SPAC Attack

Six Months In

Special Purpose Acquisition Companies (SPAC) have been a prime focus of the SEC over the last six months. On April 12, 2021, the SEC issued “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies” to highlight potential accounting implications and provide guidance on making the determination between classifying the warrants issued by SPACs as equity versus a liability. Below, the authors navigate through the valuation process of SPAC warrants and the frequent issues seen thus far in SPAC warrant valuations.

Special Purpose Acquisition Companies (SPAC) have been a prime focus of the SEC over the last five months. On April 12, 2021, the SEC issued “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies” to highlight potential accounting implications and provide guidance on making the determination between classifying the warrants issued by SPACs as equity versus a liability.[1] Below, we navigate through the valuation process of SPAC warrants and the frequent issues seen thus far in SPAC warrant valuations.

What is a SPAC?

A SPAC, also known as a “blank check” company, is a publicly listed shell company formed to raise capital with the sole purpose of acquiring an unspecified private operating company. SPACs have been around for almost three decades. However, SPACs have become increasingly popular over the last two years as they provide a relatively easy way for private companies to become public.

The typical SPAC has two years to complete an initial business combination (IBC) from its initial public offering (IPO) date. During that time, the SPAC’s founders, also known as sponsors, are responsible for searching for an IBC target. Once a suitable target is found and an agreement is reached, the sponsor may arrange PIPE financing to augment the money raised through the SPAC to complete the merger. After approval of the shareholders, the IBC closes, and the surviving target company trades publicly, typically with a new ticker symbol.

SPAC Securities

The private securities of a SPAC can consist of sponsor shares, private warrants, class B shares, and PIPE investments. Sponsor shares are issued to the sponsors/founders of the SPAC for a minimal cost of generally $25,000. The sponsors/founders will also generally purchase private warrants for a typical purchase price of $0.50 to $1.50 per warrant. SPACs may also privately negotiate a PIPE investment to supplement SPAC proceeds to close the merger.

The public securities of a SPAC consist of units, common shares, and public warrants. Units are publicly traded at the SPAC’s IPO and normally consists of one public share and a fraction of one public warrant, as determined by the warrant agreement. On rare occasions, a unit may also include the right to a fraction (typically 1/10) of a common share. Units typically trade at $10 per unit at IPO.

Usually 52 days after the IPO, or however long stated in the warrant agreement, the units will split into public shares and public warrants, each of which are traded publicly at that time. Public warrants typically have a strike price of $11.50 per share among other terms, which are discussed below. Should the holder of public shares vote against the merger, the holder may redeem the shares for $10 later.

Warrant Agreements

The typical elements of a SPAC warrant agreement are as follows:[2]

1. Strike price: For both public warrants and private warrants, the strike price is $11.50 per share.
2. Duration of warrants:
   1. Exercise—A warrant may be exercised during the period commencing on the later of 30 days after the first date on which the company completes an IBC or 12 months from the date of the closing of the IPO.
   2. Expiration—Five years after the date on which the company completes its IBC or upon liquidation if the company fails to complete an IBC.
3. Number of common shares that one warrant can exercise into: Ordinarily, each private and public warrant entitles the holder thereof to purchase one ordinary share. However, some warrant agreements state that one warrant (public or private) is exercisable into one half or three quarters of one common share.
4. Settlement of warrants: Public warrants and private warrants may be settled on a cash or cashless basis as stated in the warrant agreement.
5. Redemption of warrants: Public warrants can generally be redeemed at the option of the company. Private warrants may be redeemed as well, depending on the language of the warrant agreement. The following is sample language regarding the redemption of warrants as typically seen in Section 6 of SPAC warrant agreements.
   1. Common language for SPACs that completed their IPO prior to the middle of 2020:
      1. Private and public warrants are identical except that the private warrant cannot be sold or transferred until after the completion of an IBC and private warrants are not redeemable by the company. Public warrants can be redeemed by the company while they are exercisable prior to expiration for $0.01 per warrant as long as the stock was trading over $18 for the 20 of the last 30 days.
   2. Common language for SPACs that completed their IPO since Q3 2020:
      1. Warrants can be redeemed by the company for ordinary shares during the exercise period for $0.01 per warrant when the stock is trading for 20 of the last 30 days between $10 and $18. During the 30-day redemption period, the holders of the warrants can elect to exercise on a cashless basis and receive the number of ordinary shares determined by the make-whole table (included in the agreement) based on the redemption date and the “redemption fair market value.” Redemption fair market value means the volume weighted average price of the ordinary shares for the 10 days prior to the notice of redemption. The private warrants are identical to the public warrants, except for as long as they are held by the sponsor or any of its permitted transferees, they can be exercised for cash or on a cashless basis, cannot be transferred or sold until 30 days after the completion of an IBC, are not redeemable by the company for cash, and are only redeemable by the company pursuant to the section related to the redemption for ordinary shares if the stock is trading at less than $18.00 per share for 20 of the last 30 days; provided, however, that in the case of #2, the private warrants and any ordinary shares issued upon exercise can be transferred.

