Background

SPAC or a special purpose acquisition company is a shell company listed on a stock exchange with the purpose of acquiring a private company and, therefore, making it public without going through the traditional initial public offering (IPO) process. Going public through a SPAC merger differs from the tradition IPO in a way that the target that eventually becomes the public company is not involved in SPAC’s formation and SPAC IPO.

There are typically four phases in the life cycle of a SPAC: SPAC formation, SPAC IPO, SPAC merger with a private operating company (also referred to as a de-SPAC transaction) and post-merger as a combined public company. Financial compensation of SPAC sponsors and managers is as such that they have a strong incentive to identify and merge with the target.

Terms of a typical SPAC IPO includes a feature that allows the sale of additional equity securities by the SPAC to its underwriters. The terms of the feature are that underwriters can purchase, at their discretion, specified amount of securities within certain amount of days following the IPO close at the same price the shares were purchased initially. Generally, the amount of additional shares issuable to underwriters is 15% of the initial offering while the option term varies between 30 and 45 days. The feature is referred to as an overallotment option and, in essence, represents a written call (purchase) option.

As part of SPAC‘s formation, newly formed entity issues its founder, referred to as a sponsor shares in exchange for a nominal amount of equity capital, e.g. $25,000. In many cases, the amount of founder shares issued is determined as a specific, agreed-on percentage of total outstanding voting shares after the IPO close, e.g., 20%.

The amount of shares held by the sponsor is determined assuming underwriters will fully exercise of the overallotment option. If the overallotment option is not exercised or is only exercised in part, the sponsor is required to forfeit some previously issued shares for no consideration, so that sponsor’s share of the total issued and outstanding voting shares will equal the agreed-on percentage. Shares forfeited by the sponsor are cancelled and are not re-issued.

Illustrative Example A:

Assume SPAC has issued to its sponsor 1,000,000 of common shares in exchange for $ 25,000. According to the terms of the IPO, SPAC plans to issue 3,478,261 shares to public investors through the underwriters. The underwriters have the option to purchase 521,739 additional common shares or 15% of the initial issuance within 45 days after the IPO close. If the underwriters exercise their overallotment option, total amount of shares issued to the sponsor and public investors will be 5,000,000 or 1,000,000 + 3,478,261+ 521,739. In this case, sponsor will hold 20% of all voting shares outstanding or 1,000,000/5,000,000.

If the underwriters do not exercise the overallotment option, the sponsor will have to forfeit 130,435 of previously issued shares. In this case, sponsor will have 869,565 shares issued and outstanding or 1,000,000 less 130,435. Following the forfeiture, the sponsor will hold 20% of all voting shares outstanding or 869,565/4,347,826 where 4,347,826 is determined as 869,565 plus 3,478,261.

Many SPACs raised a question of how to account for shares forfeiture by the sponsor. Specifically, the question is how to account for forfeited shares or shares subject to forfeitures in reporting entity’s balance sheet and statement of changes in equity as well as the impact of the shares on entity’s earnings per shares (EPS).

We are aware of other situations when sponsors are required to surrender part of their shares to achieve specific ownership structure. Reporting entities and their advisors should carefully examine relevant facts and circumstances to determine proper accounting treatment for such surrenders. The scope of this publication is limited to accounting for forfeitures due to no or partial exercise of underwriter’s overallotment option.

The following publication covers general accounting questions concerning GAAP treatment of underwriter’s overallotment options: https://finacco.org/2021/08/22/accounting-for-underwriter-overallotment-option/.

Accounting Analysis

U.S. GAAP does not offer any explicit guidance related to accounting for forfeitures of shares dependent on the overallotment option. However, other accounting guidance addresses similar issues and may be applied by analogy.

Changes in Equity Structure

Per ASC 260-10-55-12, if the number of common shares outstanding increases as a result of a stock dividend or stock split, or decreases as a result of a reverse stock split, the reporting entity should adjust the computations of basic and diluted EPS retroactively for all periods presented to reflect that change in capital structure. If changes in common stock resulting from stock dividends, stock splits, or reverse stock splits occur after the close of the period but before the financial statements are issued or available for issuance, the per-share computations for those and any prior period financial statements presented should be based on the new number of shares. However, reporting entities will report the “old” or historical number of shares outstanding and use this number to calculate EPS, if the effective date of the change in equity structure is after the issuance date.

