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Credit FAQ: SPAC Warrants Reclass And Their Ratings Implications

On April 12, 2021, the SEC issued a staff statement on the accounting and reporting treatment related to special purpose acquisition companies (SPACs) warrants. Under the statement, public and private placement warrants could be accounted as liabilities and marked-to-market each reporting period. As a result, many companies have or will restate previously issued audited financial statements to comply with the SEC statement. While this fair value adjustment will not affect adjusted EBITDA, there are implications for adjusted debt under S&P Global Ratings' leverage ratio adjustment and some issuers may move closer to, or past, existing leverage-based rating downgrade triggers.

Frequently Asked Questions

What makes these warrants potentially debt-like?

There are two accounting considerations, Indexation and Tender Offer Provisions, that led to this liability determination. They are discussed below.

Per the SEC statement, under U.S. Generally Accepted Accounting Principles (GAAP), "an equity-linked financial instrument must be considered indexed to an entity's own stock in order to qualify for equity classification…We recently evaluated a fact pattern relating to the terms of warrants that were issued by a SPAC. In this fact pattern, the warrants included provisions that provided for potential changes to the settlement amounts dependent upon the characteristics of the holder of the warrant. Because the holder of the instrument is not an input into the pricing of a fixed-for-fixed option on equity shares, SEC Office of Chief Accountant (OCA) staff concluded that, in this fact pattern, such a provision would preclude the warrants from being indexed to the entity's stock, and thus the warrants should be classified as a liability measured at fair value, with changes in fair value each period reported in earnings."

The tender offer provisions written in the SPAC warrant agreements align with GAAP general principle for a liability that "if an event that is not within the entity's control could require net cash settlement, then the contract should be classified as an asset or a liability rather than as equity." Per the SEC statement, "We recently evaluated a fact pattern involving warrants issued by a SPAC. The terms of those warrants included a provision that in the event of a tender or exchange offer made to and accepted by holders of more than 50% of the outstanding shares of single class of common stock, all holders of the warrants would be entitled to receive cash for their warrants. In other words, in the event of a qualifying cash tender offer (which could be outside the control of the entity), all warrant holders would be entitled to cash, while only certain of the holders of the underlying shares of common stock would be entitled to cash."

While the warrant agreements do not require a cash settlement and could be settled through a cashless exercise, the possibility of a cash settlement without the control by the company makes them a liability rather than equity under the SEC statement.

How will the warrant liabilities appear on companies' financial statements?

The indexation and tender offer provisions would require the warrants to be classified as a liability measured at fair value with changes in fair value reported in each earnings period. In general, if a company's stock price increases, the warrant liability and mark-to-market adjustment increases and vice versa if the stock price declines. As a result, we may see added volatility in reported earnings due to this mark-to-market adjustment. Over on the balance sheet, warrant liabilities would show the fair value of the obligation (either short term or long term, depending on when the warrants expire); flow through the income statement as operating or other expense (income), the change in fair value of warrant liabilities; and appear in the cash flow statement, under operating activities, where the adjustment will show up as a change in fair value of warrant liabilities.

How will S&P Global Ratings treat these warrant liabilities?

If a company has recognized the warrants as a liability, we would add the warrants to debt. There would not be any adjusted EBITDA or cash flow impact because it is a mark-to-market adjustment. Under our Ratios & Adjustments criteria, the adjustment falls under our adjusted debt principle and contingent consideration adjustment. We treat as debt contingent and deferred consideration that is payable in cash, and consideration to be settled in shares that do not qualify as equity. The most common example of the latter is a contract to be settled with a variable number of shares. Companies typically record such arrangements, initially as a liability at fair value and then subsequently mark them to market at the end of each accounting period through charges or credits to income until settled. We add to debt the reported value of the liability-classified contingent consideration on each reporting date, understanding that it is not at amortized cost.

Are there ratings implications to the warrants?

We do not anticipate widespread ratings changes, although we will review every credit individually. While the restatements have triggered material weaknesses in financial reporting for some companies, we do not anticipate this technical trigger to result in a negative reassessment of management and governance for companies affected by this change. However, there could be less headroom in our leverage targets with the increased liability. The ranges of liabilities of entities that have already reported ranges from a few million dollars to a couple hundred million. We also note that the warrants have expiration dates, so entities with near-term expirations will see the liability drop off upon the earlier of the exercise or the expiration. For example, The Simply Good Food Foods Co. disclosed that it will be adding $110 million to $130 million to its balance sheet as a liability for its 6.7 million remaining private placement warrants that expire in a year. The company went public through a SPAC merger in 2017. Therefore, while this liability is sizable in the near term and will add over 0.5x in leverage, in a year from now the warrants will no longer be outstanding. The company also has room in its current leverage for the 'B+' rating so we do not anticipate any ratings implications.

How are future cash receipts to companies from warrant exercises factored in? Isn't that a positive event?

Yes, like employee stock options, if the warrants are exercised, there is an inflow to the company. We view the cash proceeds from the exercise of the warrants as fungible with any other form of cash inflow. We would not include the cash inflow in our forecast, but receipt of the cash and use of proceeds would be credit considerations.

Are there tax implications?

Based on conversations with companies, we do not believe they will experience tax implications. This treatment is largely only an accounting clarification that has minimal near-term cash effects.

Are there financial covenant implications?

Given the adjustment is a fair value adjustment that is marked-to-market each reporting period, it would typically not affect adjusted EBITDA, therefore we do not anticipate any covenant implications.

How would we treat corporate-sponsored SPACs (i.e., a rated issuer's own SPAC) prior to the de-SPAC (acquisition) process?

We would approach this similar to any other credit event, utilizing our existing criteria tools. First, when the SPAC is just established and no target is identified yet, the IPO proceeds will be held in trust until a target is identified or returned to shareholders if no target is found in two years. Therefore, since the cash is not accessible to the company for general corporate purposes or for debt reduction, we will not give the company any credit for that cash against its net leverage ratios.

Additionally, the warrant liability is tied to the stock price, which is linked to a listing upon the merger with a target. We would not include the warrant liability as debt to the corporate sponsor since there is no scenario for warrant payout prior to an acquisition.

Any operating expenses associated with establishing and maintaining the SPAC will be shown as operating expenses and we would view those as part of the company's ongoing operating activities, impacting EBITDA.

Related Research

S&P Global Ratings research
Other research
  • Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies ("SPACs"), website, April 12, 2021

This report does not constitute a rating action.

Primary Credit Analysts:Bea Y Chiem, San Francisco + 1 (415) 371 5070;
Robert E Schulz, CFA, New York + 1 (212) 438 7808;
Shripad J Joshi, CPA, CA, New York + 1 (212) 438 4069;
Secondary Contacts:Jeanne L Shoesmith, CFA, Chicago + 1 (312) 233 7026;
Leonard A Grimando, New York + 1 (212) 438 3487;

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