SPAC Warrant Financial Reporting: Equity Vs. Liability

Special purpose acquisition companies (SPACs) issue warrants as part of their standard unit structure, and the accounting treatment of these instruments — equity vs. liability — remains one of the more technically demanding areas of SPAC financial reporting. While the framework for warrant accounting was established by the SEC’s April 2021 statement, the analysis remains a critical diligence item for every SPAC today.

Key takeaways:

• The proper SPAC warrant classification hinges on two tests under ASC 815-40. Warrants must first clear ASC 480, the liability test, and then satisfy both indexation to common stock (via the “fixed-for-fixed criterion”) and net cash settlement requirements to qualify as equity.
• Common warrant features often force liability treatment. Holder-dependent settlement provisions and tender/exchange offer provisions could cash-settle warrant holders differently from common shareholders.
• If warrants are classified as a liability, public companies are required to conduct quarterly and annual fair value remeasurement of these warrants for reporting purposes, use a different proceeds-allocation methodology, and immediately expense issuance costs. If misclassified, there is a potential for restatement.
• The valuation approach depends on the type of warrant. Private placement warrants are typically valued using the Black-Scholes model. In contrast, public warrants with call/redemption features often require more complex Monte Carlo simulations, and liability-classified warrants need this valuation refreshed every reporting period.
• Early engagement and documentation are the best defense. Reviewing warrant terms for classification-relevant nuances, engaging accounting/valuation advisors before finalizing warrant agreements, and documenting the accounting position are the practical steps that keep SPACs ahead of compliance risk.

SPAC Warrants Defined

SPACs typically issue units at $10 per unit, each consisting of one Class A share and a warrant (or fraction of one) to purchase an additional share at $11.50. Public warrants generally cannot be exercised until a business combination or 12 months post-IPO. Separately, sponsors purchase private placement warrants at $1.50 each, which carry similar terms but with certain protections — such as non-redemption — that can fall away upon transfer to third parties.

Accounting Treatment of SPAC Warrants: Equity or Liability?

SPACs must first evaluate how warrants are issued under ASC 480 to determine if they are classified as a liability. If not, the warrants are evaluated under ASC 815-40 to assess if they are classified as an equity, which requires meeting two conditions:

a) Indexation to Common Stock

This involves a two-step test, the second of which is the “fixed-for-fixed criterion.” Variables affecting settlement amount — standard anti-dilution adjustments, down-round provisions, or holder-dependent terms — must be evaluated against this criterion:

• Standard anti-dilution adjustments generally don’t break the fixed-for-fixed criterion if the monetary amount received by the holder stays constant.
• Down-round adjustment provisions (reducing the warrant’s strike price when the SPAC issues shares or equity-linked instruments below the current strike price) require careful analysis, particularly for “imperfect” down-round features.
• Holder-dependent settlement provisions — where terms change based on who holds the warrant (e.g., sponsor vs. third-party transferee)— typically preclude indexation, since holder identity isn’t a valid input into fixed-for-fixed option pricing. This generally results in liability classification.

b) Net Cash Settlement Provisions

Under ASC 815-40-25-7 and 25-8, contracts requiring, or permitting an event outside the SPAC’s control to require, net cash settlement cannot be equity-classified unless common shareholders would also receive cash under the same circumstances. Tender or exchange offer provisions — common in warrant agreements — often trigger this: if warrant holders receive cash in a qualifying tender offer. Still, not all common shareholders do, the warrants are precluded from equity classification, even if warrant holders would likely exercise for equity in practice.

Consequences of Liability Classification for SPAC Warrants

There are a number of consequences to classifying SPAC warrants as a liability. Warrants must be remeasured at fair value at the end of every quarter and at the end of every year, in addition to the required issuance-date fair value determination. If there are any changes in fair value from the prior period, they are recognized as a “change in fair value of warrants.”

Additionally, proceeds from a combined unit issuance are first allocated to the warrants at issuance-date fair value, with the remainder allocated to the shares, rather than a relative fair value allocation if they are classified as equity. Issuance costs tied to liability-classified warrants are expensed immediately, compared to a reduction to equity for equity-classified warrants.

If a SPAC warrant is misclassified, then a restatement of previously issued financial statements might be required.

Valuation Considerations for SPAC Warrants

There are a couple of valuation considerations for SPAC warrants, depending on whether they are private or public. Private placement warrants are typically valued using Black-Scholes, with inputs including share price, strike price, volatility, time-to-merger, time from merger to warrant expiration, risk-free rate, and probability of a successful merger. Public warrants with more complex features (e.g., call/redemption triggers tied to sustained share price levels) often require a Monte Carlo simulation, adjusted for merger-success probability.

Restatements SPAC Warrants

Occasionally, SPAC warrants are restated since materiality assessment considers both quantitative and qualitative factors. For example, a misstatement flips a net loss to net income or affects management compensation calculations. If a material “Big R” restatement occurs, SPAC are required to file amended Form 10-Ks/10-Qs and a Form 8-K (Item 4.02) within four business days of the restatement determination, along with ASC 250-compliant disclosures. However, SPACs also have the option instead to consolidate the restatement into a single “Super 10-K” filing.

Internal Control Assessments for SPAC Warrants

If a SPAC’s warrant classification is changed, the internal control over financial reporting (ICFR) and disclosure controls should be reassessed and evaluated individually and in aggregate. Many SPACs form a disclosure committee specifically tasked with reviewing accounting positions on warrants and other complex financial instruments — and by engaging auditors, accounting advisors, and valuation specialists early, ideally before finalizing warrant agreements at IPO.

Practical Next Steps

Below are the next steps SPACs can take to determine the appropriate accounting treatment for warrants.

1. Review warrant agreement terms for classification-relevant nuances (down-round provisions, holder-dependent settlement, tender/exchange features).
2. Engage auditors, accounting advisors, and valuation specialists early — ideally before IPO for SPACs that are still finalizing their warrant agreements.
3. Determine the appropriate classification and document the accounting position, even if no restatement is ultimately required.
4. If liability classification applies, engage a valuation specialist for ongoing quarterly fair value measurement.
5. Assess materiality of any prior misclassification and prepare for SEC filing deadlines (four business days for Form 8-K) if restatement is warranted.

EisnerAmper’s technical accounting team helps SPACs navigate the complexities to meet your specific goals. Please contact our team below.