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Domestic SPAC mergers - financial reporting and accounting considerations

Publication date: 25 Jan 2021 (updated 26 Sep 2022)

us In depth 2021-01

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At a glance

Special purpose acquisition companies (SPACs) provide an alternative way for management teams and sponsors to take companies public. A SPAC raises capital through an initial public offering (IPO) with the intention of acquiring a private operating company (“private company” or “target company”). When a private company is acquired by a publicly traded SPAC, it effectively becomes a public company without executing its own IPO.

The merger of a SPAC with a target company presents several challenges. This In depth highlights several of the financial reporting and accounting considerations and our responses to frequently asked questions on the SPAC merger process, “Super 8-K” reporting, and the ongoing reporting requirements subsequent to the SPAC merger.

We plan to update this In depth as additional guidance, financial reporting, or accounting considerations are identified.

This In depth was updated on March 11, 2021 to include new sections on Up-SPAC transactions and EPS considerations for certain earnout provisions in SPAC mergers, and to update the discussion of transaction costs.

This In depth was updated on April 27, 2021 to add additional guidance related to earnouts and warrants, and to reflect recent guidance from the SEC staff.

This In depth was updated on September 26, 2022 to reflect recent guidance from the SEC which changed the EGC revenue threshold from US$1.07 billion to US$1.235 billion.

A SPAC is created with capital from its initial investors and undergoes an IPO to raise additional capital, with the intention to acquire one or more unspecified private companies. Following the IPO, proceeds are placed into a trust account and, based on the terms of its governing documents, the SPAC typically has 18-24 months to identify and complete a merger with a target company, sometimes referred to as “de-SPACing.” After being acquired, the private company becomes a public company (or a subsidiary of a public company). If the SPAC does not complete a merger within the specified time frame, absent an extension, the SPAC will liquidate and return the remaining IPO proceeds to its shareholders. The IPO proceeds will be impacted by interest income on the cash balances held in trust and expenses incurred related to identifying a target and operating as a public company.

The SPAC merger presents several challenges, including having policies and processes in place to perform as a public company, including assessing complex accounting considerations and various financial reporting and SEC filing requirements.

This In depth addresses several key accounting issues for the SPAC merger, common questions related to various SEC reporting requirements, as well as other questions regarding the SPAC merger transaction and ongoing reporting requirements in domestic transactions.

SPAC overview and lifecycle

There are three distinct phases in the life of a SPAC: SPAC formation and IPO, SPAC target search, and the SPAC merger (de-SPAC). Management teams need to plan ahead and be prepared for the financial reporting and SEC filing requirements in much the same way as for a traditional IPO.

SPAC formation and IPO

A SPAC is formed by a management team, or a sponsor, with nominal invested capital (commonly known as founder shares). The SPAC subsequently issues “units'' in an IPO, which results in approximately 80% of the outstanding shares being held by public shareholders and approximately 20% of the shares being held by the founders. Each unit consists of a share of common stock and a fraction of a warrant.

Founder shares and public shares generally have similar voting rights, with the exception that founder shares usually have the sole right to elect SPAC directors. Warrant holders generally do not have voting rights and only whole warrants are exercisable.

Securities issued by the SPAC in its IPO are registered on a Form S-1 and are subject to the SEC staff review process. The SPAC is required to file a current report on Form 8-K shortly after the IPO with an audited balance sheet reflecting the receipt of proceeds. The SPAC is subject to the normal SEC reporting requirements upon the effectiveness of the Form S-1 (e.g., Form 10-Qs, Form 10-Ks).

The IPO proceeds are held in a trust account that earns interest while the SPAC conducts its search for a target company. A SPAC generally has very limited operating activity and the financial statements consist of cash, deferred offering costs, shareholder’s equity, and general and administrative expenses associated with start up activities and operating as a public company during the target search.

SPAC target search

The SPAC formation agreements typically specify a period of 18 to 24 months to identify a target company and complete the acquisition. After identifying the target, the SPAC will execute a letter of intent, complete due diligence, and negotiate the terms of the merger agreement, including the proposed transaction structure and governance of the combined entity.

A SPAC may need to secure additional financing to fund the SPAC merger or shareholder redemptions of common stock. A SPAC can secure additional funding for a SPAC merger in various ways, including:

Private investment in public equity (PIPE) deals, typically forward purchase commitments by affiliates of the sponsor or institutional investors to purchase common stock
Additional common stock offerings to the public
Preferred equity investments
Debt financing (e.g., registered notes, private placement, term loans, revolving credit facilities)

Once the terms of the merger agreement are finalized, the SPAC announces the transaction and files a current report on Form 8-K under Item 1.01 - Entry into a material definitive agreement, within four business days after the occurrence of the event.

SPAC merger (de-SPAC)

To solicit a shareholder vote on the merger, the SPAC will prepare a proxy statement on Schedule 14A (a proxy statement), which may include the following additional proposals:

Amendments to the SPAC’s articles of incorporation
Election of directors
Re-domiciling of the SPAC

If the SPAC registers securities as part of the merger transaction, it will file a joint registration and proxy statement on Form S-4 (Form S-4/proxy statement) in lieu of a proxy statement. Additional information required in the proxy or Form S-4/proxy statement includes:

Financial statements of the SPAC
Financial statements of the target company and its significant business acquisitions and equity investees
Pro forma financial information to reflect the merger transaction
Management’s discussion and analysis (MD&A) of the SPAC and the target company
Comparative per share financial information of the SPAC and the target company
Risk factors
Background of the merger
Information about the target company (business section)
Selected Financial Data under S-K 301

Note: In November 2020, the SEC amended Regulation S-K to eliminate the need to provide selected financial data (Regulation S-K, Item 301). The amended rules were published in the Federal Register on January 11, 2021 and become effective on February 10, 2021. As with any change in administration, there is the possibility that the Biden administration could postpone the effective date of these amendments. Companies should discuss with their advisers whether there have been any changes in the effective date. See In depth US2020-09: SEC amends MD&A and eliminates selected financial data, for discussion of the amended rules.

The SEC staff review process related to the merger transaction follows the process of a typical IPO in that the SEC staff will review the filing and issue comment letters, which could result in multiple rounds of comments. The SPAC will solicit proxies from shareholders (mailed 20 days before the shareholder vote) and hold the vote on approval of the merger. When the merger is consummated, a current report on Form 8-K is required to be filed within four business days that includes historical financial statements and associated pro formas. That is, the 71-day grace period afforded certain information required in Form 8-Ks is not available when the legal acquirer/issuer is a shell company. This Form 8-K is known as a “Super 8-K” because it includes the information that would be required for a Form 10 registration statement. See Figure 1-3 in the Super 8-K section for the related reporting items.

As the registrant only has four business days to comply with this filing requirement, it is important that all required information, including the related financial information, be prepared in advance of the transaction being consummated.

Public shareholders of the SPAC have an opportunity to redeem their common shares prior to the close of a merger if they do not want to be invested in the target(s). Warrants issued to these shareholders are typically not forfeited on redemption of the common shares. If the SPAC does not identify a suitable target company or the proposed merger is unsuccessful, the SPAC liquidates and the remaining IPO proceeds are returned to the public shareholders.

SEC financial statement filing requirements

Within the proxy or Form S-4/proxy statement, the SPAC and the target company will need to consider the following:

Emerging Growth Companies (EGCs) - If the SPAC is an EGC and has not filed its first Form 10-K, and the target company would qualify as an EGC assuming it was conducting its own IPO, only two years of annual audited financial statements would be required. For a target that is a private company to qualify as an EGC, its total annual gross revenues need to be less than $1.235 billion for the most recently completed fiscal year and it can not have issued more than $1.0 billion of nonconvertible debt over the past three years.
Smaller Reporting Companies (SRCs) - The SEC staff has indicated it will not object if a target company includes two years of annual audited financial statements rather than three years if it qualifies as an SRC. To qualify as an SRC, generally the non-reporting target company would need to have reported annual revenue less than $100 million in its most recent fiscal year.

If the first annual report on Form 10-K of the SPAC has been filed and the target does not qualify as an SRC, three years of audited annual financial statements of the target are required. The SEC staff has indicated that the inclusion of annual audited financial statements of the SPAC in a proxy or Form S-4/proxy statement is equivalent to the filing of its first annual report on Form 10-K for purposes of determining the number of years of audited annual financial statements of the target that are required.

The evaluation of the required number of years to include in a filing and consideration of the age of the financial statements needs to be performed each time an amendment is filed (e.g., in response to an SEC staff comment letter) and when the Super 8-K is filed.

Financial statements considerations

The financial statements of the target company need to be compliant with Regulation S-X and SEC Staff Accounting Bulletins (SABs). Private company accounting alternatives adopted by the Private Company Counsel (PCC alternatives) are not permitted. Any PCC alternatives applied (for example, amortization of goodwill) would need to be unwound.

Other key reminders for private companies preparing Regulation S-X compliant financial statements include, but are not limited to, the following: (1) stating separately product, service, rental, and other revenue (if applicable) on the face of the income statement (Regulation S-X, Rule 5-03(b)), (2) disclosure of an income tax rate reconciliation (Regulation S-X, Rule 4-08(h)), (3) identifying related party transactions on the face of the financial statements (Regulation S-X, Rule 4-08(k)), and (4) disclosure of required balance sheet line items (Regulation S-X, Rule 5-02).

