Technical Line: A closer look at accounting for financial instruments

What you need to know

• Merging with a special purpose acquisition company (SPAC) offers an alternative to

an IPO for private companies that want to enter the public markets.

• Both SPACs and companies that are considering merging with them need to be aware

of the accounting implications of the financial instruments issued by the SPACs.

• SPACs and combined companies resulting from SPAC mergers should consider an

SEC staff statement on accounting for warrants issued by SPACs when evaluating the

classification of warrants they issue.

• At the latest AICPA and CIMA Conference on Current SEC and PCAOB Developments, the

SEC staff clarified its view that Class A shares issued by a SPAC that become redeemable

upon its liquidation or merger should be presented outside of permanent equity.

Overview

There are typically four phases in the life cycle of a SPAC: SPAC formation, initial public offering

(IPO) of the SPAC, SPAC merger with a private operating company (also referred to as a de-SPAC

transaction) and post-merger as a combined public company. SPACs and companies that are

considering merging with them need to be aware of the accounting implications of the following

financial instruments that SPACs typically issue during their formation and IPO phases:

•

Founder shares (e.g., Class B shares) that are issued to the sponsors of the SPAC and

their affiliates at the time of the SPAC’s formation

No. 2021-03

3 March 2022

Technical Line

A closer look at accounting for

financial instruments issued by

SPACs

In this issue:

Overview ............................ 1

Accounting considerations . 2

SPAC formation ................ 2

SPAC IPO ......................... 4

SPAC merger

(de-SPAC transaction) .. 26

Post-merger ................... 36

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A closer look at accounting for financial instruments issued by SPACs 3 March 2022

•

Private placement warrants that are typically sold to sponsors of the SPAC and their

affiliates to fund costs incurred by the SPAC

•

Class A shares that are issued to public shareholders in the IPO

•

Public warrants that are typically issued to IPO investors as part of a unit with Class A

shares to enhance the investors’ overall return

This publication addresses the issuer’s accounting for these and other financial instruments

such as earn-out arrangements and private investments in public equity that are often issued

by SPACs. It supplements our Technical Line,

Navigating the requirements for merging with

a special purpose acquisition company.

Accounting considerations

SPAC formation

Upon formation, a SPAC is initially capitalized by a sponsor and its affiliates, who contribute

nominal capital (usually $25,000) in exchange for founder shares, typically in the form of Class B

common stock, that are intended to make up 20% of the equity interests in the SPAC after the IPO.

The sponsor and its affiliates may need to forfeit some shares to maintain their 20% interest if

the underwriters do not fully exercise their overallotment options (see further discussion below).

To fund start-up costs and pay expenses associated with the IPO, such as the typical 2%

underwriting fee, the SPAC sponsor and its affiliates may also purchase private placement

warrants to acquire Class A shares at a strike price of $11.50. Those private placement

warrants are generally purchased for about $1.50 per warrant.

Class B shares and private placement warrants

Unit of account

Because Class B shares acquired by the sponsor and its affiliates upon the SPAC’s formation

and private placement warrants are typically issued at different times, SPACs generally

consider them freestanding financial instruments under the guidance in Accounting Standards

Codification (ASC) 480.

That guidance defines a freestanding financial instrument as a

financial instrument that is entered into (1) separately and apart from any of the entity’s

other financial instruments or equity transactions or (2) in conjunction with some other

transaction and is legally detachable and separately exercisable.

Class B shares

Class B shares generally have voting rights and a conversion feature that automatically

converts them into Class A shares upon an IPO. SPACs should consider whether these shares

are compensatory and therefore in the scope of ASC 718.

We believe Class B shares

generally are not subject to ASC 718 because there is no explicit service, performance or

other condition that suggests that the shares are issued in exchange for goods or services to

be used or consumed in the SPAC’s operations.

SPAC merger Post-merger

SPAC

formation

SPAC IPO

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A closer look at accounting for financial instruments issued by SPACs 3 March 2022

Class B shares are equity in legal form and should only be classified as liabilities under

ASC 480 if they:

•

Are mandatorily redeemable for cash or other assets (ASC 480-10-25-4)

•

Embody an unconditional obligation to issue a variable number of shares for which the

monetary value is based solely or predominantly on (1) a fixed amount, (2) variations in

something other than the fair value of the SPAC’s equity shares or (3) variations that move in

the opposite direction to changes in fair value of the SPAC’s equity shares (ASC 480-10-25-14)

Because the Class B shares are not mandatorily redeemable and do not embody an obligation

by the SPAC to issue a variable number of shares, the Class B shares are not classified as

liabilities under ASC 480. Furthermore, because Class B shares are not redeemable, they are

not required to be presented as “mezzanine” equity on the SPAC’s balance sheet under the

Securities and Exchange Commission (SEC) staff’s guidance on redeemable equity securities

cited in ASC 480-10-S99.

While Class B shares generally do not meet the definition of a derivative in ASC 815,

the

existence of the conversion feature requires the SPAC to analyze the share (a hybrid

instrument with an embedded conversion feature) to determine whether the conversion

feature needs to be bifurcated and accounted for as a derivative. ASC 815-15-25-1 provides

criteria that, if met, will result in an embedded derivative being bifurcated. In the case of the

Class B shares, the conversion feature typically does not require bifurcation because the

economic characteristics and risks of the conversion feature and those of the host contract,

which is deemed an equity host, are clearly and closely related.

As discussed above, upon the SPAC’s formation, the sponsor receives Class B shares that are

intended to make up 20% of the equity interests in the SPAC after the IPO. The determination

of the number of shares issued at formation necessary to maintain the sponsor’s equity

interest at 20% after the IPO assumes the underwriters will fully exercise certain

overallotment options that the SPAC expects to grant to them. The overallotment options

allow the underwriters to purchase a number of IPO units made up of one Class A share and

one public warrant at the IPO price within a short period of time after the IPO.

If the underwriters do not fully exercise their overallotment options, the sponsor agrees to

forfeit a number of shares so that its Class B shares will equal 20% of the equity interests in

the SPAC after the IPO and after the exercise of any overallotment options. This forfeiture

provision generally does not require accounting consideration until a forfeiture actually

occurs. That is because such a forfeiture provision, which represents an embedded feature in

the Class B shares, is deemed to have economic characteristics and risks that are clearly and

closely related to the nature of the equity host in the Class B shares. Therefore, bifurcation

and derivative accounting are not required.

Private placement warrants

SPACs may issue private placement warrants to the sponsor and affiliates during the

formation phase or in connection with the IPO to raise working capital, including funding to

cover the cost of the IPO (such as the 2% underwriting fee, which is a significant component of

the SPAC’s expenses).

A SPAC may also issue private placement warrants to its employees or third-party service

providers in exchange for goods or services provided to the SPAC. These warrants would be in

the scope of ASC 718 since they would be considered compensation or payment for goods or

services. Warrants that are not accounted for under ASC 718 should be assessed under ASC 480

and ASC 815-40

to determine whether they should be classified as equity or liabilities. See

the SPAC warrants, including public warrants

section below for further discussion.

Class B shares

are

generally

classified in equity

in the

ir entirety.

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A closer look at accounting for financial instruments issued by SPACs 3 March 2022

SPAC IPO

In its IPO, a SPAC typically offers investors units comprising one Class A share and one public

warrant for $10 per unit. Public warrants typically are issued with a strike price of $11.50

and become exercisable shortly after the SPAC acquires an operating company.

Unit of account

Although the Class A shares and public warrants are issued as a unit to investors, they can be

traded separately soon after the IPO. Because they are both legally detachable and separately

exercisable, the instruments are considered “freestanding” under the definition of a freestanding

financial instrument in ASC 480.

SPACs would then consider the guidance in ASC 815-10-15-9 to determine whether the

economic substance of these freestanding financial instruments suggests that accounting for

them on a combined basis (i.e., one unit of account) is more appropriate. That guidance

provides indicators to be considered in determining whether freestanding financial

instruments should be viewed as a unit and requires combining freestanding financial

instruments in some cases to prevent circumvention of the derivative guidance.

Indicators that freestanding financial instruments should be combined

Indicator 1 Indicator 2 Indicator 3 Indicator 4

The transactions

were entered into

contemporaneously

and in contemplation

of one another.

The transactions

were executed

with the same

counterparty (or

structured through

an intermediary).

The transactions

relate to the same

risk.

There is no apparent

economic need or

substantive business

purpose for

structuring the

transactions

separately that could

not also have been

accomplished in a

single transaction.

SPACs generally conclude that they should treat Class A shares and public warrants as separate

units of account because there is a substantive business purpose for issuing the public warrants

concurrently with the Class A shares. That is, the public warrants are intended to give the

holders the opportunity to invest in additional equity interests of the combined company once

the SPAC merges with an operating company.

Allocation of proceeds

A SPAC allocates the proceeds it receives for each unit (i.e., $10 per unit) between the two

instruments. We understand that the staff of the Financial Accounting Standards Board

(FASB) and the staff of the SEC both believe that a freestanding instrument issued concurrently

with other instruments should be initially measured at fair value if it is required to be subsequently

measured at fair value under US GAAP, with the residual proceeds from the transaction

SPAC merger Post-merger

SPAC IPO

SPAC

formation

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A closer look at accounting for financial instruments issued by SPACs 3 March 2022

allocated to remaining instruments. In this case, the Class A shares are classified in equity

(see discussion below). Therefore, the subsequent measurement of the public warrants

determines how the proceeds should be allocated:

•

If the public warrants are classified as liabilities that must be measured at fair value at

each reporting period with changes in fair value recognized in earnings, proceeds would

be allocated to the public warrants equal to their fair value and the residual would be

allocated to the Class A shares.

•

If the public warrants are classified as equity, the relative fair value method would be used

to allocate the proceeds. It requires an entity to allocate a portion of the proceeds based

on the proportion of an instrument’s fair value to the sum of the fair values of all the

instruments covered in the allocation.

Class A shares

In general, SPACs do not issue Class A shares to receive goods or services; therefore, Class A

shares are generally not considered share-based payment arrangements that would be subject

to ASC 718. Class A shares that are not accounted for under ASC 718 should be assessed under

ASC 480 and ASC 815-40 to determine whether they should be classified as equity or liabilities.

Classification

Distinguishing liabilities from equity (ASC 480)

Because the legal form of Class A shares is equity, they should be classified as liabilities under

ASC 480 only if they:

•

Are mandatorily redeemable for cash or other assets (ASC 480-10-25-4)

•

Embody an unconditional obligation to issue a variable number of shares for which the

monetary value is based solely or predominantly on (1) a fixed amount, (2) variations in

something other than the fair value of the SPAC’s equity shares or (3) variations that move in

the opposite direction to changes in fair value of the SPAC’s equity shares (ASC 480-10-25-14)

The Class A shares generally are not liabilities because they are not mandatorily redeemable

and don’t represent an unconditional obligation to issue a variable number of equity shares of

the SPAC with the characteristics described in ASC 480-10-25-14. As a result, they are

generally classified in equity.

Embedded derivatives (ASC 815)

Freestanding financial instruments that are not in the scope of ASC 480 should be evaluated

pursuant to ASC 815. Those instruments may either be derivatives themselves or may

contain embedded features that would be derivatives if they were freestanding.

