months after
the initial filing date, financial statements that met the
requirements for the age of financial statements as of the initial
filing date may no longer meet those requirements when a subsequent
amendment is filed or immediately before the effective/mailing date.
In such cases, the financial statements are sometimes described as
“stale,” and Regulation S-X, Rule 3-12, requires the SPAC to
“update” the financial statements that were included in the initial
filing (i.e., by providing financial statements of the target as of
a more recent date) before (1) an amendment is filed, (2) a
registration statement is declared effective, or (3) a proxy
statement is mailed. Typically, a SPAC will need to file an
amendment to the proxy/registration statement that provides more
current financial statements of the target that meet the
requirements for the age of financial statements.
Pro Forma Financial Information
The proxy/registration statement must include pro forma
financial information that reflects the close of the transaction. Pro
forma financial information, which is unaudited, typically includes an
introductory paragraph, a pro forma balance sheet, a pro forma income
statement (or statements), and accompanying explanatory notes. The
introductory paragraph briefly describes the transaction(s), the
companies involved, the periods for which the pro forma financial
information is presented, and any other information that may help
readers understand the content of the pro forma information. Ordinarily,
the pro forma balance sheet and income statement(s) are presented in a
columnar format that shows (1) historical financial information of the
SPAC, (2) historical financial information of the target, (3) pro forma
adjustments, and (4) pro forma totals. Further, each pro forma
adjustment should include a reference to an explanatory note that
clearly discusses the assumptions involved and how the adjustments were
derived or calculated.
A pro forma balance sheet is required as of the same date as the SPAC’s
most recent balance sheet included in the proxy/registration statement
(i.e., one pro forma balance sheet as of the end of the fiscal year or
the subsequent interim period, whichever is later). In the computation
of pro forma balance sheet adjustments, it is assumed that the
transaction was consummated on the balance sheet date. Pro forma income
statements are required for both (1) the SPAC’s most recent fiscal year
and (2) any subsequent year-to-date interim period included in the
proxy/registration statement. In the computation of pro forma income
statement adjustments, it is assumed that the transaction was
consummated at the beginning of the most recently completed fiscal year
(and carried forward to the interim period, if presented).
The preparation of the pro forma financial information will depend on the
determination of the accounting acquirer. As discussed in the
Identifying the Accounting Acquirer section, if
the target is identified as the accounting acquirer, the transaction may
be a reverse recapitalization (i.e., the SPAC, which is a shell company,
is the legal acquirer but not the accounting acquirer). However, in
other instances, the SPAC may be identified as the accounting acquirer,
and the transaction may be an acquisition of either (1) a business or
(2) a group of assets (if the target does not meet the U.S. GAAP
definition of a business).
For a reverse recapitalization, the pro forma
adjustments would give effect to the issuance of the target’s equity
interests in exchange for the net assets of the SPAC and subsequent
recapitalization. For an acquisition in which the SPAC is determined to
be the accounting acquirer, the pro forma adjustments would reflect the
consideration transferred and the target’s assets and liabilities,
including goodwill (if applicable), measured in accordance with ASC 805.
In either circumstance, additional adjustments may be necessary to
reflect (1) the target’s acquisition of a significant acquiree (or
significant acquirees) or (2) other financing transactions that will
occur on or before the close of the transaction. Note that the above
list of pro forma adjustments is not exhaustive, and SPACs and targets
should carefully analyze the structure of the transaction to
appropriately reflect the pro forma results.
Connecting the Dots
Because the pro forma financial information will
reflect the accounting for the transaction and any related
financing, the target must preliminarily determine the
appropriate accounting before the close of the transaction. See
the Identifying the Accounting Acquirer, Financial Statement
Presentation for Reverse Recapitalizations, and
Classifying Share-Settleable Earn-Out
Arrangements sections, as applicable, for further
information.
In addition, the SPAC’s public shareholders typically
have redemption rights through which they may elect to redeem their
shares in the SPAC for their initial investment before the close of the
transaction. As a result, the amount of cash the SPAC will have at the
closing is unknown at the time the proxy/registration statement is
filed. In accordance with Regulation S-X, Rule 11-02(a)(10), the SPAC
will need to present multiple pro forma scenarios to reflect a range of
possible results (e.g., assuming no redemptions and assuming maximum
redemptions) because the outcome of the redemption scenario may vary. In
some cases, the level of redemptions may influence the identification of
the accounting acquirer and, thus, the accounting treatment of the
transaction. In these circumstances, the pro forma financial information
may need to reflect the SPAC as the accounting acquirer in one scenario
and the target as the accounting acquirer in another scenario.
Irrespective of the accounting for the transaction, the
SPAC and the target should carefully consider any income tax impacts and
related pro forma adjustments associated with the transaction. These
adjustments will largely depend on the structure of the transaction and
the planned corporate structure of the combined company. Special
consideration should be given to “UP-C” structures since these can
result in additional tax complexities. See Section 11.7.4.1 of Deloitte’s Roadmap Income
Taxes for additional information on UP-C
structure–related income tax considerations.
Changing Lanes
As discussed in the Financial Statements of Acquired or
to Be Acquired Businesses section, in May 2020,
the SEC issued a final rule that amends the requirements for pro
forma financial information. For calendar-year-end companies,
the amendments apply for all filings on or after January 1,
2021. Among other changes, the amendments eliminate the previous
requirement that adjustments to the pro forma income statement
must be expected to have a continuing (or recurring) impact on
the registrant. The amendments do not distinguish between
adjustments that are deemed recurring and adjustments that are
deemed nonrecurring by management; however, they include a
requirement to disclose items that will not recur in the
explanatory notes to the pro forma financial information. For
additional information, see Section 4.4 of Deloitte’s
Roadmap Initial Public Offerings. [Paragraph
amended February 10, 2021]
Other Financial and Nonfinancial Information
In addition to the financial statements discussed above, the
proxy/registration statement must also include the following disclosures
related to the target:
-
Management’s discussion and analysis (MD&A) of financial condition and results of operations (see SEC Regulation S-K, Item 303). Typically includes an overview section about the company and its business, an analysis of the results of operations that addresses period-to-period changes in income statement line items, a discussion of liquidity and capital resources that focuses on the company’s financial position and cash flows, and a summary of the company’s critical accounting policies that highlights financial statement items for which significant management estimates and judgment are required. In addition to the discussion and analysis of historical information, MD&A requires companies to disclose any known trends, events, or uncertainties that are reasonably likely to have a material effect on their future liquidity, capital resources, or results of operations.
-
Selected financial data (see Regulation S-K, Item 301). Reflects net sales or operating revenues, income (loss) from continuing operations, income (loss) from continuing operations per common share, total assets, long-term obligations and redeemable preferred stock (including long-term debt, capital leases, and redeemable preferred stock), and cash dividends declared per common share of the target for the five most recent fiscal years (required unless the target would qualify as an SRC).
Changing Lanes
[Added February 10,
2021]
On November 19, 2020, the SEC issued a
final rule5 that modernizes and simplifies MD&A and certain
financial disclosure requirements in SEC Regulation S-K. Among
other changes, the final rule:
- Eliminates the requirement for selected financial data (see Regulation S-K, Item 301).
- Simplifies the requirement for supplementary financial information (see Regulation S-K, Item 302).
- Amends certain aspects of MD&A, including critical accounting estimates (see Regulation S-K, Item 303).
Early adoption on an item-by-item basis is
permitted for filings on or after February 10, 2021. The final
rule must be applied in a registrant’s first fiscal year ending
on or after August 9, 2021. See Deloitte’s November 24, 2020,
Heads
Up for more information.
-
Quantitative and qualitative disclosures about market risks (see Regulation S-K, Item 305). Generally describes the impact that certain market risks, such as interest rate risk, may have on the target (required unless the target would qualify as an SRC).
-
Comparative per share information (see Item 14(b)(10) of Schedule 14A, “Information Required in Proxy Statement,” and Form S-4, Item 3(f)).
-
A description of the target’s business (see Regulation S-K, Item 101), properties (see Regulation S-K, Item 102), legal proceedings (see Regulation S-K, Item 103), and directors and officers (including their compensation) (see Regulation S-K, Items 401, 402, and 404).
-
Risk factors related to the target (see Regulation S-K, Item 105).
Changing Lanes
On August 26, 2020, the SEC issued a
final rule6 to amend Regulation S-K, Items 101, 103, and 105, to
simplify compliance and improve the readability of the
disclosures. The amendments are effective for filings made on or
after November 9, 2020. For more information about the new rule,
see Deloitte’s September 3, 2020, Heads Up.
For additional details regarding the requirements
related to this information, see Chapter 4 of Deloitte’s Roadmap
Initial Public
Offerings.
Identifying the Accounting Acquirer
In each acquisition, one of the combining entities must be identified as the
acquirer. The ASC master glossary defines an acquirer as follows:
The entity that obtains control of the acquiree. However, in a
business combination in which a variable interest entity (VIE) is
acquired, the primary beneficiary of that entity always is the
acquirer.
Accordingly, if the acquiree is a VIE, the primary beneficiary of the VIE is
considered the acquirer.
In an acquisition effected primarily by transferring cash or other assets or
by incurring liabilities, the acquirer usually is the entity that transfers
the cash or other assets or incurs the liabilities. In an acquisition
effected primarily by exchanging equity shares, the entity that issues its
equity interests to effect the transaction (the “legal acquirer”) is usually
the accounting acquirer. However, in some transactions, the legal acquirer
is determined to be the accounting acquiree, while the entity whose equity
interests are acquired (the “legal acquiree”) is for accounting purposes the
accounting acquirer. Such transactions are commonly called reverse
acquisitions. ASC 805-40-05-2 provides the following example of a reverse acquisition:
As one example of a reverse acquisition, a private operating entity
may want to become a public entity but not want to register its
equity shares. To become a public entity, the private entity will
arrange for a public entity to acquire its equity interests in
exchange for the equity interests of the public entity. In this
situation, the public entity is the legal acquirer because it issued
its equity interests, and the private entity is the legal acquiree
because its equity interests were acquired. However, application of
the guidance in paragraphs 805-10-55-11 through 55-15 results in
identifying:
-
The public entity as the acquiree for accounting purposes (the accounting acquiree)
-
The private entity as the acquirer for accounting purposes (the accounting acquirer).
Entities should consider the following factors in ASC 805-10-55-12 and 55-13
when identifying the accounting acquirer in business combinations effected
primarily by exchanging equity shares:
-
“The relative voting rights in the combined entity after the business combination.”
-
“The existence of a large minority voting interest in the combined entity.”
-
“The composition of the governing body of the combined entity.”
-
“The composition of the senior management of the combined entity.”
-
“The terms of the exchange of equity interests.”
-
The “relative size (measured in, for example, assets, revenues, or earnings)” of the combining entities.
While an evaluation of the pertinent facts and circumstances
often results in the clear identification of one of the combining entities
as the acquirer, in some transactions the determination of the acquirer may
be less straightforward (i.e., some indicators point to one entity and
others point to the other). Since ASC 805 does not specify a hierarchy or
the weight to place on each fact and circumstance associated with the
assessment, an entity may sometimes need to use judgment. In such cases, the
SEC staff typically expects the entity’s disclosures to give financial
statement users insight into how the accounting acquirer was determined
(e.g., a description of the facts and circumstances deemed by the entity to
be the most instructive in its identification of the accounting
acquirer).
A transaction in which a SPAC acquires a target must be analyzed to determine
whether the SPAC or the target is the accounting acquirer. Entities should
consider all pertinent facts and circumstances in its evaluation.
Considerations related to each potential outcome are as follows:
-
The SPAC is determined to be the accounting acquirer — The entities must assess whether or not the target meets the definition of a business in accordance with U.S. GAAP. If it does, the transaction is accounted for as a business combination and the SPAC recognizes the target’s assets and liabilities in accordance with the guidance in ASC 805-10, ASC 805-20, and ASC 805-30, generally at fair value. If the target is determined to be a group of assets that does not meet the definition of a business in accordance with U.S. GAAP, the transaction is accounted for as an asset acquisition and the SPAC recognizes the target’s assets and liabilities in accordance with the guidance in ASC 805-50, generally at relative fair value.