The target company also needs to consider if it has completed significant business acquisitions (Regulation S-X, Rule 3-05) or has significant equity method investments (Regulation S-X, Rule 3-09) that would require the inclusion of financial statements. SRCs may follow the scaled disclosures under Regulation S-X, Article 8.

Typically an acquired company that is private need not include certain disclosures such as EPS (ASC 260-10-15-2) or segments (ASC 280-10-15-3) as the company is nonpublic as defined by those accounting standards and therefore the disclosures are not required. However, the target in a SPAC transaction will likely be the predecessor entity. Accordingly, the definition of public business entity (PBE) in each applicable accounting standard will need to be assessed to determine whether the disclosures are required. Typically, EPS and segment disclosures are required.

Additionally, public companies are required to present contingently redeemable preferred stock (i.e., redeemable upon the occurrence of an event outside the control of the issuer) and preferred stock that is redeemable at the option of the holder, in mezzanine equity. See Section 5.6.3.1 in PwC’s Financial statement presentation guide for additional details on mezzanine equity presentation.

QUESTION 1.1

Since Regulation S-X, Article 12 schedules (e.g., valuation and qualifying accounts schedule) are not required to be included with historical financial statements required under Regulation S-X, Rule 3-05, would Article 12 schedules be required to be included with the historical financial statements of a target in a SPAC merger?

PwC response

Yes, while Article 12 schedules are specifically excluded from the Regulation S-X, Rule 3-05 financial statement requirement, this exclusion does not apply to financial statements of a target company in a SPAC merger. However, if a target company is required to include its own Regulation S-X, Rule 3-05 financial statements, those financial statements could omit the schedules.

Accounting standards for the target company are required to be adopted on the PBE timeline, with deferred adoption available if (1) the SPAC entity is an EGC and has deferred the adoption of accounting standards on the PBE timeline, (2) the target company meets the criteria to be an EGC, and (3) the combined company will maintain EGC status following the consummation of the transaction. See the highlights of the July 2020 CAQ SEC Regulations Committee meeting for financial statement requirements in a filing for a target with a SPAC.

QUESTION 1.2

When would a calendar year-end target company be required to adopt recent accounting standards such as ASC 606, Revenue, ASC 842, Leases, and ASC 326, Credit Losses?

PwC response

If the criteria referenced above are met with respect to EGC status of the SPAC, the target company, and post-merger entity, the financial statements of a target company with a December 31 fiscal year end could reflect the adoption of ASC 606 as of January 1, 2020, ASC 842 as of January 1, 2022, and ASC 326 as of January 1, 2023. See In depth US2019-20: How to apply the FASB’s deferral of effective dates, for additional information on accounting standard adoption dates.

Other areas that may present complexities when preparing the financial statements to be included in a proxy or Form S-4/proxy statement include: different year ends for the SPAC and the target company; multiple target companies being acquired by the SPAC in the transaction; and the acquisition of a division or business that results in the need for carve-out financial statements. Refer to PwC’s Carve-out financial statements guide for further details on the preparation of carve-out financial statements.

Audit requirements

Typically, private companies are audited in accordance with auditing standards generally accepted in the United States (US GAAS) issued by the AICPA Auditing Standards Board. In a SPAC merger, the target’s financial statements included in the SEC filing are required to be audited in accordance with PCAOB standards by a firm that is registered with the PCAOB. The audit will be under dual standards, both PCAOB and AICPA, which usually results in incremental audit procedures by the registered accounting firm. For dual standard audits of fiscal years ended on or after December 15, 2020, critical audit matters must be included in auditors’ reports. Financial statement preparers and auditors should evaluate the implications on the audit report, even if the SPAC is an EGC and the target would qualify as an EGC.

Age of financial statements

The guidelines for determining the age of a registrant's and a target’s financial statements to be filed with the SEC in a proxy or Form S-4/proxy statement are set forth in Regulation S-X Rule 3-01, Regulation S-X Rule 3-02, and Regulation S-X Rule 3-12. Smaller reporting companies, if eligible, may use the scaled disclosure requirements of Regulation S-X Rule 8-08. The age of financial statements in the Form 8-K due upon completion of the merger is determined by reference to Item 13 of Form 10.

As a general rule, the most recent financial statements provided in the filing should not be dated more than 134 days before the date the filing is made (or more than 129 days in the case of an accelerated filer or a large accelerated filer). Registrants must meet the age of financial statements requirements at the initial filing date, at the date of any amendment (pre-effective or post-effective), at the effective date, and, with respect to a proxy statement, as of the mailing date. In the case of a Form S-4/proxy statement, the SEC staff has indicated that the age of financial statements requirements do not need to be evaluated as of the mailing date of the proxy unless the mailing is delayed beyond the time necessary to prepare the material for mailing (generally no more than a few days after the Form S-4 becomes effective).

Audited annual financial statements

If a proxy or Form S-4/proxy statement filing is made 45 days or less after the most recently completed fiscal year, the SPAC and the target company are not required to provide audited financial statements for that recently completed fiscal year unless those audited financial statements are available.

The following discussion and examples assume the SPACs are non-accelerated filers and have incurred losses. A non-accelerated SPAC filing a proxy or Form S-4/proxy statement on day 46 through (and including) day 89 after year-end would typically need to include audited financial statements for its most recently completed fiscal year and therefore likely does not meet the requirements of Regulation S-X Rule 3-01(c) or Regulation S-X Rule 8-08(b) for an SRC.

Unaudited interim financial statements

If the audited balance sheet date is 135 or more days from the filing date (or mailing/effective date), then the unaudited financial statements must be dated no more than 134 days before the filing date (or mailing/effective date).

Figure 1-1 illustrates the age of financial statement requirements for different filing dates. The age of financial statements can present unique challenges and the specifics for each transaction should be considered early in the process.

Figure 1-1
Age of financial statements - illustrative examples

SPAC is a calendar year company formed in 2021 that completes its initial IPO in July 2021.The SPAC files its first Form 10-K in March 2022 with inception to date financial statements for 2021. In September 2022, the SPAC announces an agreement to acquire a target company. The target company is a non-public, privately held entity. The SPAC qualifies as an EGC and the target company would qualify as an EGC if evaluated separately.

Filing date :	SPAC	Target company	Pro forma
November 1, 2022	Audited financial statements as of December 31, 2021 and for the period from inception to December 31, 2021 Unaudited interim financial statements as of June 30, 2022 and for the year-to-date comparative financial statements	Audited financial statements as of December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020, and 2019 Unaudited interim financial statements as of June 30, 2022 and for the year-to-date comparative financial statements	Pro forma balance sheet as of June 30, 2022 and pro forma statement of operations for the year ended December 31, 2021 and the interim year-to-date period ended June 30, 2022
December 18, 2022	Audited financial statements as of December 31, 2021 and for the period from inception to December 31, 2021 Unaudited interim financial statements as of September 30, 2022 and for the year-to-date comparative financial statements	Audited financial statements as of December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020, and 2019 Unaudited interim financial statements as of September 30, 2022 and for the year-to-date comparative financial statements	Pro forma balance sheet as of September 30, 2022 and pro forma statement of operations for the year ended December 31, 2021 and the interim year-to-date period ended September 30, 2022

If a SPAC has (1) not yet filed its first Form 10-K or updated its annual financial statements to include an additional year in the proxy or Form S-4/proxy and (2) the SPAC qualifies as an EGC and the target company would qualify as an EGC if evaluated separately, only two years of audited financial statements are required for the target company.

In compliance with Item 303 of Regulation S-K, MD&A is required for all annual and interim periods presented in the financial statements for the SPAC and the target company.

Determining the accounting acquirer

In a SPAC merger transaction, an important accounting judgment is the determination of which entity is the accounting acquirer. The accounting acquirer is the entity that obtains control of the reporting entity and may be different from the legal acquirer. If the transaction is between entities under common control (for example, the same entity or individual controls the target company and the combined entity after the transaction), acquisition accounting would not apply. Refer to Chapter 7 of PwC’s Business combinations and noncontrolling interests guide for guidance on common control transactions.

If the SPAC merger is effectuated primarily by transferring cash or other assets or by incurring liabilities, the SPAC is usually the accounting acquirer. If the target company is a variable interest entity (VIE), the entity that is the primary beneficiary and consolidates the VIE is the accounting acquirer (i.e., if the SPAC becomes the primary beneficiary as a result of the merger, the SPAC would be the accounting acquirer). Refer to Chapter 2 of PwC’s Consolidations guide for guidance on VIE analysis. Also see Section 3.5.4 for consolidation considerations when assessing limited liability companies and other similar entities.

If the voting interest model applies and the SPAC merger consideration is equity or a combination of cash and equity, it may not be clear which entity is the accounting acquirer and further evaluation may be required. These situations require consideration of all pertinent facts and circumstances. The guidance in ASC 805-10-55-11 through ASC 805-10-55-15 includes factors that may indicate which party is the accounting acquirer, including:

relative voting rights in the reporting entity,
existence and size of a single minority voting interest in the reporting entity,
composition of the governing body of the reporting entity,
composition of senior management of the reporting entity,
terms of the exchange of equity interests (entity that pays a premium), and
relative size of the entities.

