November 24, 2021

SPACs: What’s Behind the Latest Accounting Issue?

Last week, Bloomberg Tax published an article indicating that the SEC, which previously caused a wave of restatements by SPACs over warrant accounting issues, has identified another accounting issue that SPACs need to address. This excerpt says the problem is the way that issuers have treated Class A shares:

SPACs typically issue two types of shares: founder shares and Class A shares. Class A shares are redeemable, meaning that investors can ask for their money back if they don’t like a company the SPAC targets to take public. This feature is a key part of what makes SPACs attractive to early investors: if they aren’t happy with the merger, they don’t lose their money.

The new accounting issue is that SPACs for years have incorrectly treated Class A shares as permanent equity instead of temporary equity, auditors said. “Many of the auditing firms took the position that it was a little R,” Bukzin said, referring to a revision. “But the SEC came back and made it clear that they believe it’s a big R.”

According to Marcum, the SEC won’t require SPACs to amend their old 10Qs, as is the case with typical “Big R” restatements. Instead, SPACs can offer details about the corrections in their next filing, Bukzin said the SEC told his firm. It is unclear how the regulator will require corrections for past annual financial statements.

The proper classification of Class A shares issued in a SPAC’s IPO isn’t a new issue, but based on a review of a number of SEC filings, it looks like the Staff has changed its view on the way SPACs accounted for those shares.

By way of background, companies are required to classify redeemable shares as temporary equity if, among other things, their redemption is out of the company’s control. Classification as temporary equity means that dividends and other adjustments to the shares that would ordinarily run through the balance sheet result in a hit to the income statement as well.

In an effort to limit the number of shares classified as temporary equity, SPACs have included language in their charters providing that in no event would the company redeem its public shares in a de-SPAC in an amount that would cause its net tangible assets to be less than $5,000,001. In that situation, the company would not proceed with the redemption of its public shares or the related de-SPAC, and instead would search for an alternate de-SPAC transaction.

The argument, which the Staff appears to have accepted in the past, was that since the SPAC wouldn’t approve any redemptions in excess of that amount, the de-SPAC would fail, and the shares would no longer be subject to redemption. That would place the redemption within the company’s control, and therefore take the shares out of the temporary equity classification.

The Staff seems to have rethought its position in recent months. A good way to illustrate the change is to compare the Staff’s responses to two companies who responded to identical comments concerning the temporary equity issue at exactly the same time.  On August 19th, Aesther Healthcare Acquisition Corp. responded to an SEC comment on the temporary equity issue in accordance with the argument outlined above.  On that same day, Maxpro Acquisition provided an identical response to the same comment.

The Staff didn’t comment further on Aesther’s response, and its S-1 was declared effective in September.  In contrast, the Staff didn’t reply to Maxpro’s response letter for nearly a month. When it did, its comment letter laid out what appears to be the Staff’s current position on the temporary equity issue, and Maxpro agreed to revise its accounting treatment.

In essence, the Staff’s current view appears to be that because the SPAC doesn’t control whether the minimum net assets threshold is reached or which shareholders choose to redeem their shares, it doesn’t have control over the redemption. As a result, those Class A shares must be treated as temporary equity.

John Jenkins