-
The target is determined to be the accounting acquirer — Typically, the SPAC’s only precombination assets are cash and investments and the SPAC does not meet the definition of a business in accordance with U.S. GAAP. Therefore, the substance of the transaction is a recapitalization of the target (i.e., a reverse recapitalization) rather than a business combination or an asset acquisition. In such a situation, the transaction would be accounted for as though the target issued its equity for the net assets of the SPAC and, since a business combination has not occurred, no goodwill or intangible assets would be recorded.
See Sections 3.1 and 6.8.8 of Deloitte’s Roadmap Business
Combinations for additional information on identifying
the acquirer and considerations for evaluating transactions involving SPACs.
Financial Statement Presentation for Reverse Recapitalizations
[Section added February 10, 2021]
Although U.S. GAAP does not provide direct guidance on the
accounting for reverse recapitalizations, the guidance in ASC 805-40-45-1
and 45-2 on the presentation of financial statements for reverse business
combination acquisitions has been applied by analogy. Accordingly, in SPAC
transactions accounted for as reverse recapitalizations, the financial
statements of the combined company represent a continuation of the financial
statements of the target. As a result, the assets and liabilities of the
target are presented at their historical carrying values in the financial
statements of the combined company, and the assets and liabilities of the
SPAC are recognized on the acquisition date and measured on the basis of the
net proceeds from the capital transaction.
The following table summarizes the measurement basis for the combined
company’s financial statements at the time of a reverse recapitalization
with a SPAC:
|
Balance
|
Measurement Basis
|
|---|---|
|
Assets and liabilities
|
Sum of (1) the SPAC’s net assets (net cash proceeds
from capital raise) and (2) the target’s assets and
liabilities, measured at their carrying values.
|
|
Retained earnings and other equity balances
|
The target's pretransaction carrying
amount, proportionately reduced by any preexisting
noncontrolling interests in the target.
|
|
Issued equity
|
Sum of (1) the target’s issued
equity immediately before the reverse
recapitalization, proportionately reduced by any
preexisting noncontrolling interests in the target,
and (2) the net proceeds received from the SPAC
(i.e., the hypothetical consideration transferred).
The equity structure (i.e., the number and type of
equity interests issued) reflects the target’s
equity structure. However, the balance is adjusted
to reflect the par value of the outstanding shares
of the SPAC, including the number of shares issued
in the reverse recapitalization. Any difference is
recognized as an adjustment to the additional
paid-in capital (APIC) account.
|
|
APIC
|
The historical APIC account of the
target immediately before the reverse
recapitalization is carried forward and increased to
reflect the net proceeds received for the SPAC
adjusted for any necessary changes in the par value
of the shares and the ratio of shares held by
preexisting target shareholders.
|
|
Noncontrolling interest
|
The noncontrolling interest’s
proportionate share of the target’s pretransaction
retained earnings and other equity balances.
|
|
Prior-period presentation of equity
and EPS
|
For periods before the reverse recapitalization, the
shareholders’ equity of the combined company is
presented on the basis of the historical equity of
the target before the reverse recapitalization,
retroactively recast to reflect the number of shares
received in the acquisition.
|
|
EPS
|
For periods before the reverse
recapitalization, the EPS of the combined company is
presented on the basis of the target’s shares
outstanding multiplied by the exchange ratio.
Complexities may arise for targets with
multiple-class share structures; consultation with
accounting advisers is encouraged.
|
|
Transaction costs
|
SAB Topic 5.A states that
“[s]pecific incremental costs directly attributable
to a proposed or actual offering of securities may
properly be deferred and charged against the gross
proceeds of the offering.” While a reverse
recapitalization is legally structured as a merger
or acquisition, the transaction is, in substance, a
capital raise of the target. Therefore, we believe
that specific incremental costs incurred by the
target that directly result from the transaction may
be offset against the proceeds raised. Management
salaries or other general and administrative
expenses typically are not considered incremental or
directly attributable to the SPAC transaction, even
though they may increase as a result of the
transaction. Costs incurred by the SPAC would
generally be expensed as incurred in the SPAC’s
pretransaction financial statements.
|
Accounting for Shares and Warrants Issued by a SPAC
[Section added
March 19, 2021]
The guidance in this section is based on the typical terms and
conditions that have been observed in practice. Since the specific terms can
affect the accounting, consultation with an entity’s accounting advisers is
recommended.
In its IPO, a SPAC typically issues units to third-party investors at $10.00 per
unit. Each unit generally contains both of the following:
- One Class A ordinary share (a “Class A Share”).
- A fraction of a warrant to purchase one Class A Share at an exercise price of $11.50 (a “Public Warrant”).
The sponsor and its affiliates generally receive Class B
ordinary shares (“Class B Shares”) in return for forming the SPAC. They may also
purchase warrants (“Private Placement Warrants”) to acquire Class A Shares at an
exercise price of $11.50 per share. Alternatively, a so-called “anchor investor”
may purchase Private Placement Warrants in lieu of their being purchased by the
sponsor. The Private Placement Warrants are generally purchased at $1.00 or
$1.50 per warrant, and the proceeds received by the SPAC are used to pay the
underwriting fees incurred in conjunction with the SPAC’s IPO. [Paragraph amended April 30, 2021]
In addition, there may be other arrangements that entities enter into upon the
formation of a SPAC or at a later date before the SPAC completes a merger. Those
may include the following:
- Forward contracts that (1) obligate the SPAC to issue additional Class A Shares to a counterparty at a fixed price and (2) are settled immediately before the SPAC completes a merger with a target.
- Warrants on Class A Shares or on Class B Shares that are issued to the sponsor, its affiliates, or third parties in return for providing financing to the SPAC.
- Classes of preferred stock issued to third-party investors, the sponsor, or the sponsor’s affiliates.
- Class A Shares or Class B Shares (or warrants on such shares) that are issued to the SPAC’s employees or third-party service providers as compensation for services provided.
While the discussion in this publication does not specifically
address these other arrangements, the accounting analysis of some of these
arrangements (e.g., the forward contracts and warrants described in the first
two bullet points) may be similar to that of Public Warrants or Private
Placement Warrants, which are discussed below. SPACs that issue preferred shares
or share-based payment arrangements should consider other applicable GAAP to
determine the appropriate accounting, including the potential effect of those
instruments on reported EPS. Any shares or warrants issued as a share-based
payment arrangement must be accounted for in accordance with ASC 718.
Unit of Account
Although initially issued as a unit, the Class A Shares and Public
Warrants become separately tradable shortly after the IPO. In addition,
upon exercise, the Public Warrants do not alter the terms of the Class A
Shares previously issued. Therefore, the Public Warrants (1) are legally
detachable and separately exercisable from the Class A Shares issued as
part of the units and (2) meet the definition of a freestanding
financial instrument in ASC 480-10-20.
Since the Class A Shares and Public Warrants constitute separate units of
accounting, the proceeds from the issuance of these units, net of any
direct and incremental offering costs, must be allocated between the two
components. The appropriate allocation method depends on how the Public
Warrants are classified:7
-
Public Warrants classified as liabilities — The SPAC must use the with-and-without method to allocate the net proceeds among the Class A Shares and Public Warrants. Under that method, a portion of the net proceeds from the issuance of the units that equals the Public Warrants’ issuance-date fair value must first be allocated to the Public Warrants. The entity then allocates the remaining net proceeds to the Class A Shares. The with-and-without allocation approach avoids the recognition of a “day 1” gain or loss in earnings on the Public Warrants that is not associated with a change in their fair value (i.e., an entity does not recognize a day 1 gain or loss for the Public Warrants, which are subsequently measured at fair value, with changes in fair value recognized in earnings).
-
Public Warrants classified as equity instruments — The SPAC must use the relative fair value method to allocate the net proceeds among the Class A Shares and Public Warrants. Under that method, the SPAC makes separate estimates of the fair values of the Class A Shares and Public Warrants and then allocates the net proceeds in proportion to those fair value amounts. Because the relative fair value method requires SPACs to independently measure each instrument, entities must make more fair value estimates under this method than under the with-and-without method.
The Class B Shares and any Private Placement Warrants
issued by the SPAC also generally represent separate units of
accounting. If the Private Placement Warrants were purchased by the
sponsor in contemplation of the formation of the SPAC, the entity should
consider (1) the need to allocate the amount it paid for these warrants
between the Class B Shares and Private Placement Warrants and (2)
whether such warrants represent share-based payment awards to the
sponsor. In the discussion of the classification of the Private
Placement Warrants below, it is assumed that the warrants are not
share-based payment arrangements. In a manner consistent with the
discussion of Class A Shares and Public Warrants above, if the Private
Placement Warrants are classified as liabilities, the initial amount
allocated to those warrants must equal their initial fair value. [Paragraph amended March
25, 2021]
To perform the allocations discussed above, entities
must measure the fair value of the instruments in accordance with ASC
820. Although Public Warrants and Private Placement Warrants are
generally not “in-the-money” on the issuance date and are often
contingently exercisable, their fair value is nevertheless greater than
zero. When measuring fair value, the entity must take into account the
relatively high probability that the SPAC will successfully merge with a
target and the warrants will subsequently become exercisable and contain
intrinsic value. The issuance-date fair value of a Public Warrant or
Private Placement Warrant is not zero because there is no intrinsic
value on that date. All warrants on equity shares have time value, which
equals the fair value of the warrant when it is not in-the-money.
For further information on the allocation of proceeds
to multiple freestanding financial instruments, see Section 3.4 of Deloitte’s Roadmap
Debt. For more information on fair value
measurements, see Deloitte’s Roadmap Fair Value Measurements and Disclosures
(Including the Fair Value Option).
Classification of Class A Shares
Class A Shares issued by a SPAC are equity in legal form. Therefore,
these shares should only be classified as liabilities if they represent
(1) mandatorily redeemable financial instruments under ASC 480-10-25-4
or (2) unconditional obligations to deliver a variable number of equity
shares that are liabilities under ASC 480-10-25-14. In practice,
liability classification of the Class A Shares has not been required
under this guidance.
Since a SPAC is an SEC registrant, it must apply the guidance in ASC
480-10-S99-3A on redeemable equity securities. Class A Shares generally
contain the following redemption provisions:
- If the SPAC does not consummate a business combination by a specified date after the IPO (e.g., two years after the IPO), the SPAC will liquidate and the Class A Shares will automatically be redeemed at approximately $10.00 per share.
- If the SPAC does consummate a business combination, all holders of the Class A Shares have the right to redeem their shares at approximately $10.00 per share immediately before the consummation (generally subject to the requirement that the SPAC maintain a minimum amount of net tangible assets [e.g., $5 million]).
Because it is certain that the Class A Shares will be
redeemed or become redeemable and no exceptions in ASC 480-10-S99-3A
apply, the shares (1) must be classified within temporary equity in the
SPAC’s financial statements and (2) are subject to the subsequent
measurement guidance in ASC 480-10-S99-3A. An entity must subsequently
measure the shares to their redemption amount because, as a result of
the allocation of net proceeds to the Public Warrants, the initial
carrying amount of the Class A Shares will be less than $10.00 per
share. In accordance with ASC 480-10-S99-3A(15), there are two
alternative methods that an entity can apply when subsequently measuring
Class A Shares:
- Remeasure the Class A Shares to their redemption amount (i.e., $10.00 per share) immediately as if the end of the first reporting period after the IPO was the redemption date.
- Accrete changes in the difference between the initial carrying amount and the redemption amount from the IPO date to the redemption date. To apply this method, the SPAC must consider the date on which it expects a business combination to occur, rather than merely accreting to the automatic redemption date.
Because a SPAC has two classes of shares (i.e., Class A
Shares and Class B Shares), it must apply the EPS guidance in ASC
480-10-S99-3A, which requires specific accounting for the measurement
adjustments. That is, the SPAC must apply the two-class method of
calculating EPS while taking into account the measurement adjustments
under an assumption that they represent dividends to the holders of the
Class A Shares. Generally, Public Warrants and Private Placement
Warrants do not represent participating securities; therefore, the
application of the two-class method of calculating EPS is limited to the
allocation of the SPAC’s net income or loss between the Class A Shares
and Class B Shares.
After the completion of a business combination with a target, the
redemption features on the Class A Shares generally lapse. Therefore, in
the absence of other redemption provisions, the temporary equity
classification of such shares is no longer required. That is, provided
the Class A Shares are redeemable only on an ordinary liquidation of the
SPAC after a business combination, which is generally the case, they are
not required to be classified in temporary equity.