No one factor is determinative. In some cases, determining the accounting acquirer may require significant judgment. See Section 2.3 of PwC’s Business combinations and noncontrolling interests guide for information on how to determine the accounting acquirer.

If the SPAC is the accounting acquirer, it would recognize the assets and liabilities of the target company at fair value in accordance with ASC 805, Business Combinations. The pro forma financial information included in the proxy or Form S-4/proxy statement on Form S-4 would reflect the acquisition accounting and transaction costs would be expensed.

Up-SPAC considerations

Certain target companies that are partnerships (or entities with governance provisions that are similar to partnerships) may contemplate a transaction with a SPAC entity that is intended to mimic an umbrella partnership C corporation (“Up-C”) transaction. These transactions, referred to as “Up-SPACs,” allow target company owners to retain the tax benefits of a pass-through entity while also providing a path to future liquidity as the target owners have the right to exchange their partnership (or similar) interests into common stock of the publicly traded reporting entity.

The following is an illustrative ownership structure of the public reporting entity post-merger in a typical Up-SPAC transaction.

Generally, traditional Up-C IPOs are structured such that the owners of the operating company retain control of the operations through ownership of a majority of the voting rights in the publicly traded company. This transaction would be subject to guidance for common control transactions rather than being treated as a business combination with acquisition accounting. Companies should also consider if in an Up-SPAC transaction, the same entity or individual controls the target company and public reporting entity after the transaction. If not, an assessment should be made of which party is the accounting acquirer.

A pass-through target company may be considered a variable interest entity if it is organized as a limited partnership or similar legal entity. The codification defines a similar legal entity as “...an entity (such as a limited liability company) that has governing provisions that are the functional equivalent of a limited partnership." ASC 810-10-15-14(b)(1)(ii) notes that these entities are considered VIEs when the limited partnership interests (i.e., interests or units held by target owners) do not have substantive kick-out or participating rights. See Section 2.3.3.2 in PwC’s Consolidation guide for additional information.

If the target company is a variable interest entity, the entity that is the primary beneficiary and consolidates the VIE is deemed the accounting acquirer. In an Up-SPAC transaction when the target company is a VIE (as described above), the public SPAC entity may become the primary beneficiary. For example, the SPAC entity may be designated as the general partner or managing member of the target entity, have power to control the most significant activities of the target company, and have an economic interest that provides it with the ability to participate significantly in the target’s benefits and losses. In this scenario, the SPAC entity, as primary beneficiary, would be the accounting acquirer per the guidance in ASC 805-10-25-5. The transaction would be accounted for as a business combination, not a reverse recapitalization. Certain arrangements with target company owners, such as earnouts or tax receivable arrangements, may be accounted for differently in a business combination versus a reverse recapitalization.

Reverse recapitalization

If the target company is the accounting acquirer, the transaction is considered a reverse merger. A reverse merger with a SPAC is typically accounted for as a reverse recapitalization because often the SPAC’s only pre-merger asset is cash received from investors and the SPAC generally does not meet the definition of a business. Instead, the substance of these types of reverse mergers are capital transactions of the legal acquiree and are equivalent to the issuance of shares by the target company for the net monetary assets of the SPAC accompanied by a recapitalization. As a result, qualifying transaction costs incurred by the target company are charged directly to equity. Recording direct costs against the proceeds of the offering is consistent with SEC staff guidance in SAB Topic 5.A. In some instances, the target company may have incurred transaction costs related to a different potential offering (e.g., traditional IPO) prior to entering into the SPAC merger agreement. Generally, transaction costs associated with an offering other than the SPAC merger should be expensed by the target company. Such treatment is consistent with SAB Topic 5.A, which does not permit costs to be deferred and charged against the proceeds of a subsequent offering.

With the exception of shareholder’s equity, presentation of the financial statements in a reverse merger represents a continuation of the legal acquiree (target company).The assets and liabilities of the target company are recognized at historical cost with no goodwill or other intangible assets recorded in the financial statements.

Historical retained earnings and accumulated other comprehensive income of the target company are carried forward. However, historical share balances and additional paid in capital of the target company prior to the reverse merger are retrospectively adjusted (a recapitalization) to reflect the transaction.

The number and type of equity interests issued must reflect the equity structure of the legal acquirer. Therefore, the target company’s historical share balance is converted to the legal par value of the SPAC and adjusted for the ratio of shares held in the combined entity. The offsetting adjustment to issued equity is recorded in additional paid in capital.

Example 1-1 illustrates the retrospective adjustment of issued equity in a reverse merger transaction.

EXAMPLE 1-1
Adjustment to target company’s historical equity in a reverse recapitalization

SPAC, a public company, legally acquires Target, a private company. Target is determined to be the accounting acquirer and as a result the transaction will be accounted for as a reverse recapitalization. Immediately before the acquisition, SPAC has 100 shares outstanding ($1 par) and Target has 50 shares outstanding ($1 par). As part of the transaction, SPAC issues 400 shares in exchange for 100% of the outstanding Target shares.

How should Target’s historical share information be adjusted to reflect the transaction?

Analysis

The comparative information presented in the consolidated financial statements should be that of the legal subsidiary (Target). However, the disclosure of the number and type of equity instruments issued to support the Target’s historical equity balances is recast to reflect the capital structure of the legal parent (SPAC).

The conversion ratio is calculated as the number of shares of the legal parent (SPAC) issued in the reverse recapitalization (400 shares) to Target’s shares at the acquisition date (50 shares).This ratio of 8:1 is then used to recast Target’s shares for all periods.

The pre-acquisition shares of Target would be adjusted from 50 to 400 using the conversion ratio. As a result, the balance in common stock (at par) would be adjusted from $50 ($1 par value * 50 shares outstanding) to $400 ($1 par value * 400 shares outstanding). The $350 increase in common stock (at par) is deducted from APIC.

All previous periods would also be adjusted using the same exchange ratio (e.g., if at the prior year end, there were only 40 shares outstanding at Target, the number of shares outstanding would be recast using the 8:1 ratio to 320 shares).

Earnings per share information is retrospectively adjusted to reflect the merger ratio applied to the Target's historical number of shares outstanding. Shares of the SPAC entity are considered issued for EPS purposes as of the date of the merger. See Section 2.10 of PwC’s Business combinations and noncontrolling interests guide for additional accounting considerations for reverse acquisitions. If the SPAC merger is accounted for as a reverse recapitalization, it should not be referred to as a business combination when describing the transaction within the financial statements.

Earnout provisions in SPAC mergers

In some cases, there may be uncertainty in the value of the operating company being acquired. One way of addressing this uncertainty is for the SPAC to enter into agreements with its sponsors, the selling shareholders of the target company, or employees whereby the SPAC will issue additional shares (or release existing shares from escrow or other restrictions) post-merger if certain performance measures (frequently based on stock price) are met. These arrangements are commonly referred to as “earnout provisions.”

Contingent payments

The assessment of the accounting acquirer in a SPAC merger should be performed prior to the evaluation of earnout provisions. If the transaction is accounted for as a business combination (i.e., the SPAC is the accounting acquirer), the guidance in ASC 805 applies.

If the SPAC is the accounting acquirer and the earnout arrangement is with target company shareholders, it may be considered contingent consideration.

ASC 805-10-55-28 provides eight indicators to assess whether any contingent payments should be accounted for as contingent consideration as part of the business combination or recognized as postcombination compensation cost.

Contingent consideration is recognized and measured at fair value as of the acquisition date in accordance with ASC 805-30-25-5. An acquirer’s obligation to pay contingent consideration should be classified as a liability or in shareholders’ equity in accordance with ASC 480, Distinguishing Liabilities from Equity, ASC 815, Derivatives and Hedging, or other applicable US GAAP (see section on Financial instruments considerations below). The accounting for contingent consideration in the postcombination period is impacted by its classification as an asset, liability, or equity, which is determined based on the nature of the instrument. See Section 2.6.4 in PwC’s Business combinations and noncontrolling interests guide for additional information on contingent consideration.

Based on the indicators in ASC 805-10-55-28, contingent payments to selling shareholders that remain employed and that are linked to future services are generally considered a compensation cost and recorded in the postcombination period. In particular, if a contingent payment is automatically forfeited upon termination of employment, it would be accounted for as postcombination compensation cost. In addition, even if not explicitly linked to future services, the contingent payment may still be viewed to be compensatory. See Section 2.6.5.1 and Section 3.3 in PwC’s Business combinations and noncontrolling interests guide for further information on contingent consideration arrangements with a compensation element.

Compensation

When the earnout arrangement is issued to employees or service providers of the SPAC or the target company, consideration should be given to whether it should be viewed as a compensation arrangement under ASC 718, Stock compensation.

If the issuance of shares is contingent on goods or services being provided by the recipient, ASC 718 applies. For example, if a SPAC investor will be employed by the merged entity, a representative of the sponsor will be appointed to the board of directors of the merged entity, or the target company shareholders will be employees of the merged entity, and the arrangement requires the individuals to remain in service through satisfaction of the earnout in order to receive the additional shares, it is likely to be accounted for as a compensatory award. See the discussion in Section 2.5 and Section 2.6 in PwC’s Stock-based compensation guide for awards with performance or market vesting conditions.

