A fresh wave of restatements by special purpose acquisition companies (SPACs) could be coming after the Securities and Exchange Commission’s chief accountant in September raised concerns about companies’ practice of classifying Class A shares as permanent equity when they should be treated as temporary. 

Because they’re redeemable at the direction of investors, the shares shouldn’t be considered permanent but rather a form of mezzanine financing or an accounting liability, the SEC believes.  

“The SEC [after holding consultations with issuers in September] objected to the historical accounting classification that SPACs have been following for the past decade,” Edward Hackert, a partner with accounting and advisory firm Marcum, said in an analysis. 

To the extent SPACs issue restatements in the coming months, it could be reminiscent of a restatement surge earlier this year in response to the SEC’s concerns over the accounting of warrants. 

SPACs were accounting for warrants as equity rather than as a liability, and the SEC saw that as a problem for the same reason it sees the Class A shares as temporary equity: their redemption is in the hands of investors, not the company.

In the early part of the year, some 90% of approved SPACs restated their financials, with the lion’s share of them because of the warrants. Now there’s the possibility the market will see another wave over the Class A shares issue. 

“The key thing to remember about this is, this is just an accounting-bookkeeping entry issue, a restatement in form only,” Wayne Stallings, head of accounting at Training The Street, a financial training company, told CFO Dive. “It doesn’t impact anything about the economics of the SPAC or change the amount of cash the SPAC has in trust or change the shares at all.” 

Shareholder equity threshold

A SPAC could see a small dip in its share price after announcing a restatement but, by itself, the news shouldn’t be taken as anything more substantive than what it is.  

“Any time you hear the word restatement people get spooked and sell, but in this case this is not a restatement for something like fraud or a negative thing,” Stallings said.

Probably the more substantive concern is the impact the restatements can have on companies’ compliance with the rules of the exchange they’re listed on. 

Rules differ by exchange, but the major ones generally require listed companies to meet thresholds for how much of their equity is considered permanent — that is, under enough control of the company that investors can’t just redeem their shares when they want. 

Nasdaq, for example, requires companies to have a minimum $5 million in shareholder equity.

The concern among SPACs is, with the restatement of their Class A shares as temporary equity, many will see their permanent equity fall below the threshold, putting them in technical violation of exchange rules.

“The traditional accounting for these SPAC shares over the years has been to leave $5 million worth of equity of redeemable shares in the equity account and treat the rest of them as temporary equity,” said Stallings. 

In other words, if a company has $10 million in shares, for accounting purposes it reports half of them as permanent equity and half as temporary even though both halves are composed of the same kind of shares. This tactic no longer appears to work given the position the SEC is taking. 

“The SEC is effectively [forcing] an accounting reclassification to move all of the proceeds of the redeemable shares out of the shareholder equity section and into the mezzanine section,” he said.

WeWork woes

Probably the most high-profile company to announce a restatement because of the issue is BowX, the sponsor parner of WeWork, which in early December said in an 8-K filing it would restate financials for the past year “to report all public shares as temporary equity.” The company went public in October through a merger with BowX. 

WeWork is making the restatements even though the misclassification of shares goes back to the accounting of BowX before the merger. 

“I was definitely surprised that they were required to go back to restate the shell company’s financial statements prior to the business combination,” said Stallings. “Once the business transaction happens, it’s really a moot issue.”

Response options

For companies whose equity drops after restatement below the threshold required by their exchange, it’s not clear what the enforcement action will be. The exchanges have said they're aware of the problem, Stallings said, but haven’t yet offered a solution.   

There are some options for companies at risk of dropping below the threshold, though. One is to beef up shareholder equity, including through a private investment in public equity (PIPE), but this only solves the problem if the shares aren’t redeemable in the same way as the existing shares. Even if they aren't, a company might not get the price it wants for the shares, if it can sell them at all.  

Another option is to list on an exchange with easier equity requirements, like those hosting penny stocks, but that might not be an attractive option given the reputation of penny stocks as higher-risk investments.