Classification of Class B Shares
The Class B Shares issued by a SPAC are equity in legal
form. SPACs should consider whether these shares are within the scope of
ASC 718 on the basis of the specific terms of the shares and other
relevant facts and circumstances. The classification guidance in ASC 718
refers to the classification guidance in ASC 480, but there are
additional considerations under ASC 718 that SPACs should take into
account. The Class B Shares should be classified as liabilities if they
represent (1) mandatorily redeemable financial instruments under ASC
480-10-25-4 or (2) unconditional obligations to deliver a variable
number of equity shares that are liabilities under ASC 480-10-25-14. In
practice, liability classification of the Class B Shares has not been
observed. [Paragraph
amended March 25, 2021]
Class B Shares are generally not redeemable by the holder, and a holder
is not entitled to any proceeds if the SPAC liquidates because of a
failure to complete a business combination. That is, in the absence of a
merger of the SPAC with a target, the Class B Shares will be worthless.8 Because there are no redemption provisions, entities are not
required to classify Class B Shares in temporary equity under ASC
480-10-S99-3A.
Public Warrants
To determine the appropriate classification of the Public Warrants, SPACs
must first consider the liability classification guidance in ASC 480.
ASC 480-10-25-8 states:
An entity shall classify as a liability (or an
asset in some circumstances) any financial instrument, other
than an outstanding share, that, at inception, has both of the
following characteristics:
- It embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation.
- It requires or may require the issuer to settle the obligation by transferring assets.
The evaluation of whether Public Warrants are liabilities under ASC
480-10-25-8 will generally depend on when the warrants become
exercisable
|
The Public Warrants may be exercised before
a merger with a target.
|
The Public Warrants are liabilities under ASC
480-10-25-8 because the Class A Shares received
upon exercise of the warrants may be redeemed at
the holder’s option upon a merger of the SPAC. The
SPAC is obligated to use its best efforts to
complete a merger.
|
|
The Public Warrants may be
exercised only after a
merger with a target. For example, they may be
exercised only upon on the later of (1) 30 days
after the SPAC completes a business combination
and (2) 12 months from the date on which the
SPAC’s IPO closes.
|
The Public Warrants are not liabilities under ASC
480-10-25-8 because once the warrants are
exercisable, the holder will receive Class A
Shares that are not redeemable. As discussed
above, once a merger with a target is completed,
the holders of Class A Shares no longer have any
ability to redeem their shares. Rather, such
shares are redeemable only upon an ordinary
liquidation of the combined company.
|
If the Public Warrants are not liabilities under ASC 480-10-25-8, the
SPAC should consider whether they represent liabilities under ASC
480-10-25-14. In practice, it would be unusual for such warrants to
represent an obligation to issue a variable number of equity shares
whose monetary value is based solely or predominantly on (1) a fixed
amount, (2) variations in something other than the fair value of the
Class A Shares, or (3) variations that are inversely related to the fair
value of the Class A Shares. Public Warrants that are not liabilities
under ASC 480 are classified as liabilities or equity in accordance with
ASC 815-40.9
To be classified as an equity instrument under ASC 815-40, the Public
Warrants must meet two conditions:
- They are indexed to the SPAC’s stock.
- They meet the criteria for equity classification (i.e., the SPAC controls the ability to settle the warrants in shares; note that these criteria are relevant even if the contract requires settlement in shares).
Indexation
ASC 815-40-15 contains a two-step model that an entity must apply to
determine whether the Public Warrants are indexed to the SPAC’s
stock. The evaluation must consider the following:
- Step 1 — The exercise or settlement of the contract (“contingent exercise provisions”).
- Step 2 — The monetary value of the settlement amount (i.e., factors that affect the settlement amount, or “settlement provisions”).
For each unit of account, the entity evaluates the indexation
requirements in ASC 815-40-15. If the entity determines that the
contract is not considered indexed to the company’s stock, the
contract must be classified as a liability (i.e., equity
classification is never permitted).
ASC 815-40-15-7A addresses step 1 of the two-step indexation
evaluation and states, in part:
An exercise contingency shall not preclude an instrument (or
embedded feature) from being considered indexed to an
entity's own stock provided that it is not based on either
of the following:
- An observable market, other than the market for the issuer's stock (if applicable)
- An observable index, other than an index calculated or measured solely by reference to the issuer's own operations (for example, sales revenue of the issuer; earnings before interest, taxes, depreciation, and amortization of the issuer; net income of the issuer; or total equity of the issuer).
The following features, which are exercise
contingencies that generally exist in Public Warrants, would not
preclude the warrants from being indexed to the SPAC’s stock under
step 1 of ASC 815-40-15:
- The Public Warrants are exercisable only if the SPAC completes a business combination.
- The Public Warrants are no longer exercisable if the SPAC liquidates.
- The SPAC can force early exercise of the Public Warrants through certain redemption features.
While the above features represent the typical
contingent exercise provisions in Public Warrants, there may be
other features that must be evaluated under step 1 of ASC 815-40-15.
ASC 815-40-15-7C through 15-7I discuss the evaluation of settlement
provisions. Any provision that (1) can potentially alter either the
exercise price or the number of Class A Shares that are issuable
upon exercise of the Public Warrants and (2) is not considered a
down-round provision must be evaluated to determine whether it
represents an input into the pricing of a fixed-for-fixed forward or
option on equity shares. Common provisions that require evaluation
include the following:
- Antidilution-type adjustment provisions.
- Replacement of the Class A Shares with other consideration in a reorganization or recapitalization.
- Adjustments to the exercise price or number of Class A Shares as a result of the SPAC’s issuance of additional Class A Shares or other equity instruments at a price or effective price that is less than the Public Warrants’ exercise price (note that for such a provision to not preclude the Public Warrants from being indexed to the SPAC’s stock, the provision must meet the ASC master glossary definition of a down-round feature).
- Adjustments to the number of Class A Shares issuable to compensate the holder for lost time value upon an early settlement of the Public Warrants.
- Adjustments to the exercise price or number of Class A Shares that are made at the discretion of the SPAC to benefit the holders of the Public Warrants.
Public Warrants generally contain multiple
provisions that adjust the settlement amount to compensate the
holders for lost time value upon an early exercise or settlement.
For such provisions to not preclude the Public Warrants from being
considered indexed to the SPAC’s stock under step 2 of ASC
815-40-15, the entity must conclude that the adjustment (e.g., the
increase in the number of additional Class A Shares issuable)
represents a reasonable amount of compensation to the holder for
lost time value. We generally believe that if the additional value
paid to the holder does not exceed the amount of lost time value,
the adjustment will not preclude the Public Warrants from being
indexed to the SPAC’s stock under step 2 of ASC 815-40-15. That is,
as long as the holder would receive a monetary amount upon
settlement that is (1) not less than the intrinsic value of the
Public Warrants on the early settlement date and (2) not more than
the fair value of the Public Warrants on the early settlement date,
the settlement provision would not preclude the Public Warrants from
being indexed to the SPAC’s stock under step 2 of ASC 815-40-15. For
the purpose of this determination, fair value means an amount that
is consistent with the fair value measurement guidance in ASC 820.
Many Public Warrants contain a provision that allows
the SPAC to call them for either (1) $0.10 per warrant or (2) Class
A Shares, provided that the shares’ fair value equals or exceeds
$10.00.10 If the SPAC exercises this call right, the holders are
entitled to exercise and settle the Public Warrants on a net share
basis. While such a feature may specify the payment of $0.10 per
warrant, the economic substance of the feature is the same even if
the $0.10 payment is not specified. (Hereafter, such a call right is
also referred to as a “redemption-for-stock” feature). The
determination of the number of Class A Shares issuable upon a
settlement of a redemption-for-stock feature is based on a table
whose axes are share price and time to maturity. The purpose of the
table is to prescribe the amount of compensation the holder should
receive for lost time value for any settlement that occurs when the
Class A Share price is below $18.00. For the settlement amounts in
this table to not preclude the Public Warrants from being indexed to
the SPAC’s stock under step 2 of ASC 815-40-15, the entity must
conclude, on the basis of reasonable assumptions as of the issuance
date of the Public Warrants, that each settlement number in the
table represents a reasonable amount of compensation for lost time
value. The assumptions that affect the estimated fair value of the
Public Warrants should affect the number of shares included in each
cell in the settlement table and should be determined in a
commercially reasonable manner. Those assumptions include stock
volatility, interest rates, and dividends. Because these assumptions
change over time, a SPAC cannot conclude that a potential settlement
based on share amounts in the table does not preclude the Public
Warrants from being indexed to the SPAC’s stock under step 2 of ASC
815-40-15 solely because the share amounts in the table are the same
as those in other Public Warrant agreements issued by other SPACs.
Rather, each SPAC will generally need to consult with valuation
specialists to determine whether the settlement provisions that
apply in accordance with these settlement tables preclude the Public
Warrants from being indexed to the SPAC’s stock under step 2 of ASC
815-40-15. See Chapter 4 of Deloitte's Roadmap Contracts on an
Entity's Own Equity for further information
on the indexation requirements. [Paragraph amended April 30, 2021]
Some Public Warrants contain a provision that
indicates that the settlement amount could differ if the warrants
are held by the SPAC’s officers or directors. This settlement
difference would arise in the event that the SPAC exercises its
redemption-for-stock feature. In such cases, holders of Public
Warrants that are not officers or directors of the SPAC would
receive a number of Class A Shares per warrant on the basis of the
table described in the previous paragraph, but holders of Public
Warrants that are officers or directors of the SPAC would
receive a number of Class A Shares on the basis of the fair value of
their warrants. An example of such a provision is as follows: [Paragraph added
April 30, 2021]
Public Warrants held by the
Company’s officers or directors. The Company agrees that if
Public Warrants are held by any of the Company’s officers or
directors, the Public Warrants held by such officers and directors
will be subject to the redemption rights provided in Section 6.2,
except that such officers and directors shall only receive “Fair
Market Value” (“Fair Market Value” in
this Section 6.6 shall mean the last sale price of the Public
Warrants on the Alternative Redemption Date) for such Public
Warrants so redeemed.
On April 12, 2021, the SEC staff issued
Staff Statement on Accounting and Reporting
Considerations for Warrants Issued by Special Purpose
Acquisition Companies (“SPACs”) (the
“SEC Staff Statement”), which addresses certain balance sheet
classification matters related to warrants issued by SPACs. The SEC
Staff Statement discusses a fact pattern related to the terms of
warrants that were issued by a SPAC and states, in part: [Paragraph added
April 30, 2021]
[T]he 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.
ASC 815-40-15-7E discusses the inputs into the pricing of a
fixed-for-fixed option on equity shares. As indicated in the SEC
Staff Statement, the holder is not an input into the pricing of an
option on equity shares. Therefore, if the settlement terms of the
instrument (i.e., the exercise price or number of shares) could
potentially vary on the basis of its holder, the instrument is not
considered indexed to the SPAC’s stock. Public Warrants with an
officer or director provision such as the one described above have
settlement terms that depend on the holder. Accordingly, such Public
Warrants are not considered indexed to the SPAC’s stock and must be
classified as liabilities. Note that such liability classification
is required both before and after a SPAC merges with a target. [Paragraph added April 30,
2021]
Equity Classification Conditions
[Section amended April 30,
2021]
If an entity determines that the Public Warrants are
considered indexed to the SPAC’s stock under ASC 815-40, it must
evaluate the conditions in ASC 815-40-25 to determine whether it
controls the ability to settle the contract in its shares. Only
contracts for which the entity controls settlement in shares (i.e.,
that meet the conditions in ASC 815-40-25) may be classified in
equity. For example, if (1) the holder of Public Warrants is able to
net cash settle its warrants upon the occurrence of an event outside
the SPAC’s control and (2) holders of the common shares underlying
such warrants are not entitled to the same cash settlement right,
the Public Warrants would not meet the equity classification
requirements in ASC 815-40-25.
Public Warrants often contain a provision that
allows their holders to receive cash in the event of a tender or
exchange offer involving the common shares underlying such warrants.