SPAC transactions accounted for as a reverse recapitalization may also include situations when holders of unvested restricted stock or unexercised stock options of the target company receive the right to contingent shares. Depending on the terms, this could lead to additional compensation cost being recorded, and may impact the subsequent accounting for the instrument as well, depending on whether it is subject to the guidance in ASC 718, Stock Compensation, or ASC 815, Derivatives and Hedging. For example, an arrangement that requires continued employment or service in order to vest in or be eligible for the earnout shares would typically result in treatment of the related cost as compensation cost. Further, an earnout provided in the form of modifying an existing stock option agreement (when receipt of the additional shares is dependent upon the option being exercised) would also be a modification of the existing award and any incremental fair value would be recognized as additional compensation cost. In each of these cases, the contingent share arrangement would likely be subject to ASC 718 for classification purposes as equity or liability.

Additionally, even if the contingent share arrangement is independent of the existing share-based payment award and not dependent upon continued employment, the issuance of such rights to the original share-based payment award holders would reflect incremental compensation provided to the historical award holder if issuance was not legally required under the terms of the original award. However, in this case, the contingent share arrangement may be subject to financial instrument accounting prospectively, as described below.

Financial instruments considerations

Unless the earnout arrangement is within the scope of ASC 718, the financial instrument guidance will be applicable. If the earnout is contingent consideration subject to the guidance in ASC 805, it will be subject to the financial instruments guidance for classification and subsequent recognition and measurement. In all other cases, earnout arrangements will be subject to the financial instruments guidance for classification, initial measurement, and subsequent recognition and measurement.

Application of ASC 480

The guidance in ASC 480, Distinguishing Liabilities from Equity, applies to freestanding equity and equity-linked financial instruments and requires a reporting entity to classify certain freestanding financial instruments as liabilities (or in some cases as assets). Most financial instruments within the scope of ASC 480 should be subsequently measured at fair value, with changes in fair value recorded in earnings.

In earnout arrangements, a key consideration under ASC 480 is whether the shares delivered under the earnout provision are redeemable at the option of the investor (even if based on a contingent event). If so, the earnout would be classified as a liability and measured at fair value, with changes in fair value recorded in earnings. If the earnout is not required to be reported as a liability under ASC 480, additional analysis is required under ASC 815-40.

See Section 5.5 in PwC’s Financing transactions guide for additional information on the application of ASC 480, including its scope.

Definition of a derivative

In many cases, earnout provisions will meet the definition of a derivative under ASC 815. They typically have:

an underlying: the performance measure upon which they are based and share price, if they involve the issuance of a fixed number of shares,
a notional amount: frequently, the number of shares that could be issued, and
net settlement: since the shares delivered are shares of a public company, the shares may be readily convertible to cash.

See Chapter 2 in PwC’s Derivatives and hedging guide for additional information on the definition of a derivative under ASC 815.

The “own equity” scope exception

Earnout provisions that result in financial instruments that are classified as liabilities are recognized at fair value with changes in fair value reflected in earnings. However, if the financial instrument meets the “own equity” scope exception in ASC 815-10-15-74(a), the financial instrument would be classified as equity with no subsequent remeasurement (unless the earnout is modified). It is important to note that the guidance in ASC 815-40 must be applied even if the instrument does not meet the definition of a derivative.

In order to meet this scope exception, the agreement must be (1) indexed to the company’s own stock (ASC 815-40-15) and (2) classified in stockholder’s equity in the balance sheet (ASC 815-40-25). Analyzing an agreement under this guidance can be complex. See Section 5.6 (for companies that have adopted ASU 2020-06) or Section 5.6A (for companies that have not adopted ASU 2020-06) in PwC’s Financing transactions guide for additional information on this guidance.

Indexed to the company’s own stock

The guidance in ASC 815-40-15 requires a two-step approach - first evaluating an instrument’s contingent exercise provisions (“step one”) and then the instrument’s settlement provisions (“step two”).

ASC 815-40-55-26 through ASC 815-40-55-48 contain several examples illustrating the application of the two-step approach to determining whether an instrument is indexed to a reporting entity’s own stock. The determination of which step a feature should be analyzed under is critical to the analysis as the “tests” under step one and step two are significantly different.

The analysis under ASC 815-40 should be performed at the inception of the contract and on an ongoing basis.

Step one - exercise contingencies

Any contingent provision that affects the holder’s ability to exercise the instrument must be evaluated under step one. For example, holders may have a contingent exercise right or may have their right to exercise accelerated, extended, shortened, or eliminated upon satisfaction of a contingency. This step focuses on whether an exercise contingency is based on an observable market (other than the issuer’s stock) or an observable index (other than an index based on the issuer’s own operations).

See Section 5.6.2.1 (for companies that have adopted ASU 2020-06) or Section 5.6.2.1A (for companies that have not adopted ASU 2020-06) in PwC’s Financing transactions guide for additional information on this guidance.

Step two - settlement provisions

Step two focuses on settlement provisions (e.g., the strike price of the instrument and the number of shares that could be issued). The guidance is often referred to as the “fixed for fixed” rule and states that a contract meets this criteria if the strike price and the notional of the contract are fixed.

Neither the strike price nor the number of shares used to calculate the settlement amount are considered fixed if the terms of the instrument or embedded component allow for any potential adjustment (except as discussed below), regardless of the probability of the adjustment being made or whether the reporting entity can control the adjustment. ASC 815-40-15-7E discusses an exception to the “fixed for fixed” rule. This exception allows an instrument to be considered indexed to the reporting entity’s own stock even if adjustments to the settlement amount can be made, provided those adjustments are based on standard inputs used to determine the value of a “fixed for fixed” forward or option on equity shares (and the step one analysis does not preclude such a conclusion).

Application to earnout provisions

The following are examples of provisions within earnout arrangements and the resulting application of the indexation guidance. It is important to note that these examples are not holistic analyses of the earnout arrangements under the accounting literature. These examples provide an accounting analysis of a specific provision under the indexation guidance. Analyzing an earnout arrangement under the indexation guidance requires careful analysis of all of the provisions both individually and collectively.

EXAMPLE 1-2

A company enters into an earnout arrangement with the following provisions:

Three-year maturity
1,000 shares will be issued if the volume weighted average price (VWAP) of the company’s stock is greater than $15 over any 20 days within a 30-day trading period

Analysis

Since this arrangement provides for only two potential settlement alternatives (either no shares are issued or 1,000 shares are issued), it would be analyzed under step one of the indexation guidance. The event that triggers the issuance of a fixed number of shares is based on an observable market price, but it is the price of the company’s shares. If the other requirements in ASC 815-40 are met, this earnout arrangement may be considered an equity instrument at issuance.

In Example 1-2, the contract only involves two settlement alternatives. Many earnout provisions provide for multiple settlement alternatives.

EXAMPLE 1-3

A company enters into an earnout arrangement with the following provisions:

Three-year maturity
100,000 shares will be issued if the VWAP of the company’s stock is greater than $15 over any 20 days within a 30-day trading period
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $20 over any 20 days within a 30-day trading period
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $25 over any 20 days within a 30-day trading period

Analysis

This arrangement provides for multiple settlement alternatives. The contract could result in the issuance of 0, 100,000, 200,000, or 300,000 shares based on whether VWAP exceeds targeted prices. Since there could be a different number of shares issued, it would be analyzed under step two of the indexation guidance. Stock price determines the number of shares to be issued, which is an input into a “fixed-for-fixed” valuation model. If the other requirements in ASC 815-40 are met, this earnout arrangement may be considered an equity instrument at issuance.

Many earnout provisions in SPAC transactions involve other factors that could influence settlement. For example, some arrangements with multiple stock price triggers may provide that a change in control or a liquidation of the company will change the number of shares to be issued. Since these “triggers'' influence the settlement amount and are not inputs into the fair value of a “fixed-for-fixed” valuation model for a forward or option on equity shares, the contract may not be considered indexed to an entity’s own stock. As a result, it would not qualify for the exception from the scope of ASC 815 and would be ineligible for equity classification (i.e., it would be a liability).

EXAMPLE 1-4

A company enters into an earnout under which a fixed number of shares will be issued if, during the subsequent three-year period:

the VWAP of the company’s stock is greater than $15 over any 20 days within a 30-day trading period or
there is a change in control of the company.

Analysis

Since this arrangement only provides for two potential settlement alternatives (either no shares are issued or a fixed number of shares are issued) it would be analyzed under step one of the indexation guidance. In instances when there are multiple contingencies that could cause the issuance of shares, each contingency and the interaction of the contingencies needs to be analyzed. One of the events that triggers the issuance of a fixed number of shares is based on an observable market price, but it is the price of the company’s shares. The other event that could trigger the issuance of a fixed number of shares is if there is a change in control, which is not an observable price or an observable index. If the other requirements in ASC 815-40 are met, this earnout arrangement may be considered an equity instrument at issuance.

