SEC’s Recent Commentary Slows SPAC Deals

Until recently, the IPO market seemed to have shifted more toward SPACs (Special Purpose Acquisition Companies), but that may be changing now with all the SEC guidance that’s been coming out in recent months. The Securities and Exchange Commission’s increasing scrutiny of SPACs and recent guidance on how to account for warrants are slowing deal activity for firms. Recently, the SEC issued a staff statement on the accounting and financial reporting considerations for SPACs, also known as “blank-check companies.” The SEC basically said that warrants, which are typically issued to early investors in such companies, might not be considered as equity instruments and would instead be accounted for as liabilities measured at fair value on a company’s books.

SPACs have become an increasingly popular way for companies to go public in recent years. With a SPAC, investors essentially create a shell company to raise money via an IPO, but with the main goal of acquiring another company. Companies that have used SPACs to go public include DraftKings, Virgin Galactic, Opendoor, and Nikola Motor. With the guidance following shortly on the heels of a warning on March 31 from the SEC about the financial reporting and auditing considerations for companies merging with SPACs, and another SEC statement that same day about accounting, financial reporting, and governance issues pertaining to SPACs, the market for SPACs is suddenly shifting to a more cautious footing.

The statement that the SEC came out with references two terms within those instruments that basically would result in a lot of these warrant instruments requiring balance sheet liability classification vs. equity classification. What the guidance basically tells you is that those instruments can no longer sit within the equity structure of the balance sheet. They have to be marked to market over a period and the change in their fair value goes to the profit and loss statement. That is going to impact basically all the SPACs that have occurred, and the SPAC transactions where the equity instruments are still with the operating company and they haven’t been exercised or redeemed. For companies that have had their IPO and their filings, they are going through these filings and evaluating whether there will be a change in accounting that is going to result in a restatement.

The series of SEC warnings and statements appear to be slowing down SPAC deal activity, but it’s probably not the only factor. The market was already starting to show signs of a slowdown earlier this month. Until the recent guidance from the SEC, the SPAC boom seemed to be peaking. The pace that it was going at for a period of time was a pace that was hard to see is sustained long term.

However, as it relates to the current issue of warrants being classified as debt vs equity on the balance sheet, the SEC had previously not raised questions with respect to the specific accounting treatment that is now under the microscope. The SEC questions have basically stopped any new IPO filings or SPAC acquisitions until SPACs resolve the accounting and related valuation questions. Some have questioned if the SEC is using the highly complex and judgmental accounting questions as a way to slow down a superheated SPAC marketplace. While it is too soon to fully conclude, the potential restatement of SPAC financial statements to apply the updated accounting interpretation reporting some warrants as a liability rather than equity, is unlikely to have any material direct impact on the value of publicly traded SPAC shares. Even though financial statements may need to be restarted, there is no cash flow impact other than the cost of engaging attorneys, accountants, and valuation specialists to assist in solving the technical financial reporting, auditing, and valuation questions. However, companies need to evaluate the liability vs. equity accounting treatment and being in agreement with their auditing firms, combined with the SEC reviews, combine to increase the timeline for a SPAC to get to market.

The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.