(Note that Private Placement Warrants may also be subject to this
provision; therefore, the discussion in this section applies to both
Public Warrants and Private Placement Warrants.) An example of such
a provision (a tender offer provision) is as follows:11
(ii) [I]f a tender, exchange or
redemption offer shall have been made to and accepted by the holders
of the Common Stock (other than a tender, exchange or redemption
offer made by the Company in connection with redemption rights held
by stockholders of the Company as provided for in the Company’s
amended and restated certificate of incorporation or as a result of
the repurchase of shares of Common Stock by the Company if a
proposed initial Business Combination is presented to the
stockholders of the Company for approval) under circumstances in
which, upon completion of such tender or exchange offer, the maker
thereof, together with members of any group (within the meaning of
Rule 13d-5(b)(1) under the Exchange Act (or any successor rule)) of
which such maker is a part, and together with any affiliate or
associate of such maker (within the meaning of Rule 12b-2 under the
Exchange Act (or any successor rule)) and any members of any such
group of which any such affiliate or associate is a part, own
beneficially (within the meaning of Rule 13d-3 under the Exchange
Act (or any successor rule)) more than 50% of the outstanding shares
of Common Stock, the holder of a Warrant shall be entitled to
receive as the Alternative Issuance, the highest amount of cash,
securities or other property to which such holder would actually
have been entitled as a stockholder if such Warrant holder had
exercised the Warrant prior to the expiration of such tender or
exchange offer, accepted such offer and all of the Common Stock held
by such holder had been purchased pursuant to such tender or
exchange offer, subject to adjustments (from and after the
consummation of such tender or exchange offer) as nearly equivalent
as possible to the [antidilution] adjustments.
The SEC Staff Statement addresses the effect of this type of
provision on the classification of Public Warrants and Private
Placement Warrants issued by a SPAC. It states, in part:
GAAP further includes a general principle
that 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. However, GAAP provides an exception to this general
principle whereby equity classification would not be
precluded if net cash settlement can only be triggered in
circumstances in which the holders of the shares underlying
the contract also would receive cash. Scenarios where this
exception would apply include events that fundamentally
change the ownership or capitalization of an entity, such as
a change in control of the entity, or a nationalization of
the entity. [Footnotes omitted]
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.
The evaluation of the accounting for
contracts in an entity’s own equity, such as warrants issued
by a SPAC, requires careful consideration of the specific
facts and circumstances for each entity and each contract.
OCA is available for consultation on accounting and
financial reporting issues, including relating to an
entity’s specific fact pattern on issues similar to those
described above or on other instruments and accounting
issues. [Footnote omitted]
The SEC Staff Statement addresses a fact pattern in which a SPAC and
a target merge, and after the transaction, the combined company has
two classes of common shares — Class A and Class B. The tender offer
provision pertains to the Public Warrants and Private Placement
Warrants, which are both exercisable into Class A Shares. The Class
B Shares control the entity and would continue to have such control
regardless of the number of Class A Shares involved in a tender or
exchange offer (i.e., there would not be a change in control of the
entity). The SEC staff concluded that as a result of the tender
offer provision, the Public Warrants and Private Placement Warrants
would not meet the ASC 815-40-25 conditions for equity
classification because (1) all such warrants could be cash settled
upon an event outside the entity’s control and it is possible that
less than all or substantially all of the Class A Shares would be
eligible to receive cash (e.g., the tender offer provision applies
if 50.1 percent of the Class A Shares are involved in a tender or
exchange offer) and (2) the provision that would result in such a
cash settlement would not lead to a change in control of the entity.
In reaching this conclusion, the SEC staff
acknowledged that ASC 815-40-55-2 through 55-4 can be interpreted as
providing a limited exception to the general principle that an
equity-linked holder cannot be entitled to receive cash unless the
holders of all shares underlying the contract are also entitled to
receive cash. The paragraphs that describe this limited exception
state:
55-2 An event that causes a change in
control of an entity is not within the entity's control and,
therefore, if a contract requires net cash settlement upon a
change in control, the contract generally must be classified
as an asset or a liability.
55-3 However, if a change-in-control
provision requires that the counterparty receive, or permits
the counterparty to deliver upon settlement, the same form
of consideration (for example, cash, debt, or other assets)
as holders of the shares underlying the contract, permanent
equity classification would not be precluded as a result of
the change-in-control provision. In that circumstance, if
the holders of the shares underlying the contract were to
receive cash in the transaction causing the change in
control, the counterparty to the contract could also receive
cash based on the value of its position under the
contract.
55-4 If, instead of cash, holders of the shares
underlying the contract receive other forms of consideration
(for example, debt), the counterparty also must receive debt
(cash in an amount equal to the fair value of the debt would
not be considered the same form of consideration as debt).
However, the SEC staff concluded that this exception could only be
applied if the event giving rise to the cash settlement of the
equity-linked financial instrument would always cause a change in
control of the entity. Because a change in control could never occur
in the fact pattern in the example, the SEC staff concluded that the
limited exception would not apply and, therefore, the registrant’s
Public Warrants and Private Placement Warrants would not meet the
equity classification conditions in ASC 815-40-25 (i.e., the cash
settlement provided by the tender offer provision violated the
general principle in ASC 815-40-25 for equity classification). As a
result, the registrant would be required to classify those warrants
as liabilities.
On the basis of informal discussions, we understand that the SEC
staff’s conclusion specifically addresses the particular facts and
circumstances of the registrant, which has a dual common share
structure. Therefore, if (1) a Public Warrant or Private Placement
Warrant contains a provision similar to the tender offer provision
described above and (2) the registrant has a dual common share
structure in which both classes are entitled to vote on matters
submitted to the vote of the entity’s stockholders (which is usually
the case before any acquisition of a target by the SPAC), the
warrant would not meet the equity classification conditions in ASC
815-40-25 and must be classified as a liability. The same conclusion
would apply if there was a single common share structure but other
classes of securities were entitled to currently vote on matters
submitted to the vote of the entity’s stockholders.
However, we do not believe that the SEC staff’s
conclusion must be applied when there is a similar tender offer
provision if (1) there is only a single class of voting common
shares and (2) only that class of shares is entitled to vote on
matters submitted to the entity’s stockholders (i.e., the entity has
no other class of voting securities). We believe that, in these
circumstances, it is acceptable to apply the limited exception for
changes in control in ASC 815-40-55-2 through 55-4.12
The table below provides examples of tender offer provisions similar
to the one described above and explains when liability
classification of Public Warrants and Private Placement Warrants is
and is not required.
|
Liability Classification Is Required
|
Liability Classification Is Not Required
|
|---|---|
|
Before a merger with a target,
a SPAC has two classes of voting shares (Class A
and Class B). The tender offer provision pertains
only to the warrants on the Class A Shares.
Liability classification of
such warrants is required as a result of the
tender offer provision because (1) it is possible
that the warrants will be cash settled in a tender
or exchange offer made by a third party (even if
those warrants are not otherwise currently
exercisable) and (2) such a tender or exchange
offer may not result in a change in control of the
SPAC.
|
After a merger with a SPAC, the combined
company has a single class of common shares that
controls the entity. The tender offer provision
pertains only to the warrants on this single class
of shares. The entity has no other voting
securities.
Liability classification of such warrants is
not required as a result of the tender offer
provision because in any cash settlement of the
warrants, the group of common shareholders before
the tender or exchange offer will no longer
control the entity after the tender or exchange
offer (i.e., a third party or group obtains
control of the entity).
|
|
After a merger with a SPAC, the combined
company has a single class of common shares.
Although the common shares collectively control
the entity, there are outstanding preferred shares
that are entitled to currently vote on an
as-converted basis.
Liability classification of such warrants is
required as a result of the tender offer provision
because (1) it is possible that the warrants will
be cash settled in a tender or exchange offer made
by a third party and (2) such tender or exchange
offer may not result in a change in control of the
entity.
|
After a merger with a SPAC, the combined
company has two classes of shares (Class A and
Class B). The Class A Shares have voting rights
and control the entity; the Class B Shares have no
voting rights. The entity has no other securities
with voting rights. The tender offer provision
pertains only to the warrants on the Class A
Shares.
Although there is a dual-class common share
structure, liability classification of such
warrants is not required as a result of the tender
offer provision. This is because in any cash
settlement of the warrants, the group of common
shareholders before the tender or exchange offer
will no longer control the entity after the tender
or exchange offer (i.e., a third party or group
obtains control of the entity).
|
The above table only addresses certain fact
patterns. Consultation with an entity’s independent advisers is
recommended if there are unique facts and circumstances involving
the terms of the tender offer provision or the capital structure of
the entity, or if contracts other than equity shares convey control
to their holder.
See Chapter 5 of Deloitte’s
Roadmap Contracts on an Entity’s Own Equity for
further information on the equity classification conditions in ASC
815-40-25.
Connecting the Dots
On the basis of the SEC Staff Statement, a
registrant may conclude that its historical accounting for
warrants was incorrect (e.g., classified as equity when
terms consistent with the SEC Staff Statement require
liability classification). In such situations, the
registrant must evaluate the materiality of the error to the
previously filed financial statements in accordance with the
guidance in SAB Topic
1.M, "Materiality." For further
information on assessing materiality and SEC comments on
this topic, see Section 2.14 of
Deloitte’s Roadmap SEC Comment Letter
Considerations, Including Industry
Insights.
If a registrant concludes that the error was
material to previously issued financial statements, it must
disclose the error by filing an Item 4.02 Form 8-K within
four business days of determining that the previously issued
financial statements and related audits and reviews should
not be relied upon. The registrant also must amend its most
recently filed Form 10-K and any subsequently filed Forms
10-Q to restate (1) the financial statements, including
applicable disclosures required for error corrections (i.e.,
ASC 250-50), (2) MD&A, (3) critical accounting estimates
that are related to the warrants, (4) quarterly financial
information for interim periods during the fiscal periods
that were affected by the error (in accordance with
Regulation S-K, Item 302), and (5) any other information in
the filings that was affected by the change (e.g., risk
factors, the business section). If the registrant’s auditor
communicated CAMs in its auditor’s report (see Auditing and
Review Standards), it needs to reevaluate
CAMs in light of the warrant matter and determine whether it
needs to make a change in an existing CAM or identify a new
CAM.
The registrant should also consider whether the factors that
led to the restatement represent a material weakness in
internal control over financial reporting (ICFR) or
ineffective disclosure controls and procedures (DCPs). The
SEC staff often comments when companies conclude that either
ICFR or DCPs remained effective after a material
restatement. For more information, see Sections 3.5 and 3.6 of Deloitte’s Roadmap
SEC Comment Letter
Considerations, Including Industry
Insights.
If the registrant
concludes that the error was either (1) not material to
the prior period being changed but would be material to
the current period if corrected in the current period or
(2) not material to any periods being presented in the
required financial statements and disclosures, it may
update the prior periods in future filings. In addition,
as noted in the SEC Staff Statement, registrants that
determine that the errors are not material to the
required financial statements and disclosures included
in a pending transaction may provide the staff, via
EDGAR correspondence, a written representation to that
effect. A registrant must also evaluate the impact of an
immaterial misstatement on ICFR and DCPs since the
severity of a deficiency in ICFR depends on whether
there is a reasonable possibility that the deficiency
could have resulted in a material
misstatement. For more information, see Section
3.6.2 of Deloitte’s Roadmap
SEC Comment Letter Considerations, Including
Industry Insights.
Earnings per Share
Because Public Warrants represent potential common shares, the
accounting and disclosure requirements of ASC 260 must be applied.
In calculating diluted EPS, the SPAC should consider the guidance on
contingently issuable shares.
Also note that whether classified as equities or liability
instruments, Public Warrants that give the holders nonforfeitable
rights to dividends represent participating securities regardless of
whether the SPAC actually declares or pays dividends.
See Deloitte’s Roadmap Earnings per Share for
further information on contingently issuable shares and
participating securities.
Private Placement Warrants
[Section amended April 30,
2021]
Although the terms of Private Placement Warrants are
often similar to the terms of Public Warrants, there may be key
differences, such as the following:
- Public Warrants often have a redemption-for-stock feature or a feature that allows the SPAC to call such warrants for $0.01 in the event the holder does not exercise them. Private Placement Warrants do not contain redemption features that allow the SPAC to call the warrants to force early exercise.
- Some exercise price adjustments are calculated differently for Private Placement Warrants and Public Warrants.