Class A shares do not meet the definition of a derivative because they require an initial

investment in cash (or other assets) equal to their fair value at inception (that is, the “no

initial net investment” criterion for a derivative is not met). However, because the shares

typically contain a redemption feature that allows a public shareholder to redeem its shares

before the merger with an operating company or when the SPAC dissolves if it doesn’t complete

a merger, the shares would be viewed as hybrid instruments that must be analyzed to determine

whether the redemption feature needs to be bifurcated and accounted for as a derivative.

This analysis starts with the assessment of whether a Class A share contains a debt host or an

equity host. ASC 815-15-25-17A requires an issuer or investor to consider the economic

characteristics and risks of a hybrid instrument issued in the form of a share, including all of

its stated and implied substantive terms and features, to determine whether the nature of the

host contract in the share is more akin to debt or to equity.

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A closer look at accounting for financial instruments issued by SPACs 3 March 2022

The table below presents several key features that are common in stock and whether those

terms and features are, by their nature, debt-like or equity-like. Each term and feature of the

hybrid instrument should be considered. Once a determination is made about whether a

feature is debt-like or equity-like, the feature should be weighted based on the relevant facts

and circumstances and, after considering the weighting of all terms and features, the nature

of the host contract should be determined.

Feature Equity-like Debt-like

Redemption Perpetual Puttable

(at holder’s

option) on

contingent event

Puttable

(at holder’s

option) with

passage of time

Mandatorily

redeemable

Dividends

Cumulative participating

(and presumably

noncumulative

participating)

Noncumulative fixed rate

(and presumably indexed

variable rate)

Cumulative fixed rate

(and presumably

cumulative indexed

variable rate)

Voting rights

Votes with

common on as-

converted basis

Votes with

common on as-

converted basis on

specific matters

Votes only on

matters related to

specific instrument

Nonvoting

Covenants No provisions that are substantively

protective covenants

Includes provisions that are

substantively protective covenants

Conversion rights Mandatorily convertible Optionally convertible Not convertible

Before the merger with an operating company, public investors of SPACs generally do not

receive dividends or have opportunities to vote on key decisions of the SPAC. This is because

the sole purpose of the SPAC is to identify a target and merge with that entity, and this is a

responsibility of the sponsors. Also, the cash raised in the IPO is typically put in a trust to fund

the acquisition and/or the redemption of Class A shares by public shareholders who elect to

do so upon the merger. Given these facts and the existence of the redemption option, some

view the nature of the host contract in the Class A shares to be debt.

However, others view the nature of the host contract in the Class A shares to be equity,

despite the redemption provision. That’s because public investors in a SPAC buy the shares to

capture the upside potential of a successful business combination with a target operating

company. This outcome provides the most upside to investors and aligns with the sole

business purpose of the SPAC (i.e., merging with a target).

If the SPAC concludes that the host instrument is equity-like, the redemption feature is not

clearly and closely related to the host. Because the redemption feature meets the definition of

a derivative (i.e., underlying, notional amount, no initial net investment, net settlement), the

SPAC would need to analyze whether the redemption feature meets the derivative scope

exception in ASC 815-10-15-74(a). However, the redemption amount is generally determined

based on a formula, which includes inputs such as taxes and the number of outstanding

shares at the time of redemption. Because these inputs are not inputs to the fair value of a

fixed-for-fixed option or forward on equity shares, the redemption amount is not considered

indexed to the SPAC’s own equity; therefore, the SPAC cannot apply the equity scope

exception in ASC 815-10-15-74(a). This would generally result in the redemption feature

being bifurcated from the equity host contract and accounted for as a derivative.

If the SPAC concludes that the host is debt-like because of the redemption feature, it would

apply the four-step test in ASC 815-15-25-42 to determine whether calls or puts that can

accelerate the repayment of principal on debt are considered to be clearly and closely related

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A closer look at accounting for financial instruments issued by SPACs 3 March 2022

to the debt host contract. Most SPACs that conclude that the host is debt-like also conclude

that they don’t have to bifurcate the redemption option and they can treat the Class A share

as one unit of account.

Classification and measurement of redeemable securities (ASC 480-10-S99-3A)

Since a SPAC is an SEC registrant, it must consider the SEC staff’s guidance in ASC 480-10-

S99-3A on redeemable equity securities. Because the Class A shares contain redemption

rights that make them certain to become redeemable by the holder and no exceptions in

ASC 480-10-S99-3A apply, the Class A shares must be classified in temporary (i.e.,

mezzanine) equity in the SPAC’s financial statements and are subject to the subsequent

measurement guidance in ASC 480-10-S99-3A. Once the SPAC successfully completes a

merger with a target, the redemption features of the Class A shares terminate. At that time,

the Class A share should be reclassified into permanent equity of the combined company.

The governing documents of SPACs typically do not permit a redemption of the Class A shares

if it would cause the company’s net tangible assets to decline below a certain threshold

(i.e., less than $5 million). Some SPACs classified a portion of the Class A shares in permanent

equity, partially because they viewed the unit of account to be the pool of the Class A shares,

not the individual share. At the latest AICPA and CIMA Conference on Current SEC and PCAOB

Developments,

the SEC staff clarified its view that each share should be presented outside of

permanent equity and said that it disagrees with the view that the pool of the class of shares is

the unit of account rather than each individual share. An entity should consider the staff’s view

when evaluating whether to classify its Class A shares in temporary or permanent equity.

Initial measurement

The SEC staff guidance cited in ASC 480-10-S99-3A says the initial carrying value of a

redeemable equity security classified in temporary equity should generally be its issuance

date fair value. However, if a redeemable equity instrument is issued with other freestanding

instruments, the initial carrying value of the amount classified in temporary equity should be

the redeemable equity instrument’s allocated proceeds.

As discussed above, because the Class A shares are issued in units that also contain warrants,

the SPAC must allocate proceeds between the two instruments. As a result, the initial

carrying amount of a Class A share in temporary equity is below the unit price of $10. If an

embedded feature requires bifurcation from a Class A share, the bifurcated feature is

allocated its full fair value and the residual would be allocated to the Class A share host

contract, which would further reduce the initial carrying value below the unit price of $10.

Subsequent measurement

ASC 480-10-S99-3A says that if the instrument is not currently redeemable but it is probable

that the instrument will become redeemable (e.g., the instrument can be redeemed upon a

contingent event that is probable of occurring, the instrument is redeemable upon passage of

time), the instrument should be remeasured pursuant to one of the following methods:

Methods Description

Method 1

Changes in the redemption value are accreted over the period

from the date of issuance to the earliest redemption date.

Method 2

Changes in the redemption value are recognized immediately

as if the redemption were to occur at the end of the reporting

date based on the conditions that exist as of that date.

Before a merger

with an operating

company, a SPAC

generally presents

its Class A shares as

“mezzanine” equity

in its financial

statements.

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Because the Class A shares contain redemption rights that make them certain to become

redeemable by the holder, the probable threshold is met. Therefore, the Class A shares are subject

to the subsequent measurement guidance in ASC 480-10-S99-3A. The SPAC can choose to

accrete the Class A shares from their initial carrying amount to the $10 redemption value over the

period from the IPO date to the redemption date (i.e., the merger transaction date) or immediately.

Earnings per share (EPS) considerations

Subsequent measurement adjustments recorded pursuant to ASC 480-10-S99-3A related to

redeemable instruments are treated in the same manner as dividends on nonredeemable stock

and may affect income available to common shareholders (i.e., the EPS numerator). The manner

in which subsequent adjustments affect EPS depends on whether the redeemable securities

are common stock or preferred stock, and if they are common stock (most common in SPAC

structures), whether the redemption value is at fair value or at an amount other than fair value.

Specifically, if the holders of redeemable common stock have a contractual right to receive a

redemption amount other than fair value (e.g., a fixed amount) of the issuer’s common

shares, those shareholders have, in substance, received a different distribution than other

holders of common stock (i.e., a preferential dividend). Paragraph 21 of ASC 480-10-S99-3A

says a class of common stock with different dividend rates from those of another class of

common stock but without prior or senior rights is required to apply the two-class method to

calculate EPS under ASC 260.

Generally, Class A shares are redeemable at a price equal to the amount deposited in the trust

account held by the SPAC (i.e., the gross proceeds from the IPO), plus any interest earned on

the amounts in the trust account, reduced by the amount used by the SPAC for taxes and

other operational expenses. This redemption price would generally not be considered a

redemption at fair value. Accordingly, the adjustments to the carrying amount should be

reflected in EPS using the two-class method.

The SEC staff believes that,

when common stock is redeemable at something other than fair

value, there are two acceptable approaches for allocating earnings between the different

classes of shareholders under the two-class method:

Approaches to apply the two-class method

Approach 1 Approach 2

Treat the entire periodic adjustment to the

security’s carrying amount like a dividend

Treat only the portion of the periodic

adjustment to the security’s carrying

amount that reflects a redemption in

excess of fair value like a dividend

An entity in this situation needs to make an accounting policy election about which approach

to use. The entity would then need to apply the approach consistently and disclose it as an

accounting policy in the notes to the financial statements. For further discussion on the effect

of redeemable securities on EPS, see section 3.2.2 of our FRD publication, Earnings per share

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SPAC warrants, including public warrants

The private placement warrants and public warrants generally include the following key terms:

•

Underlying. Each warrant is exercisable into one Class A share.

•

Strike price. The price at which holders can exercise their warrants to purchase shares is

typically $11.50 (15% above the $10 IPO price), with anti-dilution adjustments for splits,

stock and cash dividends.

•

Exercise contingencies. The warrants become exercisable on the later of 30 days after the

SPAC merger transaction and the 12-month anniversary of the SPAC IPO. The warrants

expire if a SPAC merger is not consummated.

•

Term. The term is typically five years.

•

Settlement provisions. The warrants can be physically settled upon exercise, meaning a

holder delivers $11.50 in cash in exchange for one share of Class A stock for each

warrant. In certain circumstances, the holder can be required to settle on a cashless

basis, meaning the holder receives a number of shares equal to either the intrinsic value

or the fair value of the warrant and doesn’t pay any cash.

•

Tender offer provisions. If a qualifying cash tender offer is made to the Class A

shareholders and accepted by holders of a majority of the outstanding Class A shares, all

warrant holders are entitled to receive cash for their warrants.

While most of the terms of private placement warrants are identical to those of public

warrants, there are several important differences that can affect the classification of the

instruments by both the SPAC and the combined company as well as the entities’ earnings.

Differences between private placement and public warrants

Adjustments to the strike price are calculated differently — While the strike price of both

types of warrants is often reduced when there is a change in control of the SPAC and less

than 70% of the consideration received by SPAC shareholders in that transaction is stock

listed on an exchange, the adjustments are calculated differently.

Holders of public warrants effectively can be forced to exercise them in certain situations —

The SPAC can redeem public warrants for $0.01 per warrant, effectively forcing holders to

exercise them, if the warrants are exercisable and the Class A shares trade above $18 per share

for a period of time. Private placement warrants are typically not subject to such a redemption.

Holders of public warrants effectively can be forced to exercise them on a cashless

basis — If public warrants are exercisable and the Class A shares trade at or above $10 per

share, the SPAC can redeem the public warrants for $0.10 per warrant. In this situation,

the holders’ only alternative is to exercise and settle the warrants on a cashless basis and

receive a number of Class A shares based on a “make-whole” table. Private placement

warrants are typically not subject to such a redemption.