EXAMPLE 1-5

A company enters into an earnout arrangement under which additional shares will be issued if during the subsequent three-year period, certain thresholds are met, as follows:

100,000 shares will be issued if the VWAP of the company’s stock is greater than $15 over any 20 days within a 30-day trading period.
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $20 over any 20 days within a 30-day trading period.
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $25 over any 20 days within a 30-day trading period.
300,000 shares will be issued if there is a change in control of the company.

Analysis

This arrangement provides for multiple settlement alternatives. The contract could result in the issuance of 0, 100,000, 200,000, or 300,000 shares based on whether the VWAP exceeds targeted prices. In addition, if there is a change in control, 300,000 shares are issued. Since there could be a different number of shares issued, it would be analyzed under step two of the indexation guidance.

Stock price impacts the number of shares to be issued, which is an input into a “fixed-for-fixed” valuation model. However, in the event of a change in control, 300,000 shares are issued, which is not an input into a “fixed-for-fixed” valuation model. As a result, this earnout arrangement would be required to be classified as a liability and measured at fair value with changes in fair value recorded in current earnings.

There may be other arrangements similar to Example 1-5 with multiple stock price triggers and other triggers that should be analyzed. For example, an instrument with multiple stock price triggers might also include the following provisions:

If there is a change in control of the company, and stock price is greater than $20, then 300,000 shares are issued.
If there is a liquidation of the company, then 300,000 shares are issued.
If there is a change in control of the company, and stock price is greater than $10, then a pro-rata number of shares between 0 and 100,000 will be issued.

Similar to Example 1-5, when analyzed under step two, these fact patterns (when coupled with multiple stock price triggers) will result in the instrument being liability classified and measured at fair value with changes in fair value reported in current earnings because change in control or a liquidation of the company is not an input into a “fixed-for-fixed” pricing model.

EXAMPLE 1-6

A company enters into an earnout arrangement with its sponsor under which additional shares will be issued if during the subsequent three-year period, certain thresholds are met, as follows:

100,000 shares will be issued if the VWAP of the company’s stock is greater than $15 over any 20 days within a 30-day trading period.
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $20 over any 20 days within a 30-day trading period.
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $25 over any 20 days within a 30-day trading period.
If there is a change in control of the company, the price at which the change in control occurred will be used to determine the number of shares to be issued (based upon the same stock price triggers above) as opposed to the VWAP.

Analysis

This arrangement provides for multiple settlement alternatives. The contract could result in the issuance of 0, 100,000, 200,000, or 300,000 shares based on whether the VWAP or the change in control price exceeds targeted prices. Since there could be a different number of shares issued, it would be analyzed under step two of the indexation guidance.

In evaluating the arrangement under step two, it is important to determine if stock price is the only measure that can determine the number of shares to be issued because stock price is an input into a “fixed-for-fixed” valuation model. If the manner in which the change in control price is determined and VWAP over a short time period are both reasonable means to measure the fair value of the company’s stock, the earnout arrangement may be considered indexed to the entity’s own stock.

Assessing whether the change in control price is a reasonable measure of the fair value of the company’s stock requires careful consideration of (1) the events considered to be a change in control under the arrangement and (2) the manner in which the change in control price is calculated. For example, many change in control provisions include a company selling substantially all of its assets. If the change in control price calculation does not consider the potential dilutive impact of the earnout arrangements, it would not be deemed to be a reasonable manner to calculate the fair value of the company’s stock. If, however, the change in control price calculation considers the potential dilutive impact of the earnount provisions, it may be deemed to be a reasonable manner to calculate the fair value of the company’s stock. Calculations that consider the dilutive impact of earnout provisions are complex and likely require iterative or simultaneous equation calculations.

If the change in control price calculation is not a reasonable manner to calculate the fair value of the company’s stock, the earnout arrangement would be required to be classified as a liability and measured at fair value with changes in fair value recorded in current earnings.

If the change in control price calculation is a reasonable manner to calculate the fair value of the company’s stock and the other requirements in ASC 815-40 are met, this earnout arrangement may be considered an equity instrument.

EXAMPLE 1-7

An earnout arrangement is issued to investors in the company’s stock (including the shareholders of the acquired operating company) and employees with vested and unvested stock compensation awards. Assume that additional shares will be issued if during a three-year period, certain thresholds are met, as follows:

100,000 shares will be issued if the VWAP of the company’s stock is greater than $15 over any 20 days within a 30-day trading period.
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $20 over any 20 days within a 30-day trading period.
An additional 100,000 shares will be issued if the VWAP of the company’s stock is greater than $25 over any 20 days within a 30-day trading period.

The earnout arrangements issued to employees with unvested options are subject to continued employment vesting requirements (which may be based on the employment vesting requirements in their unvested stock compensation awards). In the event that these earnout arrangements are forfeited by employees, the number of shares that could be issued under these arrangements are “re-allocated” on a pro-rata basis to the other holders of the earnout arrangements (including those held by shareholders). This is sometimes referred to as a “last man standing provision”.

Analysis

The earnout arrangements issued to unvested option holders in this case would be considered compensation and subject to the guidance in ASC 718. See the Compensation section above for additional guidance.

For the earnout arrangements not subject to ASC 718, analysis under ASC 815-40 is required. This earnout arrangement provides for multiple settlement alternatives. The total arrangement could result in the issuance of 0, 100,000, 200,000, or 300,000 shares based on whether the VWAP exceeds targeted prices. In addition, the number of shares an individual earnout holder may receive is also based on the continued employment of certain employees that were granted earnout arrangements. The number of shares an individual earnout holder receives may increase based on the forfeiture of the earnouts granted to employees with unvested options. Since there could be a different number of shares issued depending on certain events, the earnout arrangement would be analyzed under step two of the indexation guidance.

In evaluating the arrangement under step two, the vesting/continued employment of certain employees is not an input into a “fixed-for-fixed” valuation model. As a result, the earnout arrangements subject to ASC 815-40 would be required to be classified as a liability and measured at fair value with changes in fair value recorded in current earnings. As noted in the Compensation section above, the earnout arrangements subject to ASC 718 would apply ASC 718 to determine classification and measurement.

Classified in stockholder’s equity

It is important to note that not all contracts that are considered indexed to a company’s own stock qualify for equity classification. For a contract to be classified as equity, in addition to the indexation guidance, each of the additional conditions in ASC 815-40-25-10 must be met to ensure that the issuer has the ability to settle the contract in shares.

These conditions are intended to identify situations in which net cash settlement could be forced upon the issuer by investors/counterparties or in any other circumstance, regardless of likelihood, except for (1) liquidation of the issuer or (2) a change in control in which the issuer’s shareholders also receive cash.

See Section 5.6.3.1 (for companies that have adopted ASU 2020-06) or Section 5.6.3.1A (for companies that have not adopted ASU 2020-06) in PwC’s Financing transactions guide for additional information on this guidance.

The analysis under this guidance may be different if the form of the earnout is a contract to issue shares or issued shares that may be forfeit if they do not vest.

Earnings per share considerations

Earnout provisions may result in the issuance of additional shares (or release of existing shares from escrow or other restrictions) post-merger if certain performance measures (e.g., stock price targets) are met. In some cases, these earnout provisions may also entitle the holder to receive dividends if the company declares them.

Basic EPS

Generally, earnout arrangements are subject to the contingently issuable shares guidance in ASC 260-10-45-12C and ASC 260-10-45-13. As a result, the additional shares are included in the denominator in computing basic EPS only when the contingency has been met and there is no longer a circumstance in which those shares would not be issued. These shares would be included in the weighted average number of shares outstanding prospectively from the point the contingency is met. Shares that are legally issued and outstanding that are contingently returnable (e.g., shares subject to forfeiture if performance measures are not met) are treated in the same manner as contingently issuable shares for EPS purposes.

In certain cases, the earnout arrangements include a stipulated “vesting period” which may not begin until 6-12 months after the SPAC merger date. In these cases, the underlying earnout shares cannot be earned prior to the beginning of the vesting period. Therefore, they should not be included as outstanding shares unless the performance measures, such as the stock price targets, are met after the vesting period has begun.

Some earnout provisions entitle the holder to nonforfeitable dividends in their current form (i.e., if the company declares a dividend on common stock, the holder of the earnout arrangement receives an equivalent dividend on their contingent shares, which is not returnable regardless of whether the performance measures are met or not). These arrangements represent participating securities and should be included in the computation of basic EPS using the two-class method described in ASC 260-10-45-60 through ASC 260-10-45-70.

Application of the two-class method requires an allocation of any undistributed earnings between the common stockholders and the participating security holders based on their contractual rights to receive dividends, as if all undistributed earnings for the period were distributed. See Section 7.4.2 in PwC’s Financial statement presentation guide for additional information on participating securities and the two-class method.

Diluted EPS

Earnout arrangements (as described in this In depth) are subject to the contingently issuable shares guidance in ASC 260-10-45-48 when computing diluted EPS. If all necessary conditions have been satisfied by the end of the period (e.g., performance measures have been met), the shares are included in diluted EPS as of the beginning of the period. Note that if all necessary conditions have been satisfied, the shares would also be included in basic EPS, as described above, but only from the date upon which the contingency was resolved.