- The cashless (net share) settlement formulas for Private Placement Warrants differ from those that apply to Public Warrants.
The terms of Private Placement Warrants generally change
if they are transferred to a nonpermitted transferee (e.g., a party
other than the sponsor or its affiliates). In such a situation, the
Private Placement Warrants become Public Warrants.
Indexation
[Section added April 30,
2021]
As noted in the discussion of indexation of
Public Warrants, ASC 815-40-15 contains a two-step model that an
entity must apply to determine whether Private Placement Warrants
are indexed to the SPAC’s stock. Under this model, in addition to
evaluating contingent exercise provisions, an entity must determine
whether any potential adjustment to the exercise price or settlement
amount represents an input into the pricing of a fixed-for-fixed
option on equity shares. ASC 815-40-15-7E discusses such inputs.
As indicated in the SEC Staff Statement, the holder is not an input
into the pricing of an option on equity shares. Therefore, a Private
Placement Warrant that contains any of the provisions below is
considered not indexed to the SPAC’s stock and must be classified as
a liability because the provision either (1) ceases to apply or (2)
is applied differently if the Private Placement Warrants are
transferred to a nonpermitted transferee and thus become Public
Warrants. That is, in these cases, the settlement amount (i.e.,
exercise price or number of shares) of the Private Placement
Warrants depends on the holder. Note that the provisions below only
affect the classification of Private Placement Warrants because
Public Warrants cannot become Private Placement Warrants.
-
Redemption for stock feature — Public Warrants may contain a provision that allows the SPAC to call them for either (1) $0.10 per warrant or (2) Class A Shares, provided that the shares’ fair value equals or exceeds $10.00. When the SPAC exercises this call right, the holders are entitled to exercise and settle the Public Warrants on a net share basis. While such a feature may specify the payment of $0.10 per warrant, the economic substance of the feature is the same even if the $0.10 payment is not specified. An example of a redemption for stock feature is as follows:Redemption of warrants for common stock. Subject to Sections 6.5 and 6.6 hereof, not less than all of the outstanding Warrants may be redeemed, at the option of the Company, ninety (90) days after they are first exercisable and prior to their expiration, at the office of the Warrant Agent, upon notice to the Registered Holders of the Warrants, as described in Section 6.3 below, at a price equal to a number of shares of Common Stock determined by reference to the table below, based on the redemption date (calculated for purposes of the table as the period to expiration of the Warrants) and the “Fair Market Value” (as such term is defined in subsection 3.3.1(b)) (the “Alternative Redemption Price”), provided that the last sales price of the Common Stock reported has been at least $10.00 per share (subject to adjustment in compliance with Section 4 hereof), on the trading day prior to the date on which notice of the redemption is given and provided that there is an effective registration statement covering the Common Stock issuable upon exercise of the Warrants, and a current prospectus relating thereto, available throughout the 30-day Redemption Period (as defined in Section 6.3 below) or the Company has elected to require the exercise of the Warrants on a “cashless basis” pursuant to subsection 3.3.1.The exact Fair Market Value and Redemption Date (as defined below) may not be set forth in the table above, in which case, if the Fair Market Value is between two values in the table or the Redemption Date is between two redemption dates in the table, the number of Common Stock to be issued for each Warrant redeemed will be determined by a straight-line interpolation between the number of shares set forth for the higher and lower Fair Market Values and the earlier and later redemption dates, as applicable, based on a 365- or 366-day year, as applicable.The stock prices set forth in the column headings of the table above shall be adjusted as of any date on which the number of shares issuable upon exercise of a Warrant is adjusted pursuant to Section 4. The adjusted stock prices in the column headings shall equal the stock prices immediately prior to such adjustment, multiplied by a fraction, the numerator of which is the number of shares deliverable upon exercise of a Warrant immediately prior to such adjustment and the denominator of which is the number of shares deliverable upon exercise of a Warrant as so adjusted. The number of shares in the table above shall be adjusted in the same manner and at the same time as the number of shares issuable upon exercise of a Warrant.
-
Exercise price adjustment upon certain changes of control — Many warrants issued by a SPAC contain a provision that requires the exercise price to be adjusted if (1) there is a change of control of the entity and (2) less than 70 percent of the consideration received is stock listed on an exchange. The calculation of the exercise price adjustment differs for Public Warrants as compared to Private Placement Warrants. That is, for Public Warrants, the adjustment is calculated on the basis of a capped American call option, whereas for Private Placement Warrants, the adjustment is calculated on the basis of an uncapped American call option.13 If, however, the Private Placement Warrants are transferred to a nonpermitted transferee, the exercise price adjustment changes from being calculated on the basis of an uncapped American call option to being calculated on the basis of a capped American call option. An example of such a provision is as follows:[I]f less than 70% of the consideration receivable by the holders of the Common Stock in the applicable event is payable in the form of common stock in the successor entity that is listed for trading on a national securities exchange or is quoted in an established over-the-counter market, or is to be so listed for trading or quoted immediately following such event, and if the Registered Holder properly exercises the Warrant within thirty (30) days following the public disclosure of the consummation of such applicable event by the Company pursuant to a Current Report on Form 8-K filed with the Commission, the Warrant Price shall be reduced by an amount (in dollars) equal to the difference of (i) the Warrant Price in effect prior to such reduction minus (ii) (A) the Per Share Consideration (as defined below) (but in no event less than zero) minus (B) the Black-Scholes Warrant Value (as defined below). The “Black-Scholes Warrant Value” means the value of a Warrant immediately prior to the consummation of the applicable event based on the Black-Scholes Warrant Model for a Capped American Call on Bloomberg Financial Markets (“Bloomberg”). For purposes of calculating such amount, (1) Section 6 of this Agreement shall be taken into account, (2) the price of each share of Common Stock shall be the volume weighted average price of the Common Stock as reported during the ten (10) trading day period ending on the trading day prior to the effective date of the applicable event, (3) the assumed volatility shall be the 90 day volatility obtained from the HVT function on Bloomberg determined as of the trading day immediately prior to the day of the announcement of the applicable event, and (4) the assumed risk-free interest rate shall correspond to the U.S. Treasury rate for a period equal to the remaining term of the Warrant. “Per Share Consideration” means (i) if the consideration paid to holders of the Common Stock consists exclusively of cash, the amount of such cash per share of Common Stock, and (ii) in all other cases, the volume weighted average price of the Common Stock as reported during the ten (10) trading day period ending on the trading day prior to the effective date of the applicable event. If any reclassification or reorganization also results in a change in shares of Common Stock covered by subsection 4.1.1, then such adjustment shall be made pursuant to subsection 4.1.1 or Sections 4.2, 4.3 and this Section 4.4. The provisions of this Section 4.4 shall similarly apply to successive reclassifications, reorganizations, mergers or consolidations, sales or other transfers. In no event will the Warrant Price be reduced to less than the par value per share issuable upon exercise of the Warrant.
- Different formulas used to determine the number of shares
delivered in a cashless (net share) settlement —
There are often multiple definitions of “fair market value”
that may apply in the event of a cashless settlement. If the
definition(s) applicable to Public Warrants differ from the
definition(s) applicable to Private Placement Warrants in
any respect, the Private Placement Warrants are not
considered indexed to the SPAC’s stock because the
applicable definitions change if the Private Placement
Warrants are transferred to a nonpermitted transferee and
thus become Public Warrants. Two examples of a potential
difference are as follows:
-
For Public Warrants:[T]the volume weighted average price of the Common Stock as reported during the ten (10) trading day period ending on the trading day prior to the date that notice of exercise is received by the Warrant Agent from the holder of such Warrants or its securities broker or intermediary.For Private Placement Warrants:[T]he average last sale price of the Common Stock for the ten (10) trading days ending on the third trading day prior to the date on which notice of exercise of the Warrant is sent to the Warrant Agent.
-
For Public Warrants in the case of notice of redemption at $.01:The average reported last sale price of the shares of Common Stock for the ten trading days ending on the third trading day prior to the date on which the notice of redemption is sent to holders of Warrant.For Private Placement Warrants:The average reported last sale price of the shares of Common Stock for the ten trading days ending on the third trading day prior to the date of exercise.
-
If a Private Placement Warrant (1) does not contain
any settlement provision (i.e., a provision other than a standard
antidilution adjustment that affects the exercise price or number of
shares) or (2) could never become a Public Warrant, the Private
Placement Warrant could be classified as equity provided that there
are no other provisions or circumstances that cause the warrant to
not be considered indexed to the SPAC’s stock or not meet the equity
classification conditions in ASC 815-40-25. As discussed above, as a
result of a tender offer provision, Private Placement Warrants may
not meet the equity classification conditions in ASC 815-40-25.
In current practice, because warrant agreements
generally have one or more of the provisions above, most Private
Placement Warrants are not considered indexed to the SPAC’s stock
and require liability classification both before and after a merger
of the SPAC with a target.14 On the basis of the SEC Staff Statement, some registrants may
need to determine whether they have classified such warrants
incorrectly in previously filed financial statements. For
information about evaluating errors, see the Connecting the
Dots discussion in the Equity Classification
Conditions section.
Accounting for Issuance Costs
[Section added April 30, 2021]
Nonauthoritative AICPA Guidance
Technical Q&As Section 4110, “Issuance of
Capital Stock”
.01 Expenses Incurred in Public Sale of
Capital Stock
Inquiry — A closely held corporation is
issuing stock for the first time to the
public.
How would costs, such as legal and accounting
fees, incurred as a result of this issue, be
handled in the accounting records?
Reply — Direct costs of obtaining capital
by issuing stock should be deducted from the
related proceeds, and the net amount recorded as
contributed stockholders' equity.
Assuming no legal prohibitions, issue costs
should be deducted from capital stock or capital
in excess of par or stated value.
Such costs should be limited to the direct cost
of issuing the security. Thus, there should be no
allocation of officers' salaries, and care should
be taken that legal and accounting fees do not
include any fees that would have been incurred in
the absence of such issuance.
SEC Staff Accounting Bulletins
SAB Topic 5.A, Expenses of
Offering [Reproduced in ASC 340-10-S99-1]
Facts: Prior to the effective
date of an offering of equity securities, Company
Y incurs certain expenses related to the
offering.
Question: Should such costs be
deferred?
Interpretive Response: Specific incremental costs
directly attributable to a proposed or actual
offering of securities may properly be deferred
and charged against the gross proceeds of the
offering. However, management salaries or other
general and administrative expenses may not be
allocated as costs of the offering and deferred
costs of an aborted offering may not be deferred
and charged against proceeds of a subsequent
offering. A short postponement (up to 90 days)
does not represent an aborted offering.
In addition to the above guidance, SAB Topic
2.A.6 states, in part, that “[f]ees paid to an investment
banker in connection with a business combination or asset acquisition,
when the investment banker is also providing interim financing or
underwriting services, must be allocated between acquisition related
services and debt issue costs.”
In accordance with this guidance, a SPAC should evaluate which fees and
costs incurred in conjunction with its IPO and any issuance of Private
Placement Warrants or other securities represent direct and incremental
costs that would be eligible for deferral. For example, underwriting
costs incurred to issue the units, as well as certain legal and
accounting fees, may be direct and incremental costs. However, costs
that are not direct or incremental must be expensed as incurred.
After identifying the population of eligible costs that
would qualify for deferral, the SPAC should appropriately allocate such
costs to the various instruments issued. For example, when a SPAC incurs
underwriting costs with an investment bank (including deferred costs)
and the amount of those costs is directly related to the proceeds
received from issuing the units, those costs should only be allocated to
the units. Other costs that are not directly related to a specific type
of instrument may be allocated by using a rational basis.
The underwriting fees are generally allocated only to
the units because the amount of such costs is directly related to the
number of units issued. Since the units contain two separate units of
accounting (i.e., Class A Shares and Public Warrants), such costs will
be further allocated to those separate units of accounting. Any amounts
allocated to Class A Shares would be classified in temporary equity
because those shares are redeemable securities. Any costs allocated to
Public Warrants would be allocated to permanent equity if the Public
Warrants are classified as equity instruments and would be immediately
expensed if the Public Warrants are classified as liabilities that are
initially and subsequently measured at fair value, with changes in fair
value reported in earnings. For further information on the allocation of
costs, see Section
3.3.4.4 of Deloitte’s Roadmap Distinguishing Liabilities From
Equity.