Private placement warrants can become public warrants — Private placement warrants

become public warrants if they are transferred to a party that is not the sponsor or an

affiliate of the sponsor.

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The following flowchart summarizes the evaluation for classifying SPAC warrants that are not

accounted for under ASC 718. It assumes the entity has already adopted Accounting

Standards Update 2020-06, Debt — Debt with Conversion and Other Options (Subtopic 470-

20) and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40):

Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.

Distinguishing liabilities from equity (ASC 480)

Private placement warrants generally meet the definition of a freestanding financial instrument

because they are issued separately and apart from other instruments. Likewise, public

warrants are considered freestanding because they can be separately traded soon after the

IPO, even though they are issued as a unit with the Class A shares in the IPO. Consequently,

both types of SPAC warrants should first be analyzed under the guidance in ASC 480.

ASC 480 provides guidance for how an issuer classifies and measures in its statement of

financial position certain freestanding equity-linked financial instruments, including forwards,

options and warrants. Any financial instrument, other than an outstanding share, that embodies,

or is indexed to, an obligation to repurchase an issuer’s shares that may require the issuer to

transfer assets (e.g., cash) is a liability (or sometimes an asset) pursuant to ASC 480-10-25-8.

In addition, contracts that embody an obligation that must or may be settled by issuing a

variable number of shares are liabilities pursuant to ASC 480-10-25-14 if the monetary value

of the obligation does not expose the holder to risks and rewards similar to those of an owner.

Classify the

warrant in equity.

Classify the warrant

as a liability.

Yes

Does the warrant meet all the conditions

for equity classification (ASC 815-40-25)?

Yes

At inception, does the warrant embody

an obligation to (1) buy back the SPAC’s

equity shares by transferring assets

(ASC 480-10-25-8) or (2) issue a variable

number of shares for which the monetary

value is solely or predominantly fixed, varies

with something other than the fair value of

the SPAC’s equity shares, or varies inversely

in relation to the SPAC’s equity shares

(ASC 480-10-25-14)?

Is the warrant indexed to the SPAC’s

own stock (ASC 815-40-15)?

Determine whether the warrant meets

the definition of a derivative (ASC 815).

If so, it is subject to the derivative

disclosure requirements.

Classify the warrant as a liability

pursuant to ASC 480.

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If a warrant is exercisable into shares that are redeemable, or the warrant itself is redeemable,

for cash or other assets, it would be classified as a liability, pursuant to ASC 480-10-25-8.

While the SPAC warrants are not redeemable by the holders, as discussed above, the Class A

shares underlying the warrants are redeemable by the holder for cash. As a result, the warrants

would be classified as liabilities if they are exercisable before the merger (which is typically

not the case). That’s because the holder of the warrant would be receiving a Class A share

that is redeemable at the holder’s option. However, if the warrants can only be exercised after

the merger transaction (when the Class A shares are no longer redeemable by the holders),

the warrants would not be classified as liabilities under ASC 480-10-25-8 because the Class A

shares received by the holder upon exercise of the warrants are not redeemable.

If the warrants are not liabilities pursuant to ASC 480-10-25-8, the SPAC generally would

then conclude that the warrants are not liabilities under ASC 480-10-25-14 either. That’s

because the SPAC warrants generally do not represent an obligation to issue a variable number

of 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 move in the opposite direction to changes in fair value of the Class A shares.

Contracts in an entity’s own equity (ASC 815-40)

SPAC warrants that are not in the scope of ASC 480 should be evaluated under the guidance

in ASC 815-40 to determine whether they should be classified as liabilities or equity. ASC 815-40

applies to both (1) instruments that meet the definition of a derivative that are being evaluated

to determine whether the exception to derivative accounting pursuant to ASC 815-10-15-74(a)

applies and (2) instruments that do not meet the definition of a derivative to determine their

appropriate classification.

ASC 815-40 states that contracts should be classified as equity instruments (and not as an

asset or liability) if they are both:

•

Indexed to the entity’s own stock (ASC 815-40-15)

•

Classified in stockholders’ equity in the entity’s statement of financial position

(ASC 815-40-25)

The indexation guidance (ASC 815-40-15)

ASC 815-40-15 outlines a two-step evaluation to determine whether an instrument (or

embedded feature) is indexed to the issuer’s own stock.

Evaluations

Step 1: Evaluate any exercise

contingencies

Exercise contingencies based on an observable market or index that

is not based on the issuer’s stock or operations preclude an

instrument from being considered indexed to an entity’s own stock.

Step 2: Evaluate whether

each settlement provision is

consistent with a fixed-for-

fixed equity instrument

Any settlement amount not equal to the difference between the fair

value of a fixed number of the entity’s equity shares and a fixed

monetary amount precludes an instrument from being considered

indexed to an entity’s own stock (with certain exceptions for variables

that would be inputs to the valuation model for a fixed-for-fixed

forward or option contract).

Settlement amounts

for warrants can

differ depending on

who holds them.

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The exercise contingencies included in SPAC warrants generally do not preclude the warrants

from being considered indexed to the entity’s own stock under Step 1. However, SPAC

warrants often contain adjustment provisions that change the number of shares issuable upon

exercise or the strike price of the warrants. Therefore, Step 2 of the indexation guidance

should be carefully evaluated to determine whether any of these adjustment provisions would

preclude the warrants from being considered indexed to the SPAC’s own stock.

Step 2 of the indexation guidance is premised on a basic principle that the settlement amount

should be based on an exchange of a fixed number of shares for a fixed amount of consideration.

While there are exceptions to this general rule, the exceptions are limited to adjustments that

change the settlement amount based only on variables that would be inputs to the fair value

of a fixed-for-fixed forward or option on equity shares. In addition, certain adjustments that

are designed to compensate one of the parties to the instrument for changes in fair value that

are not incorporated into a standard pricing model should not preclude a conclusion that an

instrument is indexed to the company’s own stock.

Common adjustment provisions in the warrants include the following:

•

Anti-dilution adjustments for splits, stock and cash dividends

•

Adjustments to the number of Class A shares issuable upon exercise, in order to protect

the holder from a loss of time value

•

Adjustments to the exercise price based on a warrant value using the Black-Scholes model

upon certain tender or exchange offers for the SPAC’s outstanding common stock

•

Cap provisions that limit the number of Class A shares issuable upon certain “cashless”

exercises

•

Changes in the terms of private placement warrants upon a transfer to a non-affiliated party

The discussion below describes the analysis under the indexation guidance of some of the

common adjustment provisions in warrants issued by SPACs. The list is not all-inclusive.

SPACs should carefully review and analyze their warrant agreements to make sure all

adjustment provisions, regardless of the likelihood that an adjustment would be triggered, are

appropriately evaluated pursuant to the indexation guidance in ASC 815-40-15.

Common adjustment provisions in warrant agreements that generally would not preclude the

warrants from being considered indexed to the SPAC’s own stock include:

Anti-dilution adjustments. If these provisions are designed to adjust the strike price of the

warrants or the number of shares to be issued to offset the resulting dilution upon events

such as splits, stock dividends or cash dividends, they generally do not preclude the SPAC

warrants from being considered indexed to the SPAC’s own stock.

Redemption features. SPAC warrants often contain redemption features that, if exercised,

change the settlement amount of the warrants. These features generally do not preclude

warrants from being indexed to the SPAC’s stock. The table below describes the analysis a

SPAC would perform for each redemption feature.

Adjustment provisions that generally do not preclude SPAC warrants from being ‘indexed’

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Redemption feature Analysis

$0.01 redemption feature. The SPAC can

redeem the warrants for $0.01 per warrant

when the Class A share price exceeds $18

per share for a period of time. The holder is

given an opportunity during the redemption

period (typically 30 days) to exercise the

warrants. This redemption feature effectively

forces the warrant holders to exercise the

warrants (rather than receive the nominal

redemption amount of $0.01 per warrant)

and, therefore, caps the return to the holders.

Step 1 — The feature that allows the SPAC

to redeem the warrants for $0.01 per

warrant when the Class A share price

exceeds $18 per share is considered an

exercise contingency. It is not an observable

market or an observable index that is

unrelated to the SPAC, so this feature does

not preclude the warrants from being

considered indexed to the SPAC’s own stock

under Step 1. Proceed to Step 2.

Step 2 — Once the exercise contingency is

triggered, the settlement amount would

equal the difference between the fair value

of a fixed number of Class A shares

underlying the warrants and a fixed strike

price ($11.50 per share). Therefore, the

warrants would be considered indexed to

the SPAC’s own stock.

$0.10 redemption feature. The SPAC can

redeem the warrants for $0.10 per warrant

when the underlying share price equals or

exceeds $10 per share. During the

redemption period, a holder can exercise its

warrants on a “cashless basis” and receive a

number of shares determined by using a

“make-whole” table in the warrant

agreement that is designed to compensate

holders for the loss of time value in the

warrants for any settlement that occurs

when the Class A shares trade below $18.

Step 1 — The feature that allows the SPAC to

redeem the warrants for $0.10 per warrant

when the Class A share price equals or

exceeds $10 per share is considered an

exercise contingency. It is not an observable

market or an observable index that is

unrelated to the SPAC, so the feature does

not preclude the warrants from being

considered indexed to the entity’s own stock

under Step 1. Proceed to Step 2.

Step 2 — For the warrants not to be

precluded from being classified in equity

(i.e., not to fail Step 2), the “make-whole”

table in the warrants should generally

present the following characteristics:

•

The number of shares in the “make-whole”

table is determined by reference to the

table with axes of stock price and time.

•

The table is designed to compensate the

holders for intrinsic value plus lost time

value determined by assuming no change

in relevant pricing inputs (other than stock

price and time) and using reasonable

assumptions (e.g., volatility, dividends,

interest rates) known at the issuance

date of the warrants. This determination

would require an understanding and

evaluation of the appropriateness of the

pricing model used to determine the

time value.

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Redemption feature Analysis

Consistent with the example in ASC 815-40-

55-45 through 55-46, a “make-whole”

provision with these characteristics generally

does not preclude SPAC warrants from

being considered indexed to the company’s

own stock. That is because the aggregate

fair value of the shares received approximates

the fair value of the warrants exercised.

The staffs of the SEC’s Division of Corporation Finance and the Office of the Chief Accountant

issued a joint statement

in April 2021 that highlighted the potential accounting implications

of certain terms that are common in warrants issued by SPACs.

The joint statement provided the staffs’ views on common features included in these warrants

and their conclusion that certain features require SPACs to classify the warrants as liabilities

rather than as equity. After the statement was issued, many SPACs and combined companies

restated their financial statements because they historically had reported these warrants in

equity. SPACs and combined companies resulting from SPAC mergers should consider this

statement when evaluating the classification of warrants issued before and after a merger.

 SEC staff statement — indexation considerations

The SEC staff said the warrants it reviewed included provisions that could change the

settlement amounts depending on the characteristics of the warrant holder (e.g., whether

the warrant holder is a SPAC sponsor or an unaffiliated third party). Because the holder of

an instrument is not an input to an option pricing model, the SEC staff concluded that the

warrants it reviewed couldn’t be considered indexed to the entity’s own stock under the

indexation guidance and, therefore, should be classified as liabilities measured at fair

value, with changes in fair value each period recognized in earnings.