These two were merely examples of the most common types of warrant agreements. Other variants exist. Remember to always read the terms of the agreement thoroughly.

Approaches to Valuing SPAC Warrants

How to value public and private warrants depends on the SPAC’s timeline.

1. At IPO and reporting periods until SPAC units split:
   • Private warrants—Likely modified Black Scholes or Monte Carlo
   • Public warrants—Likely Monte Carlo
2. Post SPAC unit split, prior to IBC
   • Private warrants—Likely modified Black Scholes or Monte Carlo
   • Public warrants—Level 1 input
3. Post-IBC
   • Private warrants—Black Scholes or Monte Carlo
   • Public warrants—Level 1 input

If the warrant agreement does not contain a redemption feature (typically for private warrants excluded from make-whole table or no make-whole table exists), then a Black Scholes may suffice rather than a Monte Carlo.[3]

Warrant features in the agreement that may require a Monte Carlo simulation include:

• Reference value: The last reported sales price of the ordinary shares for any 20 trading days within the 30 trading-day period ending on the third trading day prior to the date the notice of the redemption is given.
• Redemption fair market value: The volume weighted average price of the ordinary shares for the 10 trading days immediately following the date the notice of redemption is sent to the registered holders.
• The make-whole table

Modified Black Scholes

Inputs:

1. Probability of successful business combination[4]
   1. Management estimate
   2. Historical data from previous SPACs
   3. Other considerations
      1. Number of SPACs looking for target now vs. historical period
      2. Size of SPAC
      3. Sponsor reputation and experience

2. Time to successful IBC[5]
   1. Management estimate
   2. Historical data from previous SPACs
   3. Other considerations
      1. Number of SPACs looking for target now vs. historical period
      2. Size of SPAC
      3. Sponsor reputation and experience
      4. If time is less than one year, remember the exercise period does not start until at least one year after IPO

3. Volatility
   1. Post-merger volatility of comparable de-SPAC companies, which would require probability of successful deal adjustment
   2. Implied volatility, which has the probability of a successful deal baked in
      1. From public warrants of comparable SPACs
      2. From own public warrants[6]
   3. Reconciliation between the two
4. Share price—$10 (or whatever the issuance price is) for valuations where the units have not split and the current SPAC common share price for units that have split
5. Strike price—$11.50 (or whatever agreement states)
6. Warrant term—Typically five years from estimated IBC
7. Risk free rate

Methodology:

The Black Scholes call option model is used to estimate the value of warrant at the acquisition date with the traditional inputs discussed above. Then the model needs to be modified by applying a probability of IBC and discounting to present value at the risk-free rate.