Consolidation of SPACs
It is becoming increasingly common for the sponsors of
SPACs to be businesses that prepare consolidated financial statements.
In these situations, the sponsor must evaluate whether the SPAC must be
consolidated under ASC 810. For further information about the
consolidation guidance in ASC 810, see Deloitte’s Roadmap Consolidation —
Identifying a Controlling Financial Interest.
If a sponsor of a SPAC concludes that it must consolidate the SPAC:
- Any instrument classified as equity in the SPAC’s financial statements that is not owned by the sponsor will represent a noncontrolling interest in the sponsor’s consolidated financial statements.
- Any instrument issued by the SPAC that is owned by the sponsor will be eliminated in the sponsor’s consolidated financial statements.
The sponsor must apply the noncontrolling interest
guidance in ASC 810 as well as the guidance that applies to SEC
registrants in ASC 480-10-S99-3A. The recognition, measurement, and EPS
guidance in ASC 480-10-S99-3A can be very complex and often requires the
entity to make several accounting policy elections (e.g., how
measurement adjustments under ASC 480-10-S99-3A will be reflected in the
income statement and EPS calculations of the sponsor). For further
information, see Deloitte’s Roadmap Noncontrolling Interests.
Classifying Share-Settleable Earn-Out Arrangements
[Section added
February 10, 2021; amended March 19, 2021]
As part of the merger negotiations, the SPAC and target may agree to enter into
what is often referred to as an “earn-out” arrangement.15 Earn-out arrangements may be entered into with the target’s shareholders,
the SPAC’s sponsors, or both. Generally, earn-out arrangements have the
following characteristics:
- The combined company is required to issue additional shares of common stock if, during a specified period after the merger date, its stock price equals or exceeds a stated amount or amounts.
- Some or all of the shares not previously issued will become issuable upon the occurrence of a specific event (e.g., a change of control of the combined company).
-
The settlement must occur in shares (i.e., the combined company or holder cannot elect cash settlement).Example 4As additional consideration for a SPAC transaction, 1 million common shares of the combined company will be issued to the target’s shareholders for each of the following share price levels achieved over the next five years:
- Level 1 — (1) The volume-weighted average price of the combined company’s common stock over any 20 trading days in a 40-day trading period is equal to or greater than $10 per share or (2) the combined company is acquired in a change of control at a price equal to or greater than $10 per share.
- Level 2 — (1) The volume-weighted average price of the combined company’s common stock over any 20 trading days in a 40-day trading period is equal to or greater than $15 per share or (2) the combined company is acquired in a change of control at a price equal to or greater than $15 per share.
- Level 3 — (1) The volume-weighted average price of the combined company’s common stock over any 20 trading days in a 40-day trading period is equal to or greater than $20 per share or (2) the combined company is acquired in a change of control at a price equal to or greater than $20 per share.
- Level 4 — (1) The volume-weighted average price of the combined company’s common stock over any 20 trading days in a 40-day trading period is equal to or greater than $25 per share or (2) the combined company is acquired in a change of control at a price equal to or greater than $25 per share.
If Level 4 is achieved, an aggregate of 4 million common shares of the combined company (i.e., 1 million shares for each level) will be issued on a pro rata basis to the target's shareholders on the basis of their pretransaction ownership interests.
For earn-out arrangements such as in the example above, the
accounting treatment for the shares awarded depends on the terms of the
arrangement. In cases in which these types of earn-out arrangements are entered
into with the SPAC’s sponsor, the shares are generally issued before the
transaction; however, at the time of the SPAC merger, they become subject to
either transfer restrictions or forfeiture on the basis of one or more share
price levels or the occurrence of a specific event (e.g., a change of control).
Such shares may or may not be held in escrow. In either case, if the holder of
the shares is subject to losing those shares (e.g., they would be forfeited if
one or more conditions are not met by a stated date), for accounting purposes,
those arrangements are treated in the same manner as earn-out arrangements that
involve the conditional issuance of shares (i.e., they are treated as
equity-linked instruments as opposed to outstanding shares). If, however, the
owner legally owns the shares and is subject only to transfer restrictions that
lapse upon the earlier of (1) meeting one or more specific conditions or (2) a
stated date, such shares are considered to be outstanding shares of stock
subject to transferability restrictions rather than equity-linked instruments.
In other words, earn-out arrangements that contain vesting-type conditions are
treated as equity-linked instruments (regardless of whether the related shares
have been issued), whereas earn-out arrangements that subject the holder only to
transfer restrictions are treated as outstanding shares.
Earn-out arrangements that represent equity-linked instruments
are classified as either liabilities or equity instruments on the basis of ASC
815-40 unless such arrangements are within the scope of ASC 718.16 Contracts that are classified in equity under ASC 815-40 are not
remeasured. However, contracts classified as liabilities must be subsequently
remeasured at fair value, with changes in fair value recognized in earnings.
To be classified as an equity instrument under ASC 815-40, an
earn-out arrangement must meet two conditions:
- The instrument is indexed to the issuer’s stock.
- The instrument meets several conditions for equity classification (i.e., the issuer controls the ability to settle the instrument in shares; note that these conditions are relevant even if the contract requires settlement in shares).
The application of ASC 815-40 to these arrangements can be very complex. Before
beginning the analysis, entities must ensure that they have a complete
understanding of all the relevant terms. For example, in some cases, the main
provisions are included in a separate section of the merger agreement, but there
could be other agreements or “side letters” that modify or expand upon such
terms. In addition, the terms of such arrangements may be affected by
definitions that are difficult to interpret. Entities may need to consult with
their legal advisers to obtain an understanding of such definitions.
There are several considerations that are relevant to the application of ASC
815-40 to an equity-linked instrument such as an earn-out arrangement. Those
considerations, which are discussed below, include determining the following:
- The unit of account.
- Whether the contract is indexed to the combined company’s stock.
- Whether the contract satisfies certain additional conditions for equity classification.
Unit of Account
The evaluation of whether an earn-out arrangement can be
classified in equity begins with a determination of the unit of account.
The arrangement may be a single unit of account or it may contain
multiple units of account, depending on whether (1) the arrangement as a
whole represents a freestanding financial contract or (2) there are
multiple freestanding financial contracts within the overall
arrangement. For more information on the unit of account, see Section 3.2 of
Deloitte’s Roadmap Contracts on an Entity’s Own Equity.
Indexation
For each unit of account, the entity then evaluates the indexation
requirements in ASC 815-40-15 by using a two-step process for
determining whether a contract is considered to be indexed to the
combined company’s stock. If the entity determines that the contract is
not considered indexed to the combined company’s stock, the contract
must be classified as a liability (i.e., equity classification is never
permitted). To determine that a contract is considered to be indexed to
the combined company’s stock, the entity must evaluate conditions that
affect either of the following steps:
-
Step 1 — The exercise or settlement of the contract (“contingent exercise provisions”).
-
Step 2 — The monetary value of the settlement amount (i.e., factors that affect the settlement amount, or “settlement provisions”).
All earn-out arrangements contain contingent exercise
provisions, and most of them also contain settlement provisions.17 In some cases, a provision reflects both a contingent exercise
provision and a settlement provision. The determination of whether the
term of an earn-out arrangement is a contingent exercise provision or a
settlement provision can significantly affect whether the contract is
indexed to the combined company’s stock because the guidance on
contingent exercise provisions is significantly different from the
guidance on settlement conditions.
Example 5
An earn-out arrangement
specifies that the combined company will issue an
aggregate of 5 million shares of its common stock
to the target’s shareholders if either (1) the
quoted price of the stock exceeds $20 during a
stated period or (2) there is a change of control.
In this example, the combined company’s stock
price and the occurrence of a change of control
affects only whether the holders will receive the
5 million shares. Both variables represent only
contingent exercise provisions because the holders
will receive either no shares or 5 million shares.
This scenario differs from that
in Example 4. In
that example, the holders may receive no shares, 1
million shares, 2 million shares, 3 million
shares, or 4 million shares, depending on the
combined company’s stock price or the price paid
in a change of control. In both examples, the
conditions are contingent exercise provisions.
However, unlike in this example, the conditions in
Example 4 are also settlement provisions.
For an exercise contingency to not prevent a contract from being indexed
to the combined company’s stock, it must meet the guidance in ASC
815-40-15-7A, which states, in part:
An exercise contingency shall not preclude an
instrument (or embedded feature) from being considered indexed
to an entity's own stock provided that it is not based on either
of the following:
- An observable market, other than the market for the issuer's stock (if applicable)
- An observable index, other than an index calculated or measured solely by reference to the issuer's own operations (for example, sales revenue of the issuer; earnings before interest, taxes, depreciation, and amortization of the issuer; net income of the issuer; or total equity of the issuer).
The terms of earn-out arrangements that reflect contingent exercise
provisions (e.g., the combined company’s stock price or a change of
control) generally do not prevent the contract from meeting the first
step in ASC 815-40-15 to be considered indexed to the combined company’s
stock. However, terms that affect the settlement value of the contract
(i.e., settlement provisions) may prevent it from being indexed to the
combined company’s stock under the second step in ASC 815-40-15. For an
instrument to meet the conditions in the second step, any input that
could affect the settlement amount must meet the condition discussed in
ASC 815-40-15-7D, which states, in part:
[T]he instrument (or embedded feature) shall still be considered
indexed to an entity's own stock if the only variables that
could affect the settlement amount would be inputs to the fair
value of a fixed-for-fixed forward or option on equity
shares.
Common terms included in these arrangements that affect the settlement
amount but generally do not prevent the contract from meeting the
requirement in step 2 of ASC 815-40-15 include:
-
The combined company’s stock price (i.e., the quoted price or a reasonable average of quoted prices).
-
Standard antidilutive adjustments.
-
Adjustments for dividends on the combined company’s stock.
-
Adjustments for lost time value upon an early settlement (provided that those adjustments reflect only reasonable compensation for lost time value).
Common terms included in these arrangements that affect the settlement
amount but that would generally prevent the contract from meeting
the requirement in step 2 of ASC 815-40-15 include:
-
All remaining shares would be issuable (or the forfeiture provisions would lapse) upon any change of control involving the combined company.
-
All remaining shares would be issuable (or the forfeiture provisions would lapse) upon a bankruptcy or insolvency of the combined company.
We have observed that in current practice, earn-out arrangements can be
generally categorized into four different types, which are discussed in
the table below.
| Type | Evaluation of Indexation Guidance |
|---|---|
|
A fixed number of shares will be issued if (1)
the combined company’s stock price meets or
exceeds a stated price or (2) there is a change of
control of the combined company.
See Example 5.
|
If one of these two conditions is met, the
issuance of the earn-out shares is only considered
an exercise contingency because there is no
variability in the number of shares issuable. This
exercise contingency does not preclude the
earn-out share arrangement from being considered
indexed to the combined company’s stock.
|
|
A variable number of shares will be issued on the
basis of the combined company’s stated stock
prices. If there is a change of control, all the
earn-out shares will be issued.
Example:
As additional consideration for
a SPAC transaction, 1 million common shares of the
combined company will be issued to the target’s
shareholders for each of the following share price
levels achieved over the next five years:
|
This arrangement contains a
provision that affects the settlement amount. The
number of earn-out shares issuable varies on the
basis of whether there is a change of control of
the combined company. That is, in the absence of a
change of control, a variable number of shares
will be issued on the basis of stock price.
However, if a change of control occurs, all of the
earn-out shares will be issued (i.e., 4 million
shares will be issued regardless of the combined
company’s stock price). This arrangement contains
a settlement provision that precludes it from
being indexed to the combined company’s stock
under step 2 of ASC 815-40-15; therefore,
liability classification is required.
|
If Level 4 is achieved, an
aggregate of 4 million common shares of the
combined company (i.e., 1 million shares for each
level) will be issued on a pro rata basis to the
target’s shareholders on the basis of their
pretransaction ownership interests. If, however,
the combined company is acquired in a change of
control, all previously unissued shares will be
issued.
| |
|
A variable number of shares will be issued on the
basis of the combined company’s stated stock
prices. If there is a change of control at a price
per share that equals or exceeds a stated amount
that is less than the price needed for all the
earn-out shares to be issued, all of the earn-out
shares will nevertheless be issued.