The tables below describe common adjustment provisions that generally preclude SPAC

warrants from being considered indexed to the SPAC’s own stock, along with examples of how

the provisions are described in a SPAC warrant agreement.

$.01 redemption feature

Adjustment provision

(affects private placement warrants only)

Analysis

If private placement warrants are not

subject to the $0.01 redemption feature

discussed above but will be when those

warrants are transferred to a third party

not affiliated with the sponsor (often

referred to as a non-permitted transferee)

and become public warrants, the calculation

of the settlement amount changes.

Because the settlement amount depends

solely on who holds the instrument, and

this is not an input to the fair value of a

fixed-for-fixed option or forward on equity

shares, this provision would cause the

warrants to fail Step 2 of the indexation

guidance. As a result, the private placement

warrants would be classified as liabilities.

SPACs and

combined

companies should

consider the SEC

staff statement

when evaluating the

classification of

their warrants.

Adjustment provisions that would preclude SPAC warrants from being ’indexed’

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Example of provision in a SPAC warrant agreement

2.6. The Private Placement Warrants shall be identical to the Public Warrants, except

that so long as they are held by the Sponsor or any of its Permitted Transferees (as

defined below) the Private Placement Warrants: (i) may be exercised for cash or on a

“cashless basis,” pursuant to subsection 3.3.1(c) hereof, (ii) including the Ordinary

Shares issuable upon exercise of the Private Placement Warrants, may not be

transferred, assigned or sold until thirty (30) days after the completion by the Company

of an initial Business Combination and (iii) shall not be redeemable by the Company

pursuant to Section 6.1 hereof; provided, however, that in the case of (ii), the Private

Placement Warrants and any Ordinary Shares issued upon exercise of the Private

Placement Warrants may be transferred by the holders thereof …

6.1. Subject to Section 6.5 hereof, not less than all of the outstanding Warrants may be

redeemed, at the option of the Company, at any time during the Exercise Period, 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 Redemption Price of $0.01 per Warrant, provided

that (a) the Reference Value equals or exceeds $18.00 per share (subject to adjustment

in compliance with Section 4 hereof) and (b) there is an effective registration statement

covering the issuance of the Ordinary Shares 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.

Different settlement amounts upon certain mergers for public vs. private warrants

Adjustment provision

(affects private placement warrants only)

Analysis

The strike price of a private placement

warrant may be adjusted upon certain

change in control transactions. For

example, if the SPAC merges into another

corporation and less than 70% of the

consideration receivable by the holders of

the SPAC’s common stock is payable in the

shares of a public company (e.g., in an all-

cash deal), the exercise price of the warrants

will be adjusted based on a warrant value

using the Black-Scholes model. However,

that Black-Scholes warrant value is

calculated differently for private

placement and public warrants. That is,

one uses an uncapped call option pricing

model, while the other uses a capped call

option pricing model. As a result, the

settlement amount would change when a

private placement warrant becomes a

public warrant because it is transferred to

a non-affiliate of the sponsor.

Because the settlement amount depends

solely on who holds the instrument, and

this is not an input to the fair value of a

fixed-for-fixed option or forward on equity

shares, this provision would cause the

warrants to fail Step 2 of the indexation

guidance. As a result, the private

placement warrants would be classified as

liabilities.

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Example of provision in a SPAC warrant agreement

4.4. … If 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, (i) Section 6 of this Agreement shall be taken

into account,

(ii) the price of each Ordinary Share shall be the volume weighted average

price of the Ordinary Shares during the ten (10) trading day period ending on the trading

day prior to the effective date of the applicable event, (iii) 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

(iv) 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. …

__________________________

In the example, Section 6 provides that certain redemption provisions do not apply to the private placement

warrants.

Cashless exercise with different settlement amounts for public vs. private warrants

Adjustment provision

(affects private placement warrants only)

Analysis

The warrants may be exercised on a

“cashless basis” in certain circumstances.

However, the “fair market value” input used

to derive the settlement amount of a

warrant upon a cashless exercise is defined

as the average last sale price of the common

stock over a number of days for private

placement warrants, and the volume

weighted average price of the common stock

over a number of days for public warrants.

As a result, the settlement amount changes

when a private placement warrant becomes

a public warrant because of a transfer to a

non-affiliate of the sponsor.

Because the settlement amount depends

solely on who holds the instrument, and

this is not an input to the fair value of a

fixed-for-fixed option or forward on equity

shares, this provision would cause the

warrants to fail Step 2 of the indexation

guidance. As a result, the private placement

warrants would be classified as liabilities.

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Example of provision in a SPAC warrant agreement

3.3.1 (c) With respect to any Private Placement Warrant, so long as such Private

Placement Warrant is held by the Sponsor or a Permitted Transferee, by surrendering

the Warrants for that number of shares of Common Stock equal to the quotient obtained

by dividing (x) the product of the number of shares of Common Stock underlying the

Warrants, multiplied by the difference between the Warrant Price and the “Fair Market

Value”, as defined in this subsection 3.3.1(c), by (y) the Fair Market Value. Solely for

purposes of this subsection 3.3.1(c), the “Fair Market Value” shall mean the 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 …

7.4.1 Registration of the Common Stock

: … holders of the Warrants shall have the right,

during the period beginning on the 61st Business Day after the closing of the Business

Combination … to exercise such Warrants on a “cashless basis,” by exchanging the

Warrants (in accordance with Section 3(a)(9) of the Securities Act (or any successor

rule) or another exemption) for that number of shares of Common Stock equal to the

quotient obtained by dividing (x) the product of the number of shares of Common Stock

underlying the Warrants, multiplied by the difference between the Warrant Price and the

“Fair Market Value” (as defined below) by (y) the Fair Market Value. Solely for purposes

of this subsection 7.4.1, “Fair Market Value” shall mean 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 …

[emphasis added]

___________________________

In the example, section 7.4.1 applies to Public Warrants.

$.10 redemption feature

Adjustment provision

(affects private placement warrants only)

Analysis

Private placement warrants typically are

not subject to the $0.10 redemption

feature discussed above but will be once

those warrants are transferred to a non-

affiliate of the sponsor and become public

warrants. As a result, the settlement

amount changes when a private placement

warrant becomes a public warrant.

Because the settlement amount depends

solely on who holds the instrument, and

this is not an input to the fair value of a

fixed-for-fixed option or forward on equity

shares, this provision would cause the

warrants to fail Step 2 of the indexation

guidance. As a result, the private placement

warrants would be classified as liabilities.

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Example of provision in a SPAC warrant agreement

6.2 Redemption of Warrants for Ordinary Shares. Subject to Sections 6.5 hereof, not less

than all of the outstanding Warrants may be redeemed, at the option of the Company,

beginning 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 Redemption Price of $0.10 per Warrant; provided that

the last reported sales price of the Ordinary Shares 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, further, that there is an

effective registration statement covering the Ordinary Shares 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(b). During

the 30-day Redemption Period in connection with a redemption pursuant to this Section 6.2,

Registered Holders of the Warrants may elect to exercise their Warrants on a “cashless

basis” pursuant to subsection 3.3.1(d) and receive a number of Ordinary Shares 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)) (a “Make-Whole Exercise”).

Fair Market Value of Class A Common Stock

Redemption

Date (period

to expiration

of warrants)

≤$10.00

$11.00 $12.00 $13.00 $14.00 $15.00 $16.00 $17.00

≥$18.00

57 months 0.257 0.277 0.294 0.310 0.324 0.337 0.348 0.358 0.365

54 months 0.252 0.272 0.291 0.307 0.322 0.335 0.347 0.357 0.365

51 months 0.246 0.268 0.287 0.304 0.320 0.333 0.346 0.357 0.365

48 months 0.241 0.263 0.283 0.301 0.317 0.332 0.344 0.356 0.365

45 months 0.235 0.258 0.279 0.298 0.315 0.330 0.343 0.356 0.365

42 months 0.228 0.252 0.274 0.294 0.312 0.328 0.342 0.355 0.364

39 months 0.221 0.246 0.269 0.290 0.309 0.325 0.340 0.354 0.364

36 months 0.213 0.239 0.263 0.285 0.305 0.323 0.339 0.353 0.364

33 months 0.205 0.232 0.257 0.280 0.301 0.320 0.337 0.352 0.364

30 months 0.196 0.224 0.250 0.274 0.297 0.316 0.335 0.351 0.364

27 months 0.185 0.214 0.242 0.268 0.291 0.313 0.332 0.350 0.364

24 months 0.173 0.204 0.233 0.260 0.285 0.308 0.329 0.348 0.364

21 months 0.161 0.193 0.223 0.252 0.279 0.304 0.326 0.347 0.364

18 months 0.146 0.179 0.211 0.242 0.271 0.298 0.322 0.345 0.363

15 months 0.130 0.164 0.197 0.230 0.262 0.291 0.317 0.342 0.363

12 months 0.111 0.146 0.181 0.216 0.250 0.282 0.312 0.339 0.363

9 months 0.090 0.125 0.162 0.199 0.237 0.272 0.305 0.336 0.362

6 months 0.065 0.099 0.137 0.178 0.219 0.259 0.296 0.331 0.362

3 months 0.034 0.065 0.104 0.150 0.197 0.243 0.286 0.326 0.361

0 months — — 0.042 0.115 0.179 0.233 0.281 0.323 0.361

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Example of provision in a SPAC warrant agreement (continued)

6.5 Exclusion of Private Placement Warrants. The Company agrees that the redemption

rights provided in this Section 6 hereof shall not apply to the Private Placement Warrants if

at the time of the redemption such Private Placement Warrants continue to be held by the

Sponsor or its Permitted Transferees. However, once such Private Placement Warrants

are transferred (other than to Permitted Transferees in accordance with Section 2.6

hereof), the Company may redeem the Private Placement Warrants pursuant to this

Section 6, provided that the criteria for redemption are met, including the opportunity

of the holder of such Private Placement Warrants to exercise the Private Placement

Warrants prior to redemption pursuant to Section 6.4. Private Placement Warrants that are

transferred to persons other than Permitted Transferees shall upon such transfer cease to

be Private Placement Warrants and shall become Public Warrants under this Agreement.

Different settlement amount for officers and directors

Adjustment provision

(affects public warrants only)

Analysis

Some warrant agreements allow the SPAC

to call the public warrants for $0.10 per

warrant when the share price of Class A

common stock equals or exceeds $10.

During the redemption period, a holder can

exercise public warrants on a cashless

basis and receive a number of shares

based on a “make whole” table in the

warrant agreement, which does not

represent the fair value of the warrant at

time of settlement. However, holders who

are officers or directors of the SPAC will

receive a settlement amount based on the

closing price of the public warrant on a

specified date.

Because the settlement amount depends

solely on who holds the instrument, and

this is not an input to the fair value of a

fixed-for-fixed option or forward on equity

shares, this provision would cause the

warrants to fail Step 2 of the indexation

guidance. As a result, the public warrants

would be classified as liabilities.

Example of provision in a SPAC warrant agreement

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 closing price of the

Public Warrants on the Alternative Redemption Date) for such Public Warrants so redeemed.