If all necessary conditions have not been satisfied by the end of the period, the number of contingently issuable shares to be included in the denominator of diluted EPS as of the beginning of the period is based on the number of shares, if any, that would be issuable if the end of the reporting period was the end of the contingency period. See further guidance in ASC 260-10-45-51 through ASC 260-10-45-55, as well as in Section 7.5.3 in PwC’s Financial statement presentation guide.

If the number of shares that are contingently issuable depends on the market price of the company’s stock at a future date (i.e., after the commencement of the “vesting period”), the computation of diluted EPS would reflect the number of shares that would be issued based on the current market price at the end of the reporting period, if dilutive. If the number of shares contingently issuable is based on an average of market prices over some period of time, the average for that period should be used. For example, if the issuance of the earnout shares were contingent upon the volume-weighted average stock price for 5 out of 10 trading days exceeding a certain target, the shares would be included in diluted EPS if this target was met utilizing the stock prices for the 10 days leading up to the reporting date. In contrast to the computation of basic EPS, this would be the case even in reporting periods prior to the beginning of the “vesting period.”

For diluted EPS purposes, if the shares are included in the denominator based on the above guidance, an adjustment to the numerator is required for earnout arrangements that are participating securities in determining whether inclusion of the earnout shares is dilutive. This adjustment is equal to the allocation of undistributed earnings to the arrangement for basic EPS purposes as described above.

Even if the arrangement is not a participating security, it may be classified as a liability arrangement (as described above) and recognized at fair value with changes in fair value recognized currently in income. If so, and the contingent shares are included in the denominator based on the above guidance, an adjustment to the numerator is similarly required for the fair value adjustment on the liability-classified earnout in determining the potential dilutive effect of the contingent shares.

Warrants

Most SPAC transactions involve issuing warrants to purchase the company’s common stock. In many cases, the warrants were issued to founders/sponsors when the SPAC was formed and to the public when the SPAC executed its IPO. Warrants may also be issued to PIPE investors and the public when the SPAC legally acquires an operating company and additional capital is raised.

The accounting considerations for warrants is similar to the accounting considerations for earnout arrangements. They should be assessed to determine if they are compensatory in nature and are within the scope of ASC 718. If they are issued for financing purposes, they should be analyzed under the equity-linked instrument accounting models, including ASC 480 and ASC 815-40. See the Earnout section of this In depth for a summary of elements of these models and related references to the PwC Financing guide for additional information.

The Acting Director of the SEC’s Division of Corporate Finance and the SEC’s Acting Chief Accountant issued a public statement on April 12 regarding their recent evaluation of fact patterns relating to the accounting for warrants issued in connection with a SPAC’s formation.

Indexed to the company’s own stock

One of the key messages in the SEC’s public statement on accounting for warrants is if the warrants issued by SPAC entities include any provisions that could change the settlement amount or how the settlement amount is calculated based on who holds the warrants, the warrants would not be considered indexed to an entity’s own stock. As a result, the warrants would be classified as liabilities and reported at fair value with changes in fair value reported in current earnings.

In our experience, there are a number of features in warrants that are issued to the founders/sponsors of the SPAC that may cause changes in how the warrant’s settlement amount is calculated in the event the founder/sponsor transfers the warrant to a third party. There may also be features in the warrants issued to the public that may involve different settlement terms depending on who holds the warrants. Warrant agreements should be carefully reviewed and any provisions that cause changes in the settlement amount of the warrant or how settlement is calculated, regardless of the significance of such impact, should be evaluated under the SEC’s public statement.

The following are examples of provisions within warrants and the resulting application of the indexation guidance. It is important to note that these examples are not holistic analyses of the warrants under the accounting literature. These examples provide an accounting analysis of a specific provision under the indexation guidance. Analyzing a warrant under the indexation guidance requires careful analysis of all of the provisions both individually and collectively.

EXAMPLE 1-8

A warrant is exercisable for 1 share of common stock over a five-year term and

has a strike price of $11.50,
in the event that the stock price of the company exceeds $18, the company can redeem the warrant for $0.01, and
if the company elects to redeem the warrant, the warrant holder can exercise the warrant.

The redemption feature is most frequently seen in warrants issued by SPACs to public investors.

Analysis

The $0.01 redemption price is generally deemed to be a non-substantive settlement feature as the warrant is only redeemable in situations when it has significant intrinsic value. As a result, holders of the warrants would be expected to exercise their warrants as opposed to receiving a $0.01 payment from the company.

The issuer’s redemption option effectively shortens the maturity of the option if (1) stock price is greater than $18 and (2) the issuer decides to redeem the warrant. It does not impact the strike price of the warrant or the number of shares issued under the warrant. As a result, this feature would be analyzed under step one of the indexation guidance. Under step one, stock price is a market price, but it is the issuer’s own stock price and the issuer’s decision to redeem the warrant is not an observable market price or index. As a result, this warrant would be considered indexed to a company’s own stock at inception. Further analysis of the warrant would be required under ASC 815-40 to determine if the warrant could be classified as an equity instrument.

EXAMPLE 1-9

A warrant is exercisable for 1 share of common stock over a five-year term and

has a strike price of $11.50,
in the event that the stock price of the company exceeds $18, the company can redeem the warrant for $0.01,
if the company elects to redeem the warrant:
- the warrant holder can exercise the warrant and
- if stock price is between $10 and $18, upon exercise, the number of shares received will be based on a “make whole” table which depends on the stock price and remaining time to the warrant’s maturity on the date of exercise, and
the company cannot redeem the warrant while it is held by the sponsor/founder of the SPAC; the company is only able to redeem the warrant if the sponsor/founder transfers the warrant.

Analysis

The $0.01 redemption price is generally deemed to be a non-substantive settlement feature as the warrant is only redeemable in situations when the warrant has significant intrinsic value. As a result, holders of the warrants would be expected to exercise their warrants as opposed to receiving a $0.01 payment from the company.

Similar to Example 1-8, this warrant has an exercise contingency as the issuer’s redemption option can shorten the maturity of the warrant and thus should be analyzed under step one. Under step one, stock price is a market price, but it is the issuer’s own stock price and the issuer’s decision to redeem is not an observable market price or index.

The amount of shares issuable may vary because of the “make whole” table so the warrant must also be analyzed under step two. In analyzing the “make whole” table under step two, the settlement amount may depend on who holds the warrant. If the warrant is held by the sponsor/founder, the holder’s settlement amount will not include the impact of the “make whole” table. However, if the warrant is held by another party, the settlement amount may include the impact of the “make whole” table. Thus, the holder of the warrant may impact the settlement amount of the warrant. Since the holder of the warrant is not an input into a “fixed for fixed” pricing model, this warrant would not be indexed to a company’s own stock and should be reported as a liability at fair value with changes in fair value recorded in current earnings.

In analyzing these features, it is important to understand if the warrant’s settlement amount can be impacted by who holds the warrant. In this example, the warrants issued to sponsors/founders contain provisions that change potential settlement amounts if the warrants are transferred to a third party. However, the warrants that are held by the public may not contain such features. If the warrants do not have any features that could change the settlement amount or how settlement is calculated, the warrants may be considered indexed to an entity’s own stock.

We understand that this is an example of a provision addressed in the SEC’s public statement referred to above.

EXAMPLE 1-10

A warrant exercisable for 1 share of common stock over a five-year term and

has a strike price of $11.50,
in the event that the stock price of the company exceeds $18, the company can redeem the warrant for $0.01,
if the company elects to redeem the warrant, the warrant holder can exercise the warrant,
the company can not redeem the warrant while it is held by the sponsor/founder of the SPAC; the company is only able to redeem the warrant if the sponsor/founder transfers the warrant, and
in the event that there is a change in control in which shareholders receive a specified form of consideration:
- the warrant holders will have the ability to exercise their warrants,
- the exercise price is reduced in an effort to compensate the holders for lost time value of the option (because they would be exercising before the warrant’s maturity date) based on a option valuation model, and
- the option valuation model works differently if the warrant is held by the founder/sponsor (not reflecting any ability of the company to redeem the warrants if transferred to a third party) or a third party (reflecting the company’s ability to redeem the warrants).

In this example, the make-whole provision (exercise price reduction) is calculated differently depending on who holds the warrant (the founder/sponsor or a third party). The identity of the holder of the warrant is not an input to a “fixed-for-fixed” valuation model. This warrant would not be considered indexed to a company’s own stock. As a result, this warrant would be required to be classified as a liability and measured at fair value with changes in fair value recorded in current earnings.

We understand that this is an example of a provision addressed in the SEC’s public statement.

There may be other features in a warrant agreement that result in changes to settlement amounts or how settlement amounts are calculated depending on who holds the warrant. For example:

In the event the company elects to redeem certain warrants and the holders exercise their warrants, the settlement amount may be different if the holder is a director or officer of the company.
Some warrants permit net share settlement upon exercise (frequently referred to as a cashless exercise). In some warrant agreements, the inputs used to calculate the net settlement amount (i.e., shares to be delivered) may be different depending on if the warrant is held by the founder/sponsor or if it is held by a third party. For example, settlement could be based on:
- the ten day VWAP when held by a sponsor/founder and the average closing price of the stock over a ten-day period when held by another party, or
- the trailing average of stock price based on the date a warrant is exercised when held by the sponsor/founder and based on the date the warrant is redeemed by the company if held by others.

