Wall Street auditors and lawyers are trying to draft new equity capital arrangements to lure investors back into the blank check market after the US regulator cracked down on the use of warrants, six industry executives told Reuters.
They are discussing the elimination of warrants issued by purpose acquisition companies or SPACs in favor of subscription rights agreements or a dramatic reorganization of the warrants after the Securities and Exchange Commission (SEC) said that many SPAC stock warrants should be considered liabilities.
The SEC’s surprise announcement in April stalled an already slowing SPAC market as accountants and attorneys tried to work with SEC staff, people said.
SPACs are publicly traded letterbox companies that raise cash to acquire a private company and take it public, allowing targets to bypass the more stringent regulatory reviews of an IPO.
“There is ongoing discussion between the accounting firms, the companies that are putting pressure on the SEC’s views,” said David Brown, attorney at Alston & Bird LLP. “Companies that have not yet gone public are certainly looking for possible workarounds.”
SPACs typically offer common stock with warrants affixed to the listing. While some Star SPAC sponsors have been able to forego warrants, most view the contracts as an important way to attract early investors who may have to lock their money on for years.
The agreements give SPAC sponsors and outside investors the right to purchase common shares of the new entity created by the merger at a pre-agreed price, an attractive offer if the share price rises. They also offer bespoke terms including anti-dilution and other provisions that mitigate potential losses.
But the SEC has grappled with them in part because they often offer better business to some investors, such as SPAC sponsors, than public investors, the sources said. Retail investors in particular may have difficulty understanding the complex terms of the warrants or not being aware of when to redeem them, the SEC said.
A change in classification means higher quarterly costs for SPACs in finding targets and provides better visibility into the fluctuations in their potential debt, sources said.
And warrants typically have complicated pricing terms and regulations that entitle holders to potential cash withdrawals that are also characteristic of debt capital rather than equity, the SEC said.
“The SEC may have been concerned that sponsors were enriched to a greater extent than other investors,” said Jeffrey Weiner, CEO of auditor Marcum LLP, who, according to SPACInsider, does over 40% of SPAC’s audit work.
A record $ 100 billion was raised by U.S. SPACs from early 2021 through March, according to Dealogic, when the market began to weaken amid increasing regulatory scrutiny. There were 298 SPAC IPOs in the US in the first three months of the year, but only 32 in April and May, according to data from Dealogic.
The SEC’s new stance means that instead of doing a one-time stock valuation, SPACs would have to leverage the warrants quarterly, an expensive process that may make them less attractive to targets and other investors.
Restructuring the contracts after the IPO is complex, and many SPACs have few options at this stage other than to reclassify the warrants as liabilities on their books, which accountants and public records say many have done.
“Doing this quarterly assessment can be time consuming and costly,” said Angela Veal, general manager of accounting firm EisnerAmper LLP.
Sponsors looking to start a SPAC IPO may have more options, Wall Street accountants and lawyers said. You are trying to find an alternative instrument that offers economic benefits similar to warrants and that does justice to equity accounting.
An alternative has been considered, Weiner and others said.
Such contracts are often used by European companies to raise capital by offering shareholders the right to buy more shares, but it may not be possible to make subscription rights agreements as tight as warrants to mitigate investors’ risks, they said the people.
Some SPAC sponsors prior to the IPO are removing or tweaking the loss limitation provisions and complex pricing terms to meet equity accounting rules, a move it is said to be on file and by Reuters.
Talks between the industry and the SEC are ongoing, people said, and it is unclear that the rights agreements or simpler warranty terms would completely address the SEC’s concerns.
An SEC spokesman said the agencies’ staff “are still available to advise on … accounting issues to facilitate capital formation and protect investors.”
Meanwhile, some SPACs focused on hot sectors are knocking out the warrants altogether. For example, last week venture investor Chamath Palihapitiya launched four biotech SPACs without warrants, which is likely to be a big test of investor appetite.
Industry executives hope that finding new terms or something to replace warrants will shake up the declining SPAC market.
“It will pick up again, but not the same pace as before,” said Weiner from Marcum.
(Reporting by Chris Prentice Additional reporting by Anirban Sen Editing by Michelle Price and Steve Orlofsky)