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Capped settlement amount when there is no effective registration statement

Adjustment provision

(affects public and private placement warrants)

Analysis

Warrants issued by a SPAC only physically

settle when there is an effective

registration statement — that is, holders

pay $11.50 per warrant in cash in

exchange for one share of Class A common

stock. When there is no effective

registration statement, a provision in the

warrant agreement may cap the number of

Class A shares issuable under the warrant

(e.g., at .361 shares per warrant) in a

cashless exercise, which is the only option

in this situation.

To illustrate that difference, if there is an

effective registration statement, the

warrants will be physically settled upon

exercise, and the holder will receive one

share that trades at $20 in exchange for its

$11.50 payment, representing a settlement

amount of $8.50. However, under the cap

that applies when there is no effective

registration statement, the holder would

only be entitled to receive .361 shares

(i.e., a $7.20 settlement amount) in a

cashless exercise.

The number of Class A shares issuable

upon warrant exercises depends on

whether there is an effective registration

statement. Because an effective

registration statement is not an input to

the fair value option model for a fixed-for-

fixed option or forward, this provision

precludes the warrants from being

considered indexed to the SPAC’s own

stock, and the private placement warrants

and public warrants would be classified as

liabilities.

Example of provision in a SPAC warrant agreement

7.4.1 Registration of the Common Stock. The Company agrees that as soon as

practicable, but in no event later than twenty (20) Business Days after the closing of its

initial Business Combination, it shall use its commercially reasonable efforts to file with

the Commission a registration statement for the registration, under the Securities Act,

of the issuance of the shares of Common Stock issuable upon exercise of the

Warrants. The Company shall use its commercially reasonable efforts to cause the same

to become effective within sixty (60) days after the closing of the Business Combination

and to maintain the effectiveness of such registration statement, and a current

prospectus relating thereto, until the expiration of the Warrants in accordance with the

provisions of this Agreement. If any such registration statement has not been declared

effective by the 60th Business Day following the closing of the Business Combination,

holders of the Warrants shall have the right, during the period beginning on the 61st

Business Day after the closing of the Business Combination and ending upon such

registration statement being declared effective by the Commission, and during any

other period when the Company shall fail to have maintained an effective

registration statement covering the shares of Common Stock issuable upon exercise

of the Warrants, to exercise such Warrants on a “cashless basis,” by exchanging the

Warrants (in accordance with Section 3(a)(9) of the Securities Act (or any successor rule)

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Example of provision in a SPAC warrant agreement (continued)

or another exemption) for that number of shares of Common Stock equal to the lesser

of (A) the quotient obtained by dividing (x) the product of the number of shares of

Common Stock underlying the Warrants, multiplied by the excess of the “Fair Market

Value” (as defined below) over the Warrant Price by (y) the Fair Market Value and (B)

0.365. Solely for purposes of this subsection 7.4.1, “Fair Market Value” shall mean

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. The date that notice of cashless exercise is received

by the Warrant Agent shall be conclusively determined by the Warrant Agent. In

connection with the “cashless exercise” of a Public Warrant, the Company shall, upon

request, provide the Warrant Agent with an opinion of counsel for the Company (which

shall be an outside law firm with securities law experience) stating that (i) the exercise of

the Warrants on a cashless basis in accordance with this subsection 7.4.1 is not required

to be registered under the Securities Act and (ii) the shares of Common Stock issued

upon such exercise shall be freely tradable under United States federal securities laws by

anyone who is not an affiliate (as such term is defined in Rule 144 under the Securities

Act (or any successor rule)) of the Company and, accordingly, shall not be required to

bear a restrictive legend. Except as provided in subsection 7.4.2, for the avoidance of

any doubt, unless and until all of the Warrants have been exercised, the Company shall

continue to be obligated to comply with its registration obligations under the first three

sentences of this subsection 7.4.1 [emphasis added].

How we see it

Cap provisions often preclude SPAC warrants from being considered indexed to the

SPAC’s own stock. A SPAC or a combined company should carefully review the warrant

agreement to identify any caps on settlement amounts. Once those caps are identified, the

SPAC needs to determine whether any of those caps could change the settlement amount

for any reason that would not be an input to the pricing model for a fixed-for-fixed forward

or option. If that is the case, the warrants would fail Step 2 of the indexation guidance and

would be precluded from being classified in equity.

Freestanding equity-linked instruments, such as SPAC warrants that are not indexed to an

entity’s own stock under ASC 815-40-15, are required to be classified as assets or liabilities

and measured at fair value, with subsequent changes in fair value recognized in earnings.

The equity classification guidance (ASC 815-40-25)

An instrument that is indexed to the entity’s own equity should also be evaluated to determine

whether the form of contractual settlement supports a conclusion of equity classification. If

an issuer is able, in all circumstances, to settle the contract in net shares or by physical

settlement (i.e., the gross exchange of the contractual shares for the contractual

consideration), the contract qualifies for equity classification.

The equity classification guidance includes conditions that focus on whether the issuer will

have the ability, in all cases, to settle in shares. If these conditions are not met, net cash

settlement is presumed, and equity classification is not permitted.

Cap provisions in

certain SPAC

warrant agreements

might precl

ude the

warrants from being

classified as equity.

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The contract is precluded from being classified in equity if it must be net cash settled, or such

a settlement is (1) a contractual alternative that is not within the control of the issuer or (2)

presumed under the guidance. In determining whether an entity controls settlement in

shares, the contractual provisions and the entity’s current capital structure and any legal

barriers to share settlement should be considered.

The equity classification guidance provides limited exceptions for net cash settlement.

ASC 815-40-25-8 says equity classification isn’t precluded if net cash settlement is trigged by

an event that is not within the entity’s control and the counterparty is permitted to receive or

deliver, upon settlement, the same form of consideration (e.g., cash, debt, other assets) as

holders of the shares underlying the contract. ASC 815-40-55-3 illustrates the application of

this exception using a change-in-control provision as the triggering event.

SEC staff statement — equity classification considerations

The SEC staff statement said the exception in ASC 815-40-25-8 that allows equity

classification applies to 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.”

The terms of both public warrants and private placement warrants often include a provision

that provides for net cash settlement in the event of a tender or exchange offer that is

made and accepted by the holders of more than 50% of the outstanding shares underlying

the warrants. The SEC staff said that, in the fact pattern it evaluated involving such a

provision, the exception didn’t apply and the warrants should be classified as liabilities.

How we see it

We understand that the issuer in the fact pattern reviewed by the staff had two classes of

voting shares outstanding. Consequently, a tender or exchange offer accepted by 50% of

the holders of the class of shares underlying the warrant would not result in the exchange

of a number of shares that could result in a change in control. As a result, the SPAC could

not apply the exception in ASC 815-40-25-8.

Illustration 1 — Tender offer provision when a SPAC has two classes of common stock

Before merging with a target operating company, SPAC X has two classes of common stock

outstanding: Class A and Class B. Both classes provide holders with the same voting rights

(one vote per share) and dividend rights. When the warrants were issued, there were 80

shares of Class A and 20 shares of Class B outstanding. When the warrants are exercised,

SPAC X will settle by issuing Class A shares.

The warrant agreement has a tender offer provision that allows the warrant holders to

receive the same form of consideration received by the Class A shareholders, if the entity

that makes the tender offer will own more than 50% of the Class A shares upon the

completion of the offer. If the tender offer results in the acquisition of 51% of the Class A

shares, the entity that made the offer will hold approximately 41% of SPAC X, which would

not be a controlling interest.

Because a tender offer for the Class A shares at the 50% level would not result in the maker

of the tender offer owning a controlling interest in SPAC X, it is not an event that

fundamentally changes the ownership or capitalization of an entity, as provided in the SEC

staff statement. Therefore, SPAC X cannot apply the exception in ASC 815-40-25-8 and

must classify the warrants as liabilities.

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Example of a tender offer provision in a SPAC warrant agreement

… (iii) if 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

adjustments provided for in this Section 4 …

Freestanding equity-classified instruments are initially measured at fair value (or allocated

value). Subsequent changes in fair value are not recognized as long as the contract continues

to be classified in equity. In contrast, if a freestanding instrument that was indexed to the

issuer’s own stock fails the requirements for equity classification, it should be classified as an

asset or liability and initially measured at fair value. The equity classification guidance

specifies that subsequent changes in fair value are recorded in earnings.

Derivative disclosure considerations (ASC 815)

If an equity-linked instrument is in the scope of ASC 480 or ASC 815-40 and is classified as a

liability (or an asset), the instrument should be further evaluated to determine whether it

would also be a derivative pursuant to ASC 815. If so, that instrument would be subject to any

disclosure requirements for derivative instruments. To be a derivative pursuant to ASC 815,

an equity contract should have all of the following characteristics:

Characteristics of a derivative

One or more

underlyings

One or more notional

amounts or payment

provisions or both

An initial net investment

that is smaller than

would be required

to acquire the

underlying asset

Net settlement

Refer to section 2.4 of our FRD publications, Derivatives and hedging (after the adoption of

ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities) or Derivatives

and hedging (before the adoption of ASU 2017-12, Targeted Improvements to Accounting for

Hedging Activities), as applicable, for additional information on the definition of a derivative.

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EPS considerations (ASC 260)

ASC 260 generally requires the use of the treasury stock method for the dilutive effect of a

warrant. Warrants issued by a SPAC are typically contingently exercisable (i.e., after an IPO

or upon a successful business combination). For EPS purposes, the warrants would generally

not be reflected in basic or diluted EPS for the SPAC until the contingency is resolved.

If the warrants give the holders nonforfeitable rights to dividends paid on the underlying stock

prior to exercise, they represent participating securities, regardless of whether the SPAC

actually declares or pays dividends, and the use of the two-class method for calculating EPS

would be required.

For further discussion of the treasury stock method, contingently issuable shares and

participating securities, see sections 4.3, 4.8 and 5.2, respectively, of our FRD publication,

Earnings per share

Underwriter’s overallotment option

Many SPAC IPOs contain features that provide the underwriter with the option to obtain more

of the units sold in the IPO. These provisions permit the underwriter to fill orders slightly in

excess of the planned amount of an offering to promote market efficiencies. The option

typically expires after 30 or 45 days.

In determining the appropriate accounting for the underwriter’s overallotment option, a SPAC

considers the following questions:

•

Is the overallotment option a freestanding financial instrument? This option is generally

considered to be freestanding from the units the SPAC issues. That is because the

underwriter holds the option, and the public investors receive the units. However, if the

underwriter purchases units at the same time it obtains the overallotment option from the

SPAC, the concurrently issued instruments (i.e., the overallotment option and the Class A

common stock and public warrant issued as a unit) should be analyzed to determine

whether they are freestanding from each other or whether one is embedded in the other.

That determination is based on the definition of a freestanding financial instrument in

ASC 480. For further discussion of the unit of account for overallotment options, see

section 5.12 of our FRD publication,

Issuer’s accounting for debt and equity financings

(after the adoption of ASU 2020-06, Accounting for Convertible Instruments and

Contracts in an Entity’s Own Equity).

•

If the overallotment option is freestanding, how should it be classified and measured? If the

option is freestanding, it is generally a liability under ASC 480 because one of its underlyings —

the Class A shares the underwriter will receive upon exercise of the overallotment option —

is redeemable upon the SPAC merger and thus would require the transfer of assets by

the SPAC (ASC 480-10-25-8). Under that guidance, the option should be initially and

subsequently measured at fair value with changes in fair value recognized in earnings.