Based on the guidance in the SEC’s public statement, these warrants would not be considered indexed to a company’s own stock because the holder of the warrant can impact the settlement amount and the identity of a holder is not an input into a “fixed for fixed” valuation model. As a result, these warrants would be classified as liabilities and reported at fair value with changes in fair value reported in current earnings.

Classified in stockholder’s equity

The following is an example of a provision within warrants and the resulting application of the classified in stockholder’s equity guidance. It is important to note that this example is not a holistic analysis of the warrant under the accounting literature. This example provides an accounting analysis of a specific provision under the classified in stockholder’s equity guidance. Analyzing a warrant under the classified in stockholder’s equity guidance requires careful analysis of all of the provisions both individually and considering how they interact.

EXAMPLE 1-11

A company has a single class of common stock and has warrants exercisable for this common stock. Upon exercise, the warrant will be settled on a gross physical basis (the warrant holder will pay the exercise price in cash and receive shares). However, in the event that there is a tender offer as a result of which the purchaser will own more than 50% of the voting stock of the company, the holders can exercise their warrants and receive the same form and amount of consideration received by the common shareholders that participated in the tender offer.

Under the classified in stockholder’s equity guidance, liability classification is generally required when a company could be forced to settle a warrant on a net cash basis (or by delivery of assets) in circumstances outside of its control. However, there is an exception to this model (discussed in ASC 815-40-55-2 through 55-6) relating to change in control provisions. This guidance states that if the warrant holder receives the same form of consideration as shareholders that participated in the transaction, then equity classification would not be prohibited.

We believe that this tender offer provision in this fact pattern is not inconsistent with the guidance in ASC 815-40 and was not a fact pattern considered in the SEC’s public statement. Accordingly, equity classification would not be prohibited. However, if the company has multiple classes of common stock, equity classification may be prohibited.

Earnings per share considerations

Basic EPS

Warrants are generally not considered in the computation of basic EPS, unless they are (1) exercisable for little to no consideration (e.g., a penny warrant) with no remaining contingencies, in which case they would be included in the denominator, or (2) participating securities, in which case they would be included in the calculation of the numerator. Warrants would be considered participating securities if they participate in dividends on a non-contingent basis. See Section 7.4.3.9 of the PwC Financial statement presentation guide for more information on penny warrants, and Section 7.4.2 for more information on participating securities and the two-class method.

Diluted EPS

Warrants should be included in the computation of diluted EPS pursuant to the treasury stock method, if dilutive. Warrants may be dilutive in periods when the average market price for the period exceeds the exercise price of the warrant. If the warrants are liability-classified, adjustments to income available to common shareholders will be required related to the earnings impact of the instruments for the period.

If the warrants are subject to a "vesting period" in a similar fashion as the earnouts described above, the warrants should be included in the computation of diluted EPS based on the contingently issuable shares guidance in ASC 260-10-45-48. Under this approach, if the vesting criteria would have been met had the end of the reporting period been within the vesting period (e.g., based on the stock price at the end of the reporting period), incremental shares calculated using the treasury stock method should be included in the diluted EPS denominator as of the beginning of a period, if dilutive. If the warrants are liability classified, adjustments to income available to common shareholders will be required related to the earnings impact of those instruments. Similarly, if the warrants are participating securities, adjustments to income available to common shareholders will be required to add back the allocation of earnings to the warrants.

Pro forma financial information requirements

Pro forma financial information in accordance with Regulation S-X Article 11 is typically required and presents the accounting impact of the business combination. In May 2020, the SEC amended the pro forma presentation requirements of Article 11; the new rules are generally effective no later than the beginning of the registrant’s fiscal year beginning after December 31, 2020. See In depth US2020-04: SEC amends disclosure rules for acquired and disposed businesses for information on pro forma presentation under the new rules.

The basis of presentation for the pro forma information is dependent on the expected accounting treatment of the transaction and typically includes adjustments for shareholder redemptions, related transactions, and the impact from any tax status change.

The identification of the accounting acquirer is key to determining the form and content of the pro forma financial information.

If the target company is the accounting acquirer, the pro forma financial information in the proxy or Form S-4/proxy statement primarily reflects the effects of the capital infusion received from the SPAC entity, and if applicable, any capital to be received from PIPE investors. Due to the uncertainty as to the number of publicly held shares that will be exchanged in the de-SPAC transaction (i.e., some public shareholders may redeem their shares for cash prior to the consummation of the transaction), the pro forma information generally presents both a minimum and maximum redemption scenario related to the public shareholders. See Figure 1-2 for an illustration of the format of pro forma financial information when the target company is the accounting acquirer.

Figure 1-2
Example of columnar pro forma financial information presentation

December 31, 20X0					Assuming no redemptions			Assuming maximum redemptions
SPAC Historical	Target Historical		Pro forma Adjustments (1)	Total		Pro forma Adjustments (1)

(1) The pro forma adjustments would consist of transaction accounting adjustments and autonomous entity adjustments, as applicable, in separate columns. Management’s adjustments (e.g., synergies and dis-synergies of an acquisition or disposition) may be presented only in the notes to the pro forma financial statements at the discretion of management if, in management’s opinion, they enhance an understanding of the pro forma effects of the transaction and certain conditions are met.

If the SPAC is the accounting acquirer, the pro forma presentation would reflect the business combination, with acquisition accounting applied to the target company.

Other typical pro forma adjustments may include the following:

Payment of deferred underwriters’ fees associated with the SPAC IPO
Transaction costs of the SPAC and target company
Repayment of debt by the target company upon consummation of the transaction
Conversion of redeemable preferred stock into common stock
Elimination of investment income related to the trust accounts of the SPAC
Elimination of interest expense if the related debt is repaid
Elimination of cumulative redeemable convertible preferred share dividends
Adjustments for income tax provision and related tax accounts
Incremental stock compensation expense for changes in awards/vesting terms
Impact on EPS of the various de-SPAC related transactions

Proxy or Form S-4/proxy statement filing requirements

Additional disclosures included in the proxy or Form S-4/proxy statement include:

Regulation S-K Item 101 Description of Business, Regulation S-K Item 103, Legal proceedings, and Regulation S-K Item 105, Risk Factors

The purpose of Item 105, Risk Factors, is to include a discussion of factors that may make an investment in the securities risky. In connection with a SPAC transaction, a material weakness may be identified for a target company, even though it was not subject to an audit of internal control over financial reporting (ICFR). Management should consider the inclusion of a target’s material weaknesses, if any, in the risk factor section. Given that the de-SPAC transaction has similarities to a traditional IPO, consideration of the disclosure trends in our Market Overview: Material weakness disclosures in an IPO, may be helpful.

See In depth US2020-08: Navigating the SEC's amended Regulation S-K disclosure rules, for information regarding the impact of rule changes to Item 101, Item 103, and Item 105 that became effective in November 2020.
Regulation S-K Item 303, MD&A, which includes a discussion of the results of operations for the periods presented as well as the impact of any known trends or uncertainties that could materially impact liquidity

Note: In November 2020, the SEC amended Regulation S-K to modernize, simplify, and enhance MD&A (Regulation S-K Item 303), streamline supplementary financial information (Regulation S-K Item 302), and eliminate the requirement to provide certain selected financial data (Regulation S-K Item 301). The amended rules were published to the Federal Register on January 11, 2021 and will become effective February 10, 2021. As with any change in administration, however, there is the possibility that the Biden administration could postpone the effective date of these amendments. Companies should discuss with their advisers whether there have been any changes in the effective date. See In depth US2020-09: SEC amends MD&A and eliminates selected financial data, for a discussion of the amended rules.
Significant acquisitions of the target

If the target company has made any “significant” acquisitions, audited historical financial statements of the acquired company are required to accompany the target company financial statements in the proxy or Form S-4/proxy statement. In addition, the pro forma financial information would reflect the impact of the significant acquisitions of the target. Significance is determined by applying the tests as defined in Regulation S-X, Rule 1-02(w). See In depth US2020-04: SEC amends disclosure rules for acquired and disposed businesses.
Comparative per share information

Presentation of historical and pro forma per share data is required to be included on a comparative basis. The comparative per share information is calculated by multiplying the pro forma per share data by the exchange ratio. Such comparative per share information is required for book value, cash dividends, and income (loss) from continuing operations.

Super 8-K

Figure 1-3 illustrates items typically included in the Super 8-K filed within four business days of consummation of the de-SPACing transaction. Registrants should consider consulting with their legal counsel regarding Form 8-K reporting requirements.