Example:
As additional consideration for a SPAC
transaction, 1 million common shares of the
combined company will be issued to the target’s
shareholders for each of the following share price
levels achieved over the next five years:
|
This arrangement contains a
provision that affects the settlement amount. The
number of earn-out shares issuable varies
depending on whether there is a change of control
of the combined company at a stated price. That
is, in the absence of a change of control at a
stated price, a variable number of shares will be
issued on the basis of stock price. However, if a
change of control occurs at a price per share of
$15 or more, all the earn-out shares will be
issued (i.e., 4 million shares will be issued
regardless of the combined company’s stock price).
This arrangement contains a settlement provision
that precludes it from being indexed to the
combined company’s stock under step 2 of ASC
815-40-15; therefore, liability classification is
required.
|
If Level 4 is achieved, an
aggregate of 4 million common shares of the
combined company (i.e., 1 million shares for each
level) will be issued on a pro rata basis to the
target’s shareholders on the basis of their
pretransaction ownership interests. If, however,
the combined company is acquired in a change of
control at a price of $15.00 or more, all
previously unissued shares will be issued.
| |
|
A variable number of shares will be issued on the
basis of either (1) the combined company’s stated
stock prices or (2) the price per share in a
change of control of the combined company.
See Example 4.
|
This arrangement contains a
provision that affects the settlement amount. The
determination of whether this arrangement is
indexed to the combined company’s stock under step
2 of ASC 815-40-15 depends on (1) how the price
per share is calculated in a change of control of
the combined company and (2) an entity’s
interpretation of the application of ASC 815-40-15
to the potential settlement that would occur upon
a change of control.
Some entities have determined
that the settlement amount is affected by the
occurrence or nonoccurrence of a change of
control, which is not an input into the pricing of
a fixed-for-fixed forward or option on equity
shares. These entities have therefore concluded
that the earn-out arrangement is not indexed to
the combined company’s stock under step 2 of ASC
815-40-15. As a result, the earn-out arrangement
is classified as a liability. Note that these
entities reach this conclusion without evaluating
the calculation of the price per share in a change
of control of the combined company.
Other entities focus on the
calculation of price per share in the event of a
change of control. On the basis of a preclearance
with the staff of the SEC’s Office of the Chief
Accountant, there are two possible outcomes:
|
|
A price per share calculation
that includes the number of shares issuable under
the earn-out arrangement can be described as a
“circular,” “net,” or “as-diluted” calculation.
Although computable, it is not a simple
calculation. In addition, the terms of the
provision that apply in the event of a change of
control are often subject to interpretation (i.e.,
ambiguous). In these situations, entities must
consult with attorneys to reach the proper legal
interpretation. If an entity cannot conclude that
the arrangement would follow the circular, net, or
as-diluted calculation, the earn-out arrangement
cannot be classified in equity. We understand that
many entities are modifying the terms of such
provisions or taking other actions to eliminate
the ambiguity in the contractual terms of the
change-of-control provision.
|
In the table above, it is assumed that none of the earn-out shares are
within the scope of ASC 718. We have seen instances in practice in which
earn-out share arrangements with target shareholders may be issuable to
employees that hold vested or unvested shares or options on the date on
which the SPAC merges with a target. In addition to ASC 718 accounting
considerations, entities should assess whether the potential shares
issuable to common stockholders for which the accounting is in
accordance with ASC 815-40 could be affected by the number of shares
issuable to recipients for which the accounting is within the scope of
ASC 718 (i.e., recipients that receive those shares as a form of
stock-based compensation). For example, assume that earn-out shares will
be issued to holders of unvested stock options on the merger date
provided that those holders are still employees on the date on which the
earn-out share target or targets are met. If an option holder is no
longer an employee as of that date, the earn-out shares otherwise
receivable by the holder will be reallocated to the pool of shares
receivable by common stockholders that did not receive such shares in
return for services (i.e., that were not within the scope of ASC 718).
In this situation, as a result of the guidance on the unit of account in
ASC 815-40, the portion of the earn-out arrangement that is within the
scope of ASC 815-40 would not be considered indexed to the combined
company’s stock because the number of shares varies on the basis of
employee behavior. In a manner consistent with Example 20 in ASC
815-40-55, the earn-out arrangement within the scope of ASC 815-40 must
be classified as a liability in its entirety.
For more information on the application of the
indexation guidance, see Chapter 4 of Deloitte’s Roadmap
Contracts on an
Entity’s Own Equity.
Equity Classification Conditions
Once a determination is made that an earn-out
arrangement is considered indexed to the combined company’s stock under
ASC 815-40, the entity must evaluate whether it controls the ability to
settle the contract in its shares. ASC 815-40-25 addresses the
conditions that must be met. Only contracts for which the entity
controls settlement in shares (i.e., that meet the conditions in ASC
815-40-25) may be classified in equity. See Chapter 5 of Deloitte’s Roadmap
Contracts on an
Entity’s Own Equity for further information on
these classification conditions.
Other Considerations
Regardless of the classification of an earn-out arrangement,
ASC 815-40 requires an entity to recognize the initial fair value of the
instrument. The offsetting entry will depend on the facts and circumstances.
We believe that for earn-out arrangements with target shareholders, the
offsetting entry should be reflected in the same manner as if the entity
declared a pro rata dividend to its common shareholders.
Entities should also consider the effect that earn-out
arrangements may have on their EPS calculations and disclosures. Earn-out
arrangements represent potential common shares. In calculating diluted EPS,
the combined company should consider the guidance on contingently issuable
shares. Also note that whether classified as equities or liability
instruments, earn-out arrangements that give the holders nonforfeitable
rights to dividends represent participating securities. This is the case
regardless of whether the combined company actually declares or pays
dividends. See Deloitte’s Roadmap Earnings per Share for further
information on participating securities and the two-class method of
calculating earnings per share.
Share-Based Payment Considerations
[Section added March 19, 2021]
As part of a target’s accounting analysis, the entity should
assess the impact that the SPAC merger will have on preexisting share-based
payment arrangements with employees and nonemployees (collectively, the
“grantees”) that are within the scope of ASC 718. When the SPAC is the
accounting acquirer and the target meets the definition of a business, the
entity should consider the guidance on business combinations in Chapter 10 of Deloitte’s
Roadmap Share-Based Payment
Awards.
If the target is determined to be the accounting acquirer and
the SPAC does not meet the definition of a business, an entity should consider
whether the preexisting target awards were modified as part of the SPAC merger.
When performing this assessment, the entity should pay careful attention to the
original terms of the preexisting target awards and any changes that result from
the SPAC merger. This may include the evaluation of any earn-out arrangements
with the grantees, including earn-out arrangements in which grantees are subject
to ongoing service requirements after the SPAC merger. In addition, the entity
should consider the effect, if any, of a SPAC merger on any antidilution
provisions included in the original terms of the target awards. These
determinations may require consultation with legal counsel. For further
discussion of the accounting for modifications, see Chapter 6 of Deloitte's Roadmap Share-Based Payment
Awards.
As noted in the Indexation section, companies may have
earn-out share arrangements that provide earn-out shares to grantees that are
subject to forfeiture. We believe that if any forfeited shares are subsequently
reallocated to the remaining grantees that are subject to the earn-out share
arrangement, the reallocation solely to grantees is analogous to a "last
man standing" arrangement. Under that view, the forfeiture and subsequent
redistribution of the awards to grantees are accounted for as (1) the forfeiture
of the original award and (2) the grant of a new award. For more information,
see Section 10.7.3
of Deloitte's Roadmap Share-Based Payment Awards.
Proxy/Registration Statement Filing and Review Process
SEC Review Process
An entity can generally expect the SEC staff to complete
its initial review of a proxy/registration statement and furnish the
first set of comments within 30 calendar days. The entity would then
respond to each of the SEC’s comments and reflect requested edits, and
include any other necessary updates, in an amended proxy/registration
statement that the SEC would also review. After the initial filing, the
SEC’s review time can vary significantly but typically is within two
weeks. An entity can experience several rounds of comment letters with
follow-up questions on responses to original comments as well as
additional comments on new information included in the amended
registration statement.
Connecting the Dots
The financial statement requirements and review
of a proxy/registration statement are largely consistent with
the requirements and review for a traditional IPO. Thus, in
addition to performing a detailed analysis of the financial
statement and pro forma requirements for the proxy/registration
statement, targets may want to understand the types of comments
that the SEC staff frequently issues. For additional information
on SEC comments, see Deloitte’s Roadmap SEC Comment
Letter Considerations, Including Industry
Insights.
Some of the SEC comments may focus on the 53 questions
highlighted in DG Topic 11, including whether disclosures address: [Paragraph added
February 10, 2021]
- Additional financing (e.g., PIPE financing) necessary to complete the transaction, whether the price and terms of the financing differ from those of the SPAC’s IPO, and the impact of any conversion features.
- Material factors the SPAC considered in pursuing the transaction and the alternative options it evaluated.
- Any conflicts of interest that the SPAC’s sponsors, directors, or officers may have, including detailed information about how they will benefit from the transaction and returns they may realize on their initial investments.
- The percentage ownership that the SPAC’s sponsors, directors, or officers will hold in the combined company, including warrants and convertible instruments.
- The amount of compensation that underwriters will receive as a result of the transaction and whether such compensation represents a deferred payment from the SPAC IPO or compensation for other services provided.
Availability of Nonpublic Review
[Section added February 10,
2021]
In a traditional IPO, companies may submit draft registration statements
to the SEC for nonpublic review. The ability to file nonpublicly is a
significant benefit because it allows companies to confidentially
respond to SEC comments and update their draft registration statement
while continuing to assess market conditions throughout the IPO process.
As a result, companies are able to delay or withdraw the IPO, if
desired, without public scrutiny. In limited circumstances, as described
below, nonpublic review of an initial draft registration statement may
be available for SPAC transactions.
The SEC staff may agree to review an initial draft Form
S-4 for a SPAC transaction if it is submitted within 12 months of the
SPAC’s IPO. Nonpublic reviews are generally not available for proxy
statements that are not combined with a Form S-4. As noted in the
highlights of the September
2017 CAQ SEC Regulations Committee joint meeting with the SEC staff, the
staff encourages SPACs to contact their respective industry review
office of the Division to assess whether a nonpublic review would be
acceptable. Note that a nonpublic review may only be used for the
initial submission and any responses to the staff comments or other
amendments to the Form S-4 must be done in a public filing. The draft
registration statement in a nonpublic review must be “substantially
complete”18 and (1) contain a signed audit report from the company’s
independent registered public accounting firm and (2) meet all line item
requirements applicable to the registration statement unless the company
is using certain permitted accommodations for omitting otherwise
required information (e.g., financial information [including financial
statements] related to periods that are not reasonably expected to be
required at the time the registration statement is filed publicly).
Super 8-K Requirements
The Super 8-K must be filed no later than four business days after the close
of a transaction. The 71-day extension typically available for an acquired
business does not apply to SPAC transactions. The Super 8-K must describe
the completion of the transaction (Item 2.01 of Form 8-K), the change in the
control of the SPAC, if applicable (Item 5.01 of Form 8-K), the change in
the SPAC’s shell company status (Item 5.06 of Form 8-K), and a change in the
fiscal year-end, if applicable (Item 5.03 of Form 8-K). Because the target’s
auditor generally becomes the auditor of the combined entity after the
transaction, the Super 8-K may describe a change in the certifying
accountant as well (Item 4.01 of Form 8-K). In addition, the Super 8-K must
include all the information that would be required if the target was filing
an initial registration statement on Form 10 (Item 9.01 of Form 8-K).
The form and content of the financial information required
in a Super 8-K are largely consistent with the information provided in a
proxy/registration statement. However, certain disclosures must be updated
to reflect information as of the Super 8-K filing date. For example, if
material, the pro forma financial information generally needs to be updated
to reflect the actual results of the transaction and any related financing,
rather than the minimum and maximum scenarios that may have been presented.
Further, entities should evaluate the number of annual periods and the age
of the financial statements included in the Super 8-K because more current
financial statements may be required. See the Age of Financial Statements section
for more information.