While an overallotment option that is short-term and has an at-the-money strike price of $10

per unit at the issuance date may have minimal value, the volatility of the underlying Class A

shares may create value, and the value of the option could change over its life.

Issuance costs

For stock that is classified in equity, direct and incremental costs paid to third parties that are

related to its issuance, such as legal fees, printing costs, and bankers’ or underwriters’ fees,

should be accounted for as a reduction of the proceeds of the stock. Internal costs that meet

the incremental and direct criteria (e.g., travel costs directly related to financing) may also be

accounted for as a reduction of proceeds, but costs such as salaries, rent and other period costs

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are not capitalizable as issuance costs. For stock classified in equity, stock issuance costs are

not amortized or accreted unless the stock is classified in temporary equity and the carrying

amount is being accreted to the full redemption amount pursuant to ASC 480-10-S99-3A.

Issuance costs for stock requiring liability classification pursuant to ASC 480 should be

accounted for under the guidance for debt issuance costs, which generally requires the costs

to be amortized and recognized as additional interest expense over the life of the instrument

using the effective interest method pursuant to ASC 835-30-35-2 through 35-3.

Issuance costs related to liability-classified instruments (e.g., liability-classified warrants) that

are subject to an ongoing fair value measurement should be immediately expensed.

Costs related to the issuance of instruments in a basket transaction (e.g., IPO units) that are

freestanding and accounted for separately should generally be allocated between the

instruments. A systematic and rational approach based on the facts and circumstances should

be applied. For a SPAC’s IPO units, allocation of issuance costs between the Class A shares

and public warrants may result in a discount on the Class A shares (i.e., a reduction in the

carrying amount of the shares). Because Class A shares are redeemable by holders upon a

merger with a private operating company (i.e., the de-SPAC transaction), accretion of this

discount may be required pursuant to ASC 480-10-S99-3A.

The table below summarizes the treatment of direct and incremental issuance costs

depending on the type of instrument and its classification:

Type of issuance

Classification of

instrument Accounting for direct and incremental costs

Class B shares Permanent equity

• Considered a reduction of equity proceeds and

recognized in additional paid-in capital (APIC)

• Not subject to amortization

Private

placement

warrants

Permanent equity

• Considered a reduction of equity proceeds and

recognized in APIC

Liability • Expensed as incurred

Class A shares Temporary equity

• Considered a reduction of equity proceeds and

recognized in APIC

• Subject to amortization before the de-SPAC

transaction

Public warrants

Permanent equity

• Considered a reduction of equity proceeds and

recognized in APIC

Liability • Expensed as incurred

Deferred underwriter fees

The underwriter of the SPAC IPO often agrees to defer all or a part of its compensation until the

closing of the de-SPAC transaction. Typically, the underwriting fee is approximately 5.5% of the

IPO gross proceeds, with 2% paid upon the SPAC IPO and 3.5% paid after the de-SPAC transaction.

The 2% paid upon the SPAC IPO is an issuance cost for the IPO units. Refer to the

Issuance

costs section above for further discussion.

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We generally believe that the deferred underwriter fees should be recognized upon the IPO if

the criteria in ASC 450

are met (i.e., the de-SPAC transaction is probable of occurring, and

the underwriter fee can be reasonably estimated). An assertion of “probable” for this purpose

should be consistent with how the SPAC considers the likelihood of the de-SPAC transaction

occurring for other purposes, such as in the valuation of warrants and the subsequent

measurement assessment of Class A shares under the temporary equity guidance.

SPAC merger (de-SPAC transaction)

When a SPAC identifies a target and prepares to merge with it, there are several accounting

issues the SPAC will need to address. For example, while the SPAC is the legal acquirer of the

private target company, the accounting for the transaction depends on which entity is

considered the acquirer for accounting purposes (i.e., the accounting acquirer).

If a SPAC is determined to be the accounting acquirer, the transaction is accounted for as a

business combination in accordance with the guidance in ASC 805 (i.e., as a forward merger).

If the private target is determined to be the accounting acquirer, the transaction is accounted

for as a reverse recapitalization rather than as a business combination. That is, the

accounting will be similar to that of a capital infusion because the only pre-combination asset

of the SPAC is likely to be cash obtained from public investors. For additional information on

determining the accounting acquirer in a SPAC merger, refer to our Technical Line,

Navigating the requirements for merging with a special purpose acquisition company

The following discussion focuses on accounting considerations for financial instruments

issued in a de-SPAC transaction.

PIPEs

When a SPAC conducts its IPO, it raises the amount of capital it expects to need to acquire a

target in a de-SPAC transaction. However, if the SPAC determines that additional capital may

be required to complete the de-SPAC transaction, a private investment in public equity (PIPE)

can be used to provide it.

PIPEs are generally executed in the form of contingent forward purchase commitments by

affiliates of the sponsor of the SPAC or institutional investors to purchase common stock of

the SPAC at a fixed price (e.g., $10) per share. PIPEs are generally settled contemporaneously

with a de-SPAC transaction.

Given that a PIPE is a contract to issue an equity instrument of the SPAC, the SPAC should

consider the analysis discussed above in the SPAC warrants, including public warrants

section,

with appropriate consideration of ASC 480 and ASC 815-40, to determine the classification of

a PIPE. The terms of PIPE arrangements can vary significantly. Therefore, these terms and the

facts and circumstances of the SPAC should be carefully evaluated to determine the accounting.

Class A shares

Class A shares issued in connection with a SPAC merger (e.g., Class A shares issued in

connection with a PIPE transaction) generally aren’t redeemable. Once issued, they are

classified in permanent equity, assuming that no other redemption features exist.

SPAC IPO

Post-merger

SPAC merger

SPAC

formation

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In addition, once the SPAC successfully completes a merger with a target, the holders of the

Class A shares issued in the IPO no longer have the right to redeem those shares. At that

time, the carrying amount of the Class A shares previously classified in temporary equity

should be reclassified into the permanent equity of the combined company pursuant to

ASC 480-10-S99-3A, assuming no other redemption features exist. Amounts recorded in

accordance with ASC 480-10-S99-3A while the shares were classified in temporary equity

should not be reversed upon the reclassification from temporary equity to permanent equity.

Warrants

The determination of whether warrants issued by the SPAC before the merger should be

classified in equity or as liabilities upon the de-SPAC transaction is based on the analysis as

described in the SPAC warrants, including public warrants

section above. In certain

circumstances, warrants may need to be reclassified upon the de-SPAC transaction.

Reassessment under ASC 480

The guidance in ASC 480-10-25-8 requires a financial instrument (other than an outstanding

share) to be classified as a liability (or an asset in some circumstances) based on whether, at

inception, it embodies an obligation to repurchase the issuer’s shares by transferring assets.

Prior to the de-SPAC transaction, the Class A shares underlying SPAC warrants are redeemable

by the holder for cash upon the SPAC merger transaction. If these warrants are exercisable

before the de-SPAC transaction, they are required to be classified as liabilities pursuant to

ASC 480-10-25-8. However, upon the merger transaction, Class A shares will no longer be

redeemable by holders. The combined entity should apply judgment to determine whether it

is appropriate to reassess the classification of these warrants because the Class A shares

underlying them are no longer redeemable for cash. While ASC 480 does not require or

explicitly permit a reassessment of the classification of an instrument once it is initially

recognized as a liability pursuant to ASC 480-10-25-8 through 25-13, we generally believe

that the combined entity may make an accounting policy election to reassess the classification

of these warrants if they no longer obligate the combined entity to transfer assets. The

combined entity may determine upon reassessment that these warrants can be reclassified

from a liability to equity.

Reassessment under ASC 815-40

ASC 815-40-35-8 requires an issuer to reassess the classification of equity-linked instruments

at each balance sheet date, and classification conclusions could change due to changes in the

issuer’s capital structure or other transactions or events that occur during a reporting period.

If the classification changes because of events occurring during the reporting period, the

instrument is reclassified as of the date of the event that caused the reclassification.

SPAC mergers trigger a reassessment if they change the capital structure of the combined

entity. In many cases, that happens because Class B shares generally convert automatically

into Class A shares upon the merger, which could result in there being only one remaining

class of voting securities.

If there is only one class of voting securities remaining, the change-of-control exception in

ASC 815-40-55-3 may apply, which would mean SPAC warrants that were classified as

liabilities because they

previously did not meet the exception could now be reclassified as

equity. If reclassification is required, SPAC warrants should be reclassified at their fair value

on the merger date.

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Earn-out arrangements

When sponsors and the selling shareholders of the target company cannot agree on the value

of the target, they often bridge the gap by negotiating an earn-out arrangement. Earn-out

arrangements may also be used to make SPACs more attractive to the Class A shareholders

of the SPAC and shareholders of potential target companies. These earn-out arrangements

can be executed by:

•

Subjecting a portion of the outstanding Class B shares to an “earnout” provision, with

these shares vesting only if certain post-closing trading price targets are achieved

•

Issuing additional shares of the combined company to the selling shareholders when

certain stock price levels of the combined company are achieved

Frequently, the vesting conditions also include the occurrence of certain liquidity events

(e.g., a merger of the combined entity with another entity, sale of substantially all of the

assets of the combined entity). Earnout arrangements are typically effective for five to seven

years after the merger.

This section focuses on the accounting for earn-out provisions when the SPAC merger is

accounted for as a reverse recapitalization (i.e., the operating company is determined to be

the accounting acquirer).

Refer to the Earn-out provisions in a business combination section in our Technical Line,

Navigating the requirements for merging with a special purpose acquisition company

, for a

discussion of how an earn-out should be considered in a business combination (i.e., when the

SPAC is identified as the accounting acquirer and the target company is a business).

Classification

Earn-out arrangements are typically considered freestanding financial instruments because

they are issued upon the merger transaction, separately and apart from other instruments.

Furthermore, an earn-out arrangement often includes multiple settlements based on different

triggering events. While the holders will receive shares when each triggering event occurs, the

components are not legally transferable by the holders. In these circumstances, the earn-out

arrangement is considered a freestanding financial instrument that contains multiple

settlement provisions triggered by different events.

Earn-out arrangements may be issued to the employees of the target as part of the merger

negotiation. For those arrangements, ASC 718 should be considered. See further discussion in the

Earn-out arrangements — stock-based compensation

section below. For earn-out arrangements

that aren’t share-based payments under ASC 718, the analysis is the same as the accounting

evaluation for the classification of SPAC warrants that are not accounted for under ASC 718,

which is described in the

SPAC warrants, including public warrants section above.

Distinguishing liabilities from equity (ASC 480)

Earn-out arrangements generally are not classified as liabilities under ASC 480 because they

do not represent obligations that must or may be settled by transferring assets and are not

obligations to issue a variable number of shares that meet one of the conditions described in

ASC 480-10-25-14.

If an earn-out arrangement is not an ASC 480 liability, it should be evaluated under the

indexation guidance (ASC 815-40-15) and the equity classification guidance (ASC 815-40-25)

to determine whether it should be classified as a liability or equity.

Earn

-out

arrangements may

need to be classified

as liabilities under

ASC

815-40.