Figure 1-3
Common Super 8-K reporting obligations

Item No.	Title	Description
1.01	Entry into a Material Definitive Agreement	Disclosure of material agreements, including any that have the effect of causing the SPAC to cease being a public shell company
2.01	Completion of Acquisition or Disposition of Assets	Description of the SPAC merger, including the parties involved and the consideration transferred (e.g., shares, cash), as well as information required for the registration of securities on Form 10
3.02*	Unregistered Sales of Equity Securities	Provided when shares are sold to private investors (e.g., in a PIPE deal) or when the owners of the target company receive shares as part of the SPAC merger
4.01*	Changes in Registrant’s Certifying Accountant	Provided when the SPAC and the target company do not have the same external auditors, which is usually the case in a SPAC merger
5.01	Changes in Control of Registrant	Required when the target company’s owners receive shares of the combined company in exchange for their ownership interest in the target; this section should include information required for registration of securities on Form 10
5.02*	Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers	Generally, the target company’s officers (e.g., CEO, CFO) will continue as officers of the combined company replacing those of the SPAC. The target company can typically elect a select number of directors to serve on the board.
5.03*	Amendments to Articles of Incorporation or Bylaws; Change in Fiscal Year	Required when the target company’s year-end is not the same as the SPACs and the combined company will change year ends or changes to the articles of incorporation or bylaws were made that had not been disclosed in the proxy or registration statement
5.06	Change in Shell Company Status	Required when as a result of acquiring an operating entity, the SPAC is no longer a shell company
9.01	Financial Statements and Exhibits	Pro forma financial information and disclosures should generally be updated to reflect the final SPAC shareholder redemptions and other terms and information finalized upon the closing of the SPAC merger. Financial information is typically updated based on staleness dates.

* Items marked may be included based on the circumstances of the deal

Gap in reporting

In some cases, the age of financial statements requirements may result in a situation in which the Super 8-K does not include the target company’s financial statements for the most recent quarter end or year end preceding the consummation of the merger. However, as the reporting entity is subject to the SEC’s periodic reporting requirements following the merger, an amended Form 8-K must be filed (using Form 8-K/A) that includes the financial statements for the target company’s most recent quarter or year end, as applicable, to avoid a gap in reporting.

The due date for the Form 8-K/A is based on the SPAC’s accelerated filer status, which determines the number of days following the target company’s period end (60, 75, and 90 days for annual periods and 40, 40, and 45 days for interim periods for large accelerated, accelerated, and non-accelerated filers, respectively).

If the merger is completed after a quarter-end or year-end date, but before the Form 10-Q or 10-K for the SPAC has been filed, the SPAC would still be required to file the Form 10-Q or 10-K.

Change in auditor

Unless the same auditor reported on the most recent financial statements of both the legal acquirer/issuer and the target company, a reverse merger will result in a change in auditor.

The Form 8-K filed to report the completion of the reverse merger should include (under Item 4.01) the relevant auditor change disclosures required by Regulation S-K Item 304. The auditor that will no longer be associated with the registrant’s financial statements is treated as the predecessor auditor. If a decision as to which firm will be the continuing auditor has not been made at the time the initial Form 8-K reporting the completion of the acquisition is filed, a separate Item 4.01 Form 8-K must be filed no later than four business days after the date that the decision is made. See SEC FRM 4520.3a. The registrant should consider indicating that a decision has not been made in the initial Form 8-K reporting the completion of the reverse merger.

In addition, the relevant disclosures required by Regulation S-K Item 304 must be made with respect to any changes in the target company’s auditor that occurred during the target company’s two most recently completed fiscal years or in any subsequent period up to the date of the reverse merger. Those disclosures must be included in the first filing containing the accounting acquirer’s financial statements. This disclosure is in addition to the disclosures in the Item 4.01 Form 8-K. See SEC FRM 4520.3(b).

Other considerations following the merger

After the merger transaction, the combined company must comply with the ongoing reporting requirements of the SEC. The following areas may require additional analysis and effort for the reporting entity: registering additional securities, determining filer status, and complying with the SEC’s disclosure requirements relating to internal control over financial reporting.

Registering additional shares

Following the close of the SPAC merger, the reporting entity will typically need to register the issuable shares related to the public and private placement warrants, and may need to register shares in connection with newly created stock award plans.

The registration of these shares would typically be on Form S-1. The SEC has addressed whether a post-merger company would be eligible to use Form S-3 based on the SPAC entity’s pre-combination reporting history. See Securities Act Forms C&DI 115.18 for Form S-3 requirements in a SPAC transaction.

For filings on Form S-1 related to newly issued shares, or Form S-8 to register shares issuable under stock award plans, companies should consider whether the financial statements included (or incorporated by reference on Form S-8, as applicable) may need to be updated based on staleness dates. The disclosure requirements of the Form S-1 or Form S-8 filing can differ from the requirements of the previous filings in connection with the SPAC merger. For example, Form S-1 includes the information required by Regulation S-K Item 302, Supplementary financial information, which would not have been previously required for the target in the proxy or Form S-4/proxy statement or Super 8-K.

Note: In November 2020, the SEC amended Regulation S-K to streamline supplementary financial information (Regulation S-K Item 302). The amended rules were published to the Federal Register on January 11, 2021 and become effective on February 10, 2021. As with any change in administration, however, there is the possibility that the Biden administration could postpone the effective date of these amendments. Companies should discuss with their advisers whether there have been are changes in the effective date. See In depth US2020-09: SEC amends MD&A and eliminates selected financial data for discussion of the amended rules.

Accelerated filer, EGC, and SRC status

We understand that the completion of a reverse merger does not trigger a requirement to reassess the registrant's accelerated filer status. Accordingly, an SEC registrant legal acquirer/issuer will retain its accelerated filer status until its next determination date.

The reporting entity’s status as an EGC or as an SRC, if applicable, impacts what information is required to be included in various SEC filings, as well as the timing of adoption of accounting standards.

The ability for the post-merger reporting entity to continue to qualify as an EGC depends on the revenues, length of time since the SPAC’s IPO, issuance of debt, and accelerated filer status. Companies should be particularly mindful of whether the reporting entity’s annual revenues will exceed $1.235 billion, and whether the public float of the reporting entity exceeds $700 million as of the end of its second fiscal quarter. In either case, the post-merger reporting entity would not qualify as an EGC for the annual period following consummation of the merger, and would need to consider the implications of losing EGC status in its Form 10-K as well as any registration statements, including the adoption of accounting standards on a PBE timeline.

QUESTION 1.3

Does the completion of the de-SPAC and the reverse recapitalization result in a requirement to reassess the SRC status as of the consummation of the de-SPAC transaction?

PwC response

We understand that the completion of a reverse merger that is accounted for as a reverse recapitalization (i.e., the accounting acquirer is the private target company) generally does not trigger a requirement to reassess the registrant's SRC status. If the legal acquirer/issuer is an SRC, then it will generally retain that status until its next determination date.

See highlights of the March 2012 CAQ SEC Regulations Committee meeting for disclosure requirements for an existing registrant that no longer meets the definition of an SRC.

Internal control over financial reporting

Public companies are required to comply with the Sarbanes-Oxley Act of 2002, which includes an annual assessment by management of the issuer’s ICFR under Section 404(a) and an annual attestation report from the issuer’s independent auditors under Section 404(b). Due to the previous IPO by the SPAC, the reporting entity is not considered a newly public company subject to the transition reporting relief if the SPAC has issued an initial annual report on Form 10-K.

The SEC staff has indicated in FAQ #3 to the Commission’s rules for Management's Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports that it may not always be possible to conduct an assessment of ICFR for a material business combination completed during the fiscal year. If this is the case, management may exclude the controls at the required entity from its assessment of ICFR in the period of acquisition.

When the legal acquirer/issuer is a pre-existing SEC registrant-shell company (SPAC) and the accounting acquirer is a private operating company, the SEC staff recognizes that the internal controls of the legal acquirer/issuer may no longer exist as of the assessment date or the assets, liabilities, and operations of the legal acquirer/issuer may be insignificant when compared to the consolidated entity. When it is not possible to evaluate ICFR, the SEC staff permits the combined company to exclude management’s assessment of internal control over financial reporting for the fiscal year in which the reverse merger was completed (and the associated auditor's report, if required). In lieu of management’s assessment of internal control, the issuer should disclose why management’s assessment has not been included in the report, specifically addressing the effect of the transaction on management’s ability to conduct an assessment and the scope of the assessment if one were to be conducted. See Regulation S-K C&DI 215.02 for additional information about internal control over financial reporting related to reverse acquisitions between an issuer and a private operating company.

Even if management's report is excluded from the Form 10-K under the circumstances described above, the CEO/CFO Section 302 certifications must include the internal control over financial reporting language in the introductory portion of paragraph 4 as well as paragraph 4(b). In other words, the certification should include the entirety of Item 4 set forth in Regulation S-K Item 601(31) (including 4a through 4d).

Registrants should consider consulting with their legal counsel regarding the ICFR and certification requirements.

If a SPAC merger is completed shortly after year end, and the company files an amended Form 8-K to include the target company’s annual audited financial statements for the most recently completed fiscal year, the Form 8-K is considered the company’s first annual report. Therefore, subsequent Form 10-K filings may not exclude management’s report on ICFR for the acquired business.

To have a deeper discussion, contact:
Karen Keelty Partner Email: karen.keelty@pwc.com	Shara Slattery Partner Email: shara.slattery@pwc.com
Matt Sabatini Partner Email: matthew.e.sabatini@pwc.com	Jay Seliber Partner Email: jay.seliber@pwc.com
Chip Currie Partner Email: frederick.currie@pwc.com	Eric Sullivan Director Email: eric.sullivan@pwc.com
Fred Harries Senior Manager Email: fred.harries@pwc.com

¹ Proxy or Form S-4/proxy statement filing example dates

² Form 10-Q for quarter ending September 30 has not yet been filed by the SPAC

PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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