This article was originally published in CFO Dive, a leading publication providing the most impactful news and trends shaping the finance industry.
By Robert Freedman
Companies are being forced to calculate the value using a complex type of modeling because of special features in the warrants, Harris Antoniades, managing director of global investment bank and advisory firm Stout, told CFO Dive.
“Companies preparing for a SPAC IPO need to go back and update their 10-Ks and 10-Qs, and those that have already IPO'd and are close to signing the business combination agreement can’t close that deal until they go back and restate their 10-Ks and 10-Qs," Antoniades said.
The Securities and Exchange Commission (SEC) raised the warrant-accounting issue earlier this month in a statement saying companies should be classifying the warrants on their balance sheet as a liability rather than as equity.
Companies issue the warrants along with shares in the SPAC as part of a unit to attract investors who are being asked to invest in the publicly traded shell company with no way of making money until it combines with a promising private company.
Analysts see the SEC action as part of an effort to cool the SPAC market, which exploded last year under a deregulatory push by the last administration to encourage more companies to go public. The SEC leadership under the Biden administration has said it also wants to encourage more IPOs while ensuring alternatives, like SPACs, are structured soundly.
The switch to classify the warrants as a liability stems from the cash outlay companies could face if they’re forced to extend a tender offer to shareholders.
“In the event of a qualifying cash tender offer (which could be outside the control of the entity), all warrant holders would be entitled to cash,” the SEC said in an April 12 statement.
Although specifics differ by SPAC, in general, if the value of a company's shares rises above a threshold level for a specified number of days within a reporting period, companies could face a qualifying tender offer and be liable for cash payments.
In practice, Antoniades said, a cash outlay is unlikely to happen; companies will make the tender offer at an amount below the redemption value, all but forcing investors to redeem their warrants rather than accept the cash payment.
“In reality, the company will never pay cash because the warrant holder will exercise [the warrant] and get the equity,” he said. “That’s more valuable to them.”
Because the tender-offer scenario is unlikely, companies are disputing the SEC’s interpretation. But, in the meantime, they still must adhere to the guidance and restate their warrants as a liability.
“There’s nothing you can do,” Antoniades said. “Unless you agree with the SEC, you cannot do an IPO. You cannot file your 10-K.”
Unlike with an equity classification, a liability requires companies to update the valuation of the warrants every quarter, rather than just at the start of the SPAC, because the cash liability changes as the valuation changes. As a result, companies must go back and recalculate on their 10-K and 10-Qs the value of the warrants for each quarter up to and after the SPAC IPO.
“It’s a liability that changes from one quarter to the next,” Antoniades said.
Adding to the burden, the valuations require complex modeling because of the specialized terms companies are using in their warrant agreements.
“If it’s a plain vanilla warrant, it’s a very easy calculation,” Antoniades said. “You can use a Black-Scholes calculation” — also known as a closed-form solution. “You’re using the share price, the strike price, the volatility of the common share, and the term of the warrant,” he said. “It’s a very simple calculation.”
But the SPAC warrants tend to have several unique terms, the most important of which is the automatic redemption feature that can lead to the qualifying cash tender offer.
Details vary, but if the price of common shares goes above a threshold — usually $18 per share for 20 days within a 30-day window — the redemption feature kicks in.
Because of that and other features, companies have to use more complex models, either a Monte Carlo simulation, which sets valuations based on random samplings — “It’s kind of like playing in a casino,” said Antoniades — or a binomial tree, which sets valuation over a period of time rather than at a single point.
“That’s one of the issues companies have,” Antoniades said. “They have these different features that you cannot use the simplified model; you have to use a more complex model.”
While companies scramble to update their numbers, the SPACs market is effectively shut down. Antoniades expects the SEC to approve new SPACs in four to five weeks, around the beginning of June. Existing SPACs will likely start closing again on the combination agreements with their target company around that time, too.
“The market will eventually find a way to [deal with] this and they will go back in business,” he said. “But it has paused the market.”