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The indexation guidance (ASC 815-40-15)

Earn-out arrangements typically have share-price triggers. For example, an earn-out

arrangement may require the combined entity to issue an additional 1,000,000 shares to

selling shareholders if the volume-weighted average price (VWAP) of the combined entity

exceeds $15 per share during a certain timeframe and an additional 1,000,000 shares if

VWAP exceeds $20 per share during the same timeframe.

Earn-out arrangements also typically contain provisions that accelerate settlement upon

liquidity events (e.g., a change in control of the combined entity). These provisions could

change the number of shares to be issued (i.e., the settlement amount) under the arrangement.

Entities evaluating their earn-out arrangements should pay particular attention to features

that change the settlement amount, because some adjustment features can preclude the

earn-out arrangement from being considered indexed to an issuer’s stock under the

indexation guidance and, therefore, require the arrangement to be classified as a liability.

Generally, when the settlement amount of an earn-out arrangement changes based on stock

price, the arrangement may be considered indexed to an entity’s own stock. But provisions

that change the settlement amount for other reasons (e.g., a change in control provision that

entitles the holder to all remaining unearned shares under the arrangement, regardless of

stock price) may preclude the arrangement from being indexed to the entity’s own stock.

The following examples illustrate common terms in earn-out arrangements, the application of

the indexation guidance to those terms and the resulting classification of the arrangements:

Illustration 2 — Earn-out arrangement — vesting based on share-price triggers

SPAC A enters into a merger agreement with OpCo X. Under the merger agreement, the

combined entity may issue up to 4,000,000 additional Class A shares to the OpCo X selling

shareholders if certain share-price thresholds of the combined company are met within five

years from the consummation date of the merger. The triggering events are as follows:

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $12, 1,000,000

shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $15, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $18, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $20, another

1,000,000 shares are issued.

If none of the share-price targets is met within five years of the merger date, the selling

shareholders will not be entitled to any additional shares. Therefore, the triggering events

are considered exercise contingencies because their occurrences trigger the holder’s ability

to settle the earn-outs and receive shares.

An exercise contingency based on the Class A share price is permissible under Step 1 of the

indexation guidance. In Step 2 of the analysis, the settlement amount changes solely based

on the share price of the Class A stock. Because share price is an input to the fair value of a

fixed-for-fixed forward or option on equity shares, this arrangement is considered indexed

to an entity’s own stock. If the criteria for equity classification under ASC 815-40-25 are

also met (see discussion below), this earn-out arrangement would be classified in equity.

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Illustration 3 – Earn-out arrangement — a change in control triggers full vesting

SPAC A enters into a merger agreement with OpCo X. Under the merger agreement, the

combined entity may issue up to 4,000,000 additional Class A shares to the OpCo X selling

shareholders if certain share-price thresholds of the combined company are met within five

years from the consummation date of the merger. The triggering events are as follows:

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $12, 1,000,000

shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $15, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $18, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $20, another

1,000,000 shares are issued.

•

If there is a change in control during the five-year period, all 4,000,000 shares will

immediately be issued to the selling shareholders.

If none of the share-price targets above is met within five years from the merger date, the

selling shareholders will not be entitled to any additional shares, unless there is a change-

in-control transaction. If the combined entity undergoes a change-in-control transaction,

which includes (1) a sale of all or substantially all of the combined entity’s assets or (2) any

merger of the combined entity with another company, all of the additional shares will be

issued, regardless of whether any share-price triggers were met.

All of these triggering events are considered exercise contingencies because their

occurrences trigger the holder’s ability to settle the earn-outs and receive shares. Because

the exercise contingencies are based on either the share price of the combined entity or a

change in control of the combined entity, they are permissible under Step 1.

In Step 2 of the analysis, the settlement amount under this arrangement changes not only

based on the share price of the Class A shares but also based on whether there is a change

in control of the combined entity over the next five years. Because a change-in-control

event is not an input to the fair value of a fixed-for-fixed forward or option on equity

shares, this arrangement would not be considered indexed to an entity’s own stock under

Step 2. Therefore, the earn-out arrangement must be classified as a liability.

Illustration 4 — Earn-out arrangement — a change in control with a minimum price trigger

SPAC A enters into a merger agreement with OpCo X. Under the merger agreement, the

combined entity may issue up to 4,000,000 additional Class A shares to the OpCo X selling

shareholders if certain share-price thresholds of the combined company are met within five

years from the consummation date of the merger. The triggering events are as follows:

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $12, 1,000,000

shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $15, another

1,000,000 shares are issued.

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•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $18, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $20, another

1,000,000 shares are issued.

•

If there is a change in control during the five-year period, and the per-share transaction

price meets or exceeds $12, the entire 4,000,000 shares will immediately be issued to

the selling shareholders.

If none of the share-price targets above is met within five years from the merger date, the

selling shareholders will not be entitled to any additional shares, unless there is a change-

in-control transaction at a price that meets or exceeds $12 per share. If the combined

entity undergoes a change-in-control transaction, which includes (1) a sale of all or

substantially all of the combined entity’s assets or (2) any merger of the combined entity

with another company, and the per-share price received by the shareholders of the

combined entity in the change-in-control transaction meets or exceeds $12, all of the

shares will be issued, regardless of whether any share-price triggers above $12 were met.

Similar to the conclusion reached for Illustration 3 above, this arrangement would not be

precluded from equity classification under Step 1 of the indexation guidance.

In Step 2 of the analysis, the settlement amount under this arrangement changes not only

based on the share price of the Class A shares but also based on whether there is a change

in control of the combined entity over the next five years. Because a change in control is

not an input to the fair value of a fixed-for-fixed forward or option on equity shares, this

arrangement would not be considered indexed to an entity’s own stock under Step 2.

Therefore, the earn-out arrangement must be classified as a liability.

Illustration 5 — Earn-out arrangement — vesting based on change-in-control price triggers

SPAC A enters into a merger agreement with OpCo X. Under the merger agreement, the

combined entity may issue up to 4,000,000 additional Class A shares to the OpCo X selling

shareholders if certain share-price thresholds of the combined company are met within five

years from the consummation date of the merger. The triggering events are as follows:

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $12, 1,000,000

shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $15, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $18, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $20, another

1,000,000 shares are issued.

•

If there is a change in control during the five-year period, the per-share price in the

change-in-control transaction will be used to determine whether the price targets have

been met and, if so, the number of shares that will be issued.

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If none of the share-price targets above is met within five years from the merger date, the

selling shareholders will not be entitled to any additional shares, unless there is a change-

in-control transaction at a per-share price that meets or exceeds those targets. That is, if

the combined entity undergoes a change-in-control transaction, which includes (1) a sale of

all or substantially all of the combined entity’s assets or (2) any merger of the combined

entity with another company, the number of shares to be issued (if any) will be based on

the per-share price determined to be received by the shareholders of the combined entity

in the transaction.

For example, if the per-share price in the change-in-control transaction is $19 per share,

the combined entity will issue 3,000,000 shares to the selling shareholders. If 1,000,000

shares were issued before the change-of-control transaction because the $12 VWAP

trigger had been met, an additional 2,000,000 shares would be issued upon the change-in-

control transaction for exceeding both the $15 and $18 targets.

Similar to the conclusion reached for Illustration 3 above, this arrangement would not be

precluded from equity classification under Step 1 of the indexation guidance.

In Step 2 of the analysis, it is important to determine whether the settlement amount varies

solely based on the Class A share price. In this example, the number of shares to be issued

is determined based on the VWAP and the per-share price.

It is also important to determine whether the per-share price in a change-in-control

transaction represents the fair value or an approximation of the fair value of a Class A

share. For example, if the calculation of the per-share price in a change-in-control

transaction includes the shares that would be issued under the earn-out arrangement, that

price may represent the fair value of a Class A share. If, however, the per-share price

calculation excludes the shares that would be issued under the earn-out arrangement, that

price may not represent the fair value of a Class A share. In that case, the arrangement

would not be considered indexed to an entity’s own stock, and the earn-out arrangement

would be classified as a liability.

A warrant agreement may specify whether the per-share price calculation in a change-of-

control transaction should include the shares issuable under an earn-out arrangement, but it

is often unclear how that price should be determined. When that is the case, combined entities

should seek the advice of legal counsel in determining the most appropriate interpretation.

The equity classification guidance (ASC 815-40-25)

An instrument that is indexed to the entity’s own equity should also be evaluated to determine

whether the form of contractual settlement supports a conclusion of equity classification.

As previously discussed, the basic principle underlying the equity classification guidance is

that instruments that require net cash settlement (or force the issuer to net-cash settle or

are presumed to net-cash settle under the equity classification guidance) are assets or

liabilities, and those that require settlement in shares (or allow the issuer to choose a form of

settlement that involves either party transferring shares) are equity instruments. In addition,

ASC 815-40-25 provides a list of conditions that must be met for equity classification. Those

conditions focus on whether the issuer will have the ability, in all cases, to settle in shares.

Otherwise, net-cash settlement is presumed, and equity classification is not permitted.

Earn-out arrangements are designed to be settled through the issuance of additional shares

(or by removing restrictions or forfeiture conditions, as discussed below). If the issuer has the

ability to issue those shares (i.e., the conditions in ASC 815-40-25 are satisfied), the earn-out

arrangement should be classified in equity.

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Earn-out arrangements in the form of legally outstanding shares

Some earn-out arrangements with SPAC sponsors are structured in the form of legally

outstanding shares. Those shares typically are issued before the merger transaction but are

modified as part of the merger to become forfeitable or subject to certain transfer restrictions.

Those forfeiture requirements and transfer restrictions typically are removed upon the attainment

of certain share-price levels or the occurrence of a specified event (e.g., a change in control).

The accounting guidance for legally outstanding shares differs from the accounting for contracts

to issue an entity’s own equity. Nevertheless, combined entities should consider the substance

of these types of shares. If the legally issued shares do not have substance as shares (e.g., they

have no dividend rights or voting rights, they are forfeitable after a period of time unless a

certain share-price level is achieved or a specified event occurs), we generally believe the

combined entity should evaluate the arrangement under the guidance for contracts in an entity’s

own equity (ASC 480 and ASC 815-40). That is, because the shares lack substance and are more

akin to the earn-out arrangements described above, the same analysis should be followed.

How we see it

The combined entity will need to evaluate the terms of any earn-out arrangements to

determine whether equity or liability classification is appropriate. This is particularly

important, given that liability classification will require the arrangements to be measured

at fair value at each reporting date, with changes in fair value recorded in earnings.

Earn-out arrangements — offsetting entry

Regardless of the classification of an earn-out arrangement, ASC 815-40 requires an entity to

initially recognize any instrument within its scope at fair value. There is diversity in views on

the offsetting entry for an earn-out arrangement granted to the selling shareholders in a de-

SPAC transaction that is accounted for as a reverse recapitalization, assuming it is not

otherwise determined to be a share-based payment.

Some believe that the earn-out arrangement represents a distribution to shareholders, akin to

a cash dividend, that should be recorded as a reduction in retained earnings. Others believe

that because an earn-out arrangement is part of a reverse recapitalization and is negotiated

between the sponsor and selling shareholders, it is better represented as an equity restructuring

that should be accounted for as a reduction in additional paid-in capital. We generally believe

that either approach is acceptable.