ASC 260-10-55-12 requires disclosure of the above changes, i.e., the impact of stock dividend or stock split on EPS.

If the above guidance, covering certain changes in equity structure is applied to forfeiture of sponsor shares, the impact of the forfeiture will be accounted for when the shares are forfeited even if the forfeiture occurs subsequent to the balance sheet date but before the issuance of the financial statements. The impact of the forfeited shares will be reflected retrospectively by adjusting the amount of commons share outstanding, basic and diluted EPS.

Applying the above guidance by analogy, before the forfeiture has occurred, SPACs would report the amount of sponsor shares subject to forfeiture as issued and outstanding. In this case, the respective shares will also increase the denominator used to determine basic and diluted EPS.

Contingently Issuable Shares

Per 260-10-45-13, shares issuable for little or no cash consideration upon the satisfaction of certain conditions or the so-called contingently issuable shares shall be considered outstanding common shares and included in the computation of basic EPS as of the date that all necessary conditions have been satisfied or, in essence, when issuance of the shares is no longer contingent.

According to ASC 260-10-45-13:

Outstanding common shares that are contingently returnable (that is, subject to recall) shall be treated in the same manner as contingently issuable shares. Thus, contingently issuable shares include shares that meet any of the following criteria:

  1. They will be issued in the future upon the satisfaction of specified conditions.
  2. They have been placed in escrow and all or part must be returned if specified conditions are not met.
  3. They have been issued but the holder must return all or part if specified conditions are not met.

Example of contingencies impacting issuance of shares include reporting entity’s stock price or earnings level, etc.

Contingently issuable shares are to be considered outstanding for basic EPS computations, even if the shares physically have not been issued provided underlying contingency impacting the issuance, other than passage of time, has been satisfied. When the contingency is satisfied and the weighted-average amount of shares outstanding used to calculate basic EPS is increased, previously reported basic EPS amounts are not restated (260-10-45-12A).

Under ASC 260, contingently issuable shares are treated differently for basic and diluted EPS. If all necessary conditions have not been satisfied by the end of the period, the number of contingently issuable shares included in diluted EPS shall be based on the number of shares, if any, that would be issuable if the end of the reporting period were the end of the contingency period and if the result would be dilutive. Those contingently issuable shares shall be included in the denominator of diluted EPS at the beginning of the interim period or as of the date of the contingent stock agreement, if later (ASC 260-10-45-48).

Illustrative Example B:

Assume that as part of the stock issuance agreement signed on January 1, 20X2, a reporting entity is obligated to issue 100 additional common shares, if the market price of entity’s stock increases to $10/share at the end of second quarterly period ending on June 30, 20X2. If, at the end of first quarterly period, ending March 31, 20X2, reporting entity’s share price was $11/share, 100 additional common shares would be considered issued and outstanding in calculation of diluted EPS, if the impact of the additional shares is dilutive. In this case, weighted-average amount of shares outstanding used to determine diluted EPS is increased effective January 1, 20X2 or beginning of the interim reporting period when the reporting entity’s share price reached $ 10/share. Weighted-average amount of shares outstanding used to determine basic EPS at March 31, 20X2 will not include the impact of contingently issuable shares. At March 31, 20X2, the reporting entity will not present contingently issuable shares as issued and outstanding in its balance sheet and statement of changes in equity.

Shares that a sponsor is obligated to forfeit due to no or only a partial exercise of the overallotment option are considered contingently returnable per ASC 260-10-45-13. Thus, the shares also appear to be subject to guidance relevant to continently issuable shares. We believe that guidance covering contingently issuable shares is more relevant to SPAC sponsor shares subject to return, depending on the exercise of the overallotment option than the guidance covering stock dividend or stock split.

We believe that the arrangement where legally issued sponsor shares are subject to return in the event of partial or no exercise of the overallotment option is equivalent to the arrangement where the sponsor will only receive additional shares, if the underwriters exercise the overallotment option. In the second type of contract, i.e., when the sponsor receives additional shares, the additional shares are not considered issued and outstanding for basic and diluted EPS until the underwriters exercise their overallotment option. Similar accounting model should apply to legally issued shares subject to return, depending on the exercise of the overallotment option.