In addition, to avoid a gap or lapse in the target’s
financial statement periods after a transaction, the combined company may
need to amend its Super 8-K to provide updated financial statements of the
target. For example, if the transaction closes soon after the target’s
fiscal quarter or year-end, the Super 8-K generally will not include the
target’s financial statements for the most recently completed period. In
such a case, the combined company will need to amend its Super 8-K to
provide the recently completed annual or interim period. The due date of the
amendment depends on the reporting requirements of the SPAC (i.e., its
filing status). For example, if the SPAC is a nonaccelerated filer, the Form
8-K amendment would be due within 45 days of the end of a quarter and within
90 days of the end of a fiscal year.
Example 6
SPAC A, a nonaccelerated filer, and a target both
have a calendar year-end. The transaction closes on
November 2, 20Y0.
SPAC A is required to file its Form 10-Q for the
quarter ended September 30, 20Y0, on or before
November 14, 20Y0. Since the transaction closed
after September 30, 20Y0, the Form 10-Q will include
A’s historical financial statements, with the
transaction disclosed as a subsequent event. The
Form 10-Q will not reflect the target’s financial
statements.
Within four business days of the
close of the transaction, A must file the Super 8-K
with the target’s (1) audited financial statements
for the two or three years ended December 20X9 (see
the Financial Statement
Requirements section) and (2) unaudited
financial statements for the interim periods ended
June 30, 20Y0, and June 30, 20X9. On or before
November 14, 20Y0, the Super 8-K must be amended to
include unaudited financial statements for the
interim periods ended September 30, 20Y0, and
September 30, 20X9.
Example 7
Assume the same facts as in
Example 1,
except that the transaction closes on February 2,
20Y1.
SPAC A is required to file its Form 10-K for the year
ended December 31, 20Y0, on or before March 31,
20Y1. Since the transaction closed after December
31, 20Y0, the Form 10-K will include A’s historical
financial statements, with the transaction disclosed
as a subsequent event. The Form 10-K will not
reflect the target’s financial statements.
Within four business days of the
close of the transaction, A must file the Super 8-K
with the target’s (1) audited financial statements
for the two or three years ended December 20X9 (see
the Financial Statement
Requirements section) and (2) unaudited
financial statements for the interim periods ended
September 30, 20Y0, and September 30, 20X9. On or
before March 31, 20Y1, the Super 8-K must be amended
to include audited financial statements for the two
or three years ended December 31, 20Y0.
Connecting the Dots
Target companies must ensure that updated quarterly or annual
financial statements are available in a timely fashion (1) during
the proxy/registration statement process, (2) through the completion
of the transaction, and (3) on an ongoing basis thereafter. The
target, as a predecessor to the SPAC, may not “skip” a reporting
period between the Super 8-K and the first periodic report on Form
10-Q or Form 10-K that reflects the transaction.
Ongoing Reporting Requirements
After a transaction, the historical financial statements of
the target become those of the registrant. Therefore, the target’s
historical financial statements will replace those of the SPAC beginning
with the filing of the financial statements that first include the
transaction. For example, if the transaction closes on March 15, 20Y0, the
financial statements for the interim period ended March 31, 20Y0, will first
include the transaction. Therefore, the financial statements included in the
March 31, 20Y0, Form 10-Q, and all future filings will represent those of
the target and no longer the SPAC. If the SPAC is determined to be the
accounting acquirer, there will be a lack of comparability between the
predecessor and successor periods because of the new basis established for
the target’s assets and liabilities as a result of the acquisition.
Therefore, the pre- and post-transaction periods must be separated,
typically by a “black line,” to emphasize the change in the basis of
accounting in the post-transaction periods (i.e., in the fact pattern above,
the Form 10-Q would reflect the operations and cash flows of the target for
the predecessor period from January 1, 20Y0, through March 14, 20Y0, and the
successor period from March 15, 20Y0, though March 31, 20Y0, as two distinct
columns separated by a black line). For a transaction in which the target is
identified as the accounting acquirer and reverse recapitalization
accounting applies, no separation of the periods before and after the
transaction is required since there is no change in basis of the target’s
assets and liabilities. See the Financial Statement Presentation
for Reverse Recapitalizations section for more
information.
The combined company is required to file Forms 10-K and 10-Q
in accordance with specific deadlines that depend on the combined company’s
filing status:
|
Filer
|
SEC Form 10-K
|
SEC Form 10-Q
|
|---|---|---|
|
Large accelerated filer
|
60 days after end of fiscal year
|
40 days after end of fiscal quarter
|
|
Accelerated filer
|
75 days after end of fiscal year
|
40 days after end of fiscal quarter
|
|
Nonaccelerated filer
|
90 days after end of fiscal year
|
45 days after end of fiscal quarter
|
The combined company may file a new or amended registration
statement after the transaction closes. For a reverse recapitalization, if
the combined company files a new or amended registration statement after the
filing of the first periodic report that reflects the transaction but before
the filing of the first annual report reflecting the transaction, it must
consider whether the historical annual financial statements need to be
retroactively revised to reflect the recapitalization. Also, if a combined
company that is not an SRC files a new or amended registration statement
after the close of the transaction and reports a material retrospective
change, it may need to disclose selected quarterly financial data for the
affected quarters within (1) the two most recent fiscal years and (2) any
subsequent interim periods for which financial statements are presented (see
Regulation S-K, Item 302). See the Changing Lanes discussion for more
information on SEC reporting requirements. [Paragraph amended February 10,
2021]
The combined company will typically be required to use
long-form registration statements (i.e., Form S-1) rather than short-form
statements (i.e., Form S-3) for a year after the transaction. Question 115.18 of
the SEC's Compliance and Disclosure Interpretations (C&DIs) on
Securities Act Forms states that the combined company may meet the
registrant requirements to use Form S-3 if it has at least 12 calendar
months of Exchange Act reporting history after the transaction (not the IPO
of the SPAC). Because of these and other matters that may arise, we
recommend consultation with accounting and legal advisers.
In addition, as a public company, the combined company is
also required to file current reports on Form 8-K that disclose various
material events that may occur. Unless otherwise specified in the Form 8-K
instructions, such events must generally be disclosed within four business
days after they occur. Management should consider the controls and
procedures in place to identify these events and report them in a timely
manner. It is recommended that an entity consult with legal advisers
regarding the Form 8-K reporting requirements. For additional information on
such requirements, see Section 7.3 of Deloitte’s Roadmap Initial Public Offerings.
Internal Control Over Financial Reporting and Disclosure Controls and Procedures
The combined company must consider the requirements that
apply to public companies related to ICFR and DCPs. After the close of the
transaction, the combined company must be prepared to (1) evaluate and
disclose material changes to its ICFR on a quarterly basis, (2) provide
quarterly disclosures and certifications from key executives that DCPs are
effective, and (3) disclose to the auditor and audit committee all
significant deficiencies and material weaknesses in ICFR and any fraud that
involves management or other employees who have a significant role in ICFR.
If the SPAC has previously filed its first Form 10-K, the combined company
must be prepared to evaluate the effectiveness of ICFR on an annual basis
(except in certain circumstances discussed in the following paragraph). In
addition, depending on its filing status, the combined company may need to
provide its auditor’s attestation report on the combined company’s ICFR on
an annual basis. As long as the combined company remains an EGC or
nonaccelerated filer, an auditor’s attestation report on ICFR is not
required.
In addition, the SEC may not object to the exclusion of
management’s report on ICFR in the first Form 10-K filed after the close of
the transaction. As noted in Section 215.02 of the C&DIs on
Regulation S-K, it may not “always be possible to conduct an assessment of
the [target’s] internal control over financial reporting in the period
between the consummation date of [the transaction] and the date of
management’s assessment of internal control over financial reporting
required by Item 308(a) of Regulation S-K.” In these circumstances, which
may arise if the transaction closes late in the fiscal year, the combined
company must also be prepared to disclose (1) why management’s assessment
has not been included, (2) the effect of the transaction on management’s
ability to conduct an assessment, and (3) the scope of the assessment, if
one had been conducted. However, if the transaction closes at the beginning
of the fiscal year and the Form 8-K is amended to include the most recent
annual period (see Example
7 in the Super 8-K Requirements section), this guidance would not
apply and the first Form 10-K that reflects the target’s financial
statements must include management’s ICFR report. Because of the complexity
involved in assessing these requirements, we recommend consultation with
accounting and legal advisers.
Contacts
If you have any questions about
this publication or the related content, please contact any of the following
Deloitte professionals:
|
|
Ashley
Carpenter
Partner
Deloitte &
Touche LLP
+ 1 203 761
3197
|
|
Sean May
Partner
Deloitte &
Touche LLP
+1 415 783
6930
|
|
|
Lisa
Mitrovich
Partner
Deloitte &
Touche LLP
+1 202 220
2815
|
|
Michael
Morrissey
Partner
Deloitte &
Touche LLP
+1 203 761
3630
|
Footnotes
2
For titles of FASB Accounting Standards
Codification (ASC) references, see Deloitte’s
“Titles of Topics and Subtopics in the FASB
Accounting Standards
Codification.”
3
SEC Final Rule Release No. 33-10786,
Amendments to Financial Disclosures About
Acquired and Disposed Businesses.
4
SEC Final Rule Release No. 33-10876,
Qualifications of Accountants.
5
SEC Final Rule Release No. 33-10890, Management’s
Discussion and Analysis, Selected Financial Data,
and Supplementary Financial Information.
6
SEC Final Rule Release No. 33-10825,
Modernization of Regulation S-K Items 101, 103,
and 105.
7
The classification of the Public Warrants and Class A Shares is
discussed below. In the discussion of the allocation of
proceeds, it is assumed that the Class A Shares are classified
as equity instruments.
8
Class B Shares generally convert into Class A
Shares upon a merger of the SPAC with a target. In some cases,
the holders can elect to convert the Class B Shares into Class A
Shares before completion of a business combination. However,
such conversion generally does not change the fact that the
shares held by the sponsor and its affiliates do not have any
redemption rights or rights to participate in the distribution
of proceeds upon a liquidation of the SPAC.
9
Public Warrants generally meet the characteristics of a
derivative instrument in ASC 815-10-15-83. However, the guidance
in ASC 815-40 must be applied regardless of whether such
warrants contain all the characteristics in ASC 815-10-15-83.
10
Public Warrants may also contain a provision
that allows the SPAC to call them for $0.01 per warrant if
the fair value of the Class A Shares exceeds $18.00 for a
defined number of trading days. This feature is only
considered an exercise contingency because it does not
change the settlement terms.
11
Note that in this example, “Common Stock”
refers to the Class A Shares of the SPAC. After a merger of
the SPAC with a target, Common Stock refers to either (1)
the single class of common shares of the combined entity or
(2) the Class A common shares if the combined entity has
multiple classes of common shares.
12
It is also acceptable to classify the Public
Warrants as liabilities provided that the approach selected
is applied consistently to all instruments with such
features.
13
In the example, the difference
arises because of the reference to Section 6 of
the Warrant Agreement, which explains that Public
Warrants are subject to redemption (i.e., forced
exercise) whereas Private Placement Warrants are
not.
14
As discussed above, this section assumes
that the Private Placement Warrants are not within the scope
of ASC 718. If a Private Placement Warrant is within the
scope of ASC 718, the classification would be determined on
the basis of the classification guidance in ASC 718. In
these circumstances, if the holder has no continuing service
requirement after the SPAC merges with a target and the
transaction is accounted for as a reverse recapitalization,
the combined company should reassess the accounting
classification of the Private Placement Warrant as of the
date of the merger with the SPAC in accordance with the
classification guidance in ASC 480-10 and ASC 815-40.
15
There may be other options or warrants on stock that were previously
issued by the SPAC or target that remain outstanding after the merger.
While many of the accounting considerations discussed in this section
are relevant to these instruments, the discussion in this section is
focused on earn-out arrangements.
16
Generally, an earn-out arrangement would be subject to
ASC 718 if, in addition to meeting one or more share price levels or
other conditions, the holder must provide service to the combined
company after the merger date. Therefore, entities should consider
whether the counterparty to the arrangement must provide services to the
combined company to earn the award. For further information, see the
Share-Based
Payment Considerations section.
17
Contracts that contain only transfer
restrictions that lapse upon the passage of time are considered
outstanding shares and are not subject to this evaluation. As
discussed above, those arrangements are accounted for as
outstanding shares as opposed to equity-linked instruments.