Earn-out arrangements — stock-based compensation

When an earn-out arrangement is made with an ASC 718 grantee (e.g., an employee who

holds vested and/or unvested options) that could result in the grantee receiving additional

share-based payments if the merged company achieves a specified VWAP, the combined

entity should determine whether the earn-out arrangement is compensatory and in the scope

of ASC 718. If the earn-out is subject to ASC 718, the award contains a market condition that

is considered in the grant date fair value because the number of earn-out shares to be issued

is contingent upon the merged entity achieving a specified share price.

If the SPAC is determined to be the accounting acquirer, the entity should consider whether the

earn-out is subject to the replacement award provisions of ASC 805

or is a new award under

ASC 718. If the operating company is determined to be the accounting acquirer and the

transaction is accounted for as a reverse recapitalization, the entity should determine whether the

earn-out represents a change to a share-based payment arrangement that requires modification

accounting under ASC 718 or a new award under ASC 718 in connection with the transaction.

For more information, refer to our FRD publication, Share-based payment

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Reallocation of forfeitable shares

Earn-out arrangements may be granted to both employees and selling shareholders. If employees

are required to provide services to participate in an earn-out arrangement, that earn-out

arrangement is in the scope of ASC 718. The combined entity should determine whether any

forfeiture of employees’ earn-out shares could affect the number of shares issuable to the

remaining employees and/or to selling shareholders (whose arrangement is accounted for

under ASC 815-40). If the settlement amount of the earn-out arrangement with the selling

shareholders is adjusted based on employment status (e.g., employees’ forfeited shares are

reallocated to the pool of earn-out shares to be issuable to selling shareholders who are not

employees), that arrangement may not be considered indexed to an entity’s own stock under

ASC 815-40. If forfeited shares are reallocated to ASC 718 grantees, this is considered a

“last-man-standing” arrangement, and the forfeiture and subsequent reallocation of the earn-

out shares are accounted for as the forfeiture of the original award and the grant of a new award.

Illustration 6 — Earn-out arrangement — reallocation of forfeited shares among

remaining employees and selling shareholders

SPAC A enters into a merger agreement with OpCo X. Under the merger agreement, the

combined entity may issue up to 4,000,000 additional Class A shares to the OpCo X selling

shareholders (who are not employees) and to employees of OpCo X that hold vested and

unvested stock options. The shares will be issued if certain share-price thresholds of the

combined entity are met within five years from the consummation date of the merger. The

triggering events are as follows:

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $12, 1,000,000

shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $15, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $18, another

1,000,000 shares are issued.

•

If VWAP over 20 out of 30 consecutive trading days meets or exceeds $20, another

1,000,000 shares are issued.

•

If an employee is no longer employed at the time any of the share-price targets are

met, his or her shares will be reallocated among the selling shareholders and remaining

employees who are entitled to the earn-out payment.

Because employees must be employed at the time the share-price triggers are met to receive

the earnout shares, the arrangement with employees is accounted for under ASC 718. The

arrangement with the selling shareholders is accounted for under ASC 815-40. If some

employees forfeit their earn-out by terminating their service before a share-price trigger is

reached, the earn-out shares originally granted to those employees are reallocated among the

selling shareholders and remaining employees who are entitled to receive an earn-out payment.

When employees receive additional earn-out shares in the reallocation, this is considered a

“last-man-standing” arrangement, which is accounted for as a forfeiture of the original

award and a grant of a new award.

Because the settlement amount to be paid to the selling shareholders can change based on

whether the employees who would otherwise be entitled to earn-out shares remain employed,

the arrangement with the selling shareholders is not considered indexed to an entity’s own stock

under Step 2 of the indexation guidance. That’s because the employment status of a grantee is

not an input to the fair value of a fixed-for-fixed forward or option on equity shares. As a

result, the earn-out arrangement with the selling shareholders would be classified as a liability.

The reallocation of

forfeited shares

employees in an

earn

-out could

preclude equity

classification

under

ASC

815-40.

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Earn-out arrangements — EPS

Shares that could be issued pursuant to an earn-out arrangement are considered contingently

issuable shares in EPS calculations. Under ASC 260, contingently issuable shares are treated

differently for basic and diluted EPS. For basic EPS, contingently issuable shares are considered

outstanding common shares and included in basic EPS as of the date that all necessary

conditions have been satisfied (i.e., when issuance of the shares is no longer contingent on

any conditions except the passage of time). If the contingency has been satisfied, such shares

are to be considered outstanding for basic EPS computations, even if the shares physically

have not been issued. If shares are returnable or placed in escrow until the shares are vested

or some other contingent criteria (other than the passage of time) are met, the shares should

be excluded from the denominator in computing basic EPS even if they have been issued.

For diluted EPS, when all the necessary conditions have been satisfied, those shares should be

included in the denominator of the diluted EPS calculation as of the beginning of the period in

which the conditions are satisfied or as of the inception date of the contingent stock

arrangement, if later. Before the end of the contingency period, the number of contingently

issuable shares included in diluted EPS is based on the number of shares, if any, that would be

issuable under the terms of the arrangement if the end of the reporting period were the end

of the contingency period, assuming the result would be dilutive.

If the earn-out arrangements give the holders a nonforfeitable right to dividends before the

resolution of the contingency, they represent participating securities, regardless of whether

the SPAC actually declares or pays dividends, and the use of the two-class method for

calculating EPS would be required.

For further discussion of contingently issuable shares and participating securities, see

sections 3.3.2, 4.8 and 5.2 of our FRD publication, Earnings per share

How we see it

Entities may reach different conclusions about whether to include potential common

shares relating to earn-out arrangements in the denominator in the calculation of diluted

EPS when shares are issuable upon achievement of a share-price target over a specified

time period (e.g., 20 of 30 consecutive trading days). One acceptable approach would be

to exclude the potential shares from the diluted EPS calculation until the condition has

been met (i.e., the threshold share price has been met or exceeded for 20 of 30 consecutive

trading days). Another acceptable alternative would be to include the potential shares in

the diluted EPS calculation if the share price at the end of the reporting period equals or

exceeds the threshold price under the assumption that the share price will not change

before the end of the contingency period. Entities should disclose how they treat potential

shares relating to earn-out arrangements in their diluted EPS calculations.

Transaction costs

The SPAC may incur various acquisition-related costs in connection with the de-SPAC

transaction. They include:

•

Direct costs of the transaction, such as costs for the services of lawyers, investment

bankers, accountants and other third parties

•

Indirect costs of the transaction, such as recurring internal costs (e.g., the cost of

maintaining an acquisition department)

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The accounting for these costs depends on whether the SPAC or the operating company is

identified as the accounting acquirer. If the SPAC is determined to be the accounting acquirer

and the target company meets the definition of a business in ASC 805 (i.e., the transaction is

accounted for as a forward merger), transaction costs are expensed as incurred pursuant to

ASC 805. If the operating company is determined to be the accounting acquirer and the

transaction is accounted for as a reverse recapitalization, qualifying transaction costs

(i.e., direct and incremental costs in connection with the merger transaction) are accounted

for differently from those incurred in a forward merger.

For reverse recapitalizations, we understand that the SEC staff views these transactions as the

issuance of equity by the accounting acquirer for the cash of the SPAC.

Accordingly, direct

and incremental transaction costs related to the SPAC merger that wouldn’t otherwise have

been incurred are treated as a reduction of the SPAC’s cash proceeds, and they are deducted

from the combined company’s additional paid-in capital rather than expensed as incurred. This

treatment is similar to the treatment described in SEC Staff Accounting Bulletin Topic 5.A.

Frequently, the combined entity may issue new financial instruments (e.g., earn-out arrangements)

or assume financial instruments (e.g., warrants that were issued by the SPAC) as part of the

reverse recapitalization. We generally believe an allocation of these costs to the individual

instruments issued and assumed in the transaction is appropriate. Generally, costs allocated to

equity-classified instruments (e.g., SPAC shares) are recorded as a reduction to additional paid-

in capital. Costs allocated to liability-classified instruments that are subsequently measured at

fair value through earnings (e.g., certain SPAC warrants) are expensed. Refer to the

Issuance

costs section above for a detailed discussion on allocation of issuance costs.

Post-merger

After a de-SPAC transaction, the combined entity may be faced with several accounting

issues. For example, if the entity decides to redeem its public warrants and/or private

placement warrants, it will need to determine the appropriate accounting for the

redemptions. Likewise, events such as the transfer of a private placement warrant to a non-

affiliate of the sponsor or a change in the combined company’s capital structure will also

require the combined entity to consider the accounting implications.

Private placement warrants transferred to a non-affiliated party

Because private placement warrants become public warrants when they are transferred to an

entity that isn’t affiliated with the sponsor, such a transfer requires a reassessment of the

warrant’s classification. This is necessary because certain provisions of private placement

warrants (discussed in the SPAC warrant, including public warrants

section above) that may

have caused the warrants to be classified as liabilities under ASC 815-40 could be resolved

upon the transfer.

For example, private placement warrants typically are not subject to the $0.01 redemption

feature, which causes them to fail Step 2 of the indexation guidance (because of differences

in settlement amounts based on the holder of the warrant) and results in liability accounting.

That’s no longer the case once the warrants are transferred to a non-affiliated party and

become public warrants.

SPAC IPO SPAC merger

Post-merger

SPAC

formation

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If the private placement warrants were classified as liabilities under ASC 815-40, and if the

public warrants are classified in equity, the former private placement warrants should be

reclassified to equity upon their transfer to a non-affiliate of the sponsor. Upon

reclassification, the carrying amount of the private placement warrant liability (after the last

mark to fair value the day they are transferred) is derecognized and credited to equity.

Changes in the combined company’s capital structure

The combined entity may change its capital structure by issuing a new class of voting

securities (e.g., voting preferred stock) or converting from a dual-class capital structure to a

single-class capital structure if that change isn’t automatic when the merger occurs. These

changes require reassessment of the classification of warrants issued by the SPAC pursuant

to ASC 815-40-35-8. That guidance says the classification conclusion could change due to

changes in the issuer’s capital structure or other similar transactions.

ASC 815-40-35-8 also says that if reclassification is required, the instrument should be

reclassified as of the date of the event that caused the reclassification. The instrument would

be marked to its fair value on the date of the reclassification.

Endnotes:

ASC 480, Distinguishing Liabilities from Equity.

ASC 718, Compensation — Stock Compensation,

ASC 480-10-S99, Distinguishing Liabilities from Equity — Overall — SEC Materials.

ASC 815, Derivatives and Hedging.

ASC 815-40, Derivatives and Hedging — Contracts in Entity’s Own Equity.

2021 AICPA & CIMA Conference on Current SEC and PCAOB Developments — Compendium of significant accounting

and reporting issues.

ASC 260, Earnings Per Share.

Footnote 17 of ASC 480-10-S99-3A.

SEC Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition

Companies (“SPACs”), issued by John Coates, Acting Director, Division of Corporation Finance, and Paul Munter,

Acting Chief Accountant, on 12 April 2021.

This is applicable to entities that have adopted Accounting Standards Update 2020-06, Debt — Debt with Conversion and

Other Options (Subtopic 470-20) and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40):

Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. US GAAP does not currently provide

subsequent measurement guidance for these instruments, and some entities carry them at cost.

ASC 450, Contingencies.

ASC 805, Business Combinations.

SEC Division of Corporation Finance’s Financial Reporting Manual, Section 12100.

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