The contingent event in the situation involving sponsor shares forfeitable, depending on the exercise of the overallotment option is the exercise of the option. Until the event occurs, i.e., the option is exercised, the shares returnable by the sponsor are considered contingent and not reported as issued and outstanding in SPAC’s balance sheet and statement of change in equity. Until the exercise of the overallotment option, the returnable shares should be excluded from the denominator in computing basic EPS even if the shares were legally issued.

When the overallotment option is exercised before the end of reporting period, the amount of shares not returned by the sponsor are reported as issued and outstanding on SPAC’s balance sheet and statement of changes in equity. The additional common shares are also used to increase the denominator used to calculate the amount of basic and diluted EPS. Exercise of the overallotment option occurring after the reporting period do not impact the amount of issued and outstanding common shares and SPAC’s EPS at the end of the reporting period. However, reporting entities should consider disclosing such changes in the subsequent event section of the footnotes to the financial statements.

Upon exercise of the overallotment option, the amount of weighted-average shares outstanding used to calculate basic EPS includes non-forfeitable shares from the date of the exercise of the overallotment option. Previously reported basic EPS should not be restated for changed circumstances, i.e., the exercise of the overallotment option.

When the overallotment option is exercised, the amount of weighted-average shares outstanding used to calculate diluted EPS is increased by the non-forfeitable shares from the later of a) the beginning the quarterly interim period in which underwriters exercised their overallotment option or b) date of the overallotment agreement between the SPAC and the underwriters.

If the overallotment option was exercised partially, only the non-returnable shares related to the exercised part of the overallotment option are reported as issued and outstanding and included in the denominator used to calculate basic and diluted EPS.

As noted above, sponsor shares issued by SPAC and subject to return depending on the exercise of underwriter’s overallotment option are not considered issued and outstanding and are not reported as such on SPAC’s balance sheet or statement of changes in equity until underwriters exercise their overallotment option. The following footnote can be added to the number of shares outstanding as presented on SPAC’s balance sheet, statement of changes in equity and EPS calculations:

[x] This number excludes up to [number] ordinary shares subject to forfeiture if the option to purchase additional units is not exercised in full or in part by the underwriters.

Conclusion

Shares that a sponsor is obligated to forfeit due to no or only a partial exercise of the overallotment option are considered contingently returnable per ASC 260-10-45-13. Thus, the shares also appear to be subject to guidance relevant to continently issuable shares.

Legally issued shares subject to return are not considered issued and outstanding and are not reported as such on SPAC’s balance sheet or statement of changes in equity until underwriters exercise their overallotment option. Returnable shares are included in the denominator used to calculate basic and diluted EPS only in the period in which underwriters exercised their overallotment option.

Reporting entities should consider disclosing exercise of the overallotment option, occurring after the end of the current reporting period in the subsequent event section of the footnotes to the financial statements.

Upon exercise of the overallotment option, the amount of weighted-average shares outstanding used to calculate basic EPS includes non-forfeitable shares from the date of the exercise of the overallotment option. Previously reported basic EPS should not be restated for changed circumstances, i.e., the exercise of the overallotment option.

When the overallotment option is exercised, the amount of weighted-average shares outstanding used to calculate diluted EPS is increased by the non-forfeitable shares from the later of a) the beginning the quarterly interim period in which underwriters exercised their overallotment option or b) date of the overallotment agreement between the SPAC and the underwriters.

If the overallotment option was exercised partially, only the non-returnable shares related to the exercised part of the overallotment option are reported as issued and outstanding and included in the denominator used to calculate basic and diluted EPS.

 

FINACCO CONTACTS:

NICK LARCHENKO, Managing Partner

646.713.4764 / nick.larchenko@finacco.org

CARLOS LARA, Accounting Advisory Manager

213.296.3020 / carlos.lara@finacco.org

 

Important Note: FinAcco Consulting LLC is not responsible for, and no person should rely upon, any advice or information presented on this website. Note that entity’s financial statements, including, without limit, the use of generally accepted accounting principles (“GAAP”) to record the effects of any proposed transaction, are the responsibility of management. Therefore, any written comments by FinAcco Consulting LLC about the accounting treatment of selected balances or transactions or the use of GAAP are to serve only as general guidance. Our comments are based on our preliminary understanding of the relevant facts and circumstances and on current authoritative literature. Therefore, our comments are subject to change. FinAcco Consulting LLC does not assume any responsibility for timely updates of its website overall or any information provided in the Insights section of the website, specifically.