Monte Carlo Simulation

Typically used for valuations of public warrants, a Monte Carlo is necessary to simulate stock price from IBC transaction date (or transaction announcement date) to expiration of warrant (or until the redemption provision is triggered). At the conclusion of the simulation, the warrant value could then be calculated and discounted back to the valuation date. Finally, it could be multiplied by the probability of successful acquisition.

Frequent Issues Seen in Valuations

Some of the frequent valuations seen thus far in the valuations of SPAC warrants include:

1. Unreasonable volatility selection: Some valuations have implemented larger operating companies in the volatility selection, which would only be reasonable if an IBC was completed. If there is no IBC, the implied volatility from the SPAC’s own public warrants should be utilized for SPACs post-unit split but prior to IBC.
2. Selection of IBC probability: When a valuation includes a volatility selection of comparable SPACs that have not announced an IBC partner, an IBC probability of 100% is reasonable as the risk of not completing a successful business combination is embedded within the selected volatility. This is also the case for a volatility selection based on the implied volatility of the SPAC’s own public warrants.
3. Make-whole provisions: If the warrant agreement includes a make-whole table and the private warrants are not excluded, the private and public warrants will likely have a de minimis difference in value. If the warrant agreement states that the make-whole provision does not apply to private warrants if the reference value equals or exceeds $18 per share, the private and public warrants will likely have a de minimis difference in value. This is because of the unlikely probability of the reference value exceeding $18 per share.

Conclusion

Although the SEC statement was released five months ago, this is still an evolving topic. Since each warrant agreement is potentially different, the valuation approach may vary depending on the terms of the agreement. In addition, as more data becomes available to the public, various assumptions such as the probability of a successful IBC and the time to successful IBC will become easier to get comfortable with. Although this is not a perfect science, if the warrant agreement was reviewed and the valuation inputs are reasonable, there should be no issue in reaching the proper accounting, financial reporting, and valuation conclusion.

 

[1] Source: https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs

[2] Each warrant agreement is potentially different and therefore, the terms may vary depending on the specific warrant agreement.

[3] In cases where there is a make-whole provision, private and public warrants will likely have a de minimis difference in value.

[4] Not needed for valuations of warrants for post-IBC SPACs.

[5] Ibid.

[6] Most reasonable selection for valuations of warrants for post SPAC unit split but prior to IBC.

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Melissa L. Charnota, ASA, CVA, is a senior manager in Marcum LLP’s Valuation, Forensic, and Litigation practice in the Advisory Services Group. She is based out of the Miami office and has more than 20 years of professional experience, including business valuation, trial support, matrimonial dissolution, fraud analysis, due diligence reviews, mergers and acquisitions, and forensic accounting.

Ms. Charnota values businesses for financial reporting, strategic planning, transactions, estate/gift tax, equitable distributions, shareholder disputes, and a variety of other purposes. In addition, she also deals with lost profit calculations, damage calculations, and performing investigative analysis in connection with various forensic accounting matters.

Professional and Civic Affiliations

• National Association of Certified Valuators and Analysts (NACVA), Certified Member
• American Society of Appraisers (ASA), Accredited Senior Appraiser
• Association of Certified Fraud Examiners (ACFE), Member
• Florida Institute of Certified Public Accountants (FICPA), Member

Ms. Charnota can be contacted at (305) 995-9749 or by e-mail to Melissa.Charnota@MarcumLLP.com.

Scott Stabile, CPA, is a Supervisor in Marcum LLP’s Valuation, Forensic, & Litigation practice in the Advisory Services Group. He is based out of the Fort Lauderdale office. Mr. Stabile’s professional experience includes business valuation, matrimonial dissolution, forensic accounting, and due diligence reviews.

Professional and Civic Affiliations

• American Institute of Certified Public Accountants (AICPA)
• Florida Institute of Certified Public Accountants (FICPA)

Mr. Stabile can be contacted at (954) 320-8189 or by e-mail to Scott.Stabile@MarcumLLP.com.