SPACs: What will the SEC’s recent scrutiny mean for valuations?

On April 12, Securities and Exchange Commission staff issued a statement arguing that certain SPAC warrants, which are traditionally treated as equity for accounting purposes, should be classified as liabilities, measured at fair value, with changes to that fair value reported in each earnings period.

Rarely do such superficially bland sentences have such resounding consequences. The superheated SPAC market, which recorded some 300 mergers filed in the first quarter, froze. Issuance dropped some 90 percent in April from March, reports said.

CFOs of firms with their own SPACs are busy figuring out if any previously issued financial statements are accurate under the SEC’s new interpretation. Some planning to be in the market may be holding back amid the uncertainty.

But David Larsen, managing director in the alternative asset advisory unit at Kroll (formerly Duff & Phelps), says the ado will likely mean little when it comes to valuations.

“While the accounting does need to be correct, there’s no real impact on the viability of the SPAC or its ability to get a deal done,” says Larsen. While there are other factors that go into valuing a SPAC’s publicly traded shares, the company it merges with is the most important deciding factor.

Other than the costs of hiring lawyers, accountants, valuation specialists, auditors and those associated with restating financials should any impact be considered material – all of which, of course, could add up to a significant amount – the SEC’s statement has no impact cashflows.

The surprises will come in the form of non-cash charges (or income), should volatility in the share price over the relevant reporting periods resulted in major changes to the value of warrants held, Larsen says.

But while the impacts to profit and loss statements will be primarily non-cash, they could be significant. “A non-cash expense is nevertheless an expense, and it will more than likely be material because there’s not a whole lot of expense to start with” for empty SPAC vehicles, being shell companies, says Larsen.

Those with the most at stake, and with the most complexities to face, are those firms with SPACs well into the process of doing a merger with a target company. Not only is an exit strategy being halted by the SEC’s surprise reinterpretation of accounting rules, but SPAC share prices generally react to an announcement of a merger – and material restatements that are seen to affect share price could result in lawsuits.

Being late-stage in the merger process also increases the complexity of getting the problem sorted. “There were a number of acquisitions that were ready to be completed, where they even received provisional approval from the SEC,” Larsen says. “Their auditors have to be involved in thinking about the potential restatement and the impact on the financial statements going forward,” as well as the valuation conclusions drawn.

The result is many private equity firms’ exit strategies have been halted indefinitely; valuations have been – at least temporarily – thrown into uncertainty; and sponsors holding warrants are left to work out what they’ve been worth in retrospect.