Tag Archives: debt vs equity

Year-End Topic 6 – Should You Consider Any Issues for OCA Consultation?

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As we approach year-end another issue to plan well in advance is whether or not you should ask OCA to pre-clear any extremely complex or subjective accounting decisions. This is a well-established process and when you are faced with a complex transaction, extremely subjective accounting determinations or an area where GAAP is not clearly established it makes sense to pre-clear the issue and avoid the possibility of restatement, amendment, or getting hung up in the CorpFin comment process. This is especially true when we know we will all be reviewed at least once every three years.

 

OCA’s process for consultation is outlined here. The process does need a significant amount of preparation and usually requires a few weeks to complete, sometimes more, so advance planning is important.   The document link above has a very detailed list of what needs to be included in your correspondence with OCA and what to expect from the process.

 

Since this is a consultation with the Office of the Chief Accountant, the answer you get will be definitive and cannot be over-ridden in the review process.

 

There is also a telephone consultation service you can use to consult with the CorpFin Chief Accountants office, a different process of course, but sometimes a good starting point. You can find out about this less formal process here.

 

Lastly, here is a recent list of frequent OCA consultation areas you can use to access whether your issues would benefit from this process:

 

Revenue Recognition, gross vs net etc.

Business combinations, who is the acquirer, business vs assets, contingent consideration

Financial assets, impairments valuation

Segments and aggregation

Consolidation VIE

Long lived assets, e.g. goodwill impairment

Taxes,

Leases

Pension

Debt vs equity

 

As always, your thoughts and comments are welcome!

Debt Versus Equity – More on Ratchets

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On November 3 we blogged about debt versus equity issues and how in late stage financings investors were demanding price adjustment and conversion rate adjustment features such as ratchet provisions. In essence this was to protect late round investors if the valuations they used for their investment was substantially higher than the IPO valuation.

As you may have been following, Square has just completed their IPO. Here is an excerpt from Square’s stockholder’s equity note in their financial statements:

The initial conversion price for the convertible preferred stock is $0.21627 for the Series A preferred stock, $0.71977 for the Series B-1 preferred stock, $0.95369 for the Series B-2 preferred stock, $5.79817 for the Series C preferred stock, $11.014 for the Series D preferred stock, and $15.46345 for the Series E preferred stock. In the event the Company issues shares of additional stock, subject to customary exceptions, after the preferred stock original issue date without consideration or for a consideration per share less than the initial conversion price in effect immediately prior to such issuance, then and in each such event the conversion price shall be reduced to a price equal to such conversion price multiplied by the following fraction:

the numerator of which is equal to the deemed number of shares of common stock outstanding plus the number of shares of common stock, that the aggregate consideration received by the Company for the total number of additional shares of common stock so issued would purchase at the conversion price immediately prior to such issuance; and

the denominator of which is equal to the deemed number of shares of common stock outstanding immediately prior to such issuance plus the deemed number of additional shares of common stock so issued.

Series E preferred stock contains a provision for the adjustment of conversion price upon a public offering. In the event of such offering, in which the price per share of the Company’s common stock is less than $18.55614 (adjusted for stock splits, stock dividends, etc.), then the then-existing conversion price for the Series E preferred stock shall be adjusted so that, as of immediately prior to the completion of such public offering, each share of Series E preferred stock shall convert into (A) the number of shares of common stock issuable on conversion of such share of Series E preferred stock; and (B) an additional number of shares of common stock equal to (x) the difference between $18.55614 and the public offering price, (y) divided by the public offering share price.

The language above is not very easy to understand, but there are various price adjustment features and the instruments that have them were entered into at various points in time, including some later stage investments. So, the debt versus equity issues is present.

Square’s IPO priced at $9, (actually below the expected price range, but the company did get a nice day one price rise on the exchange) so Square will have to make up shares to these later stage investors. This is a simple example where late stage financing valuations were higher than the IPO price.

Here are two links to information about the transaction. Buzzfeed has a nice summary of the deal at:

www.buzzfeed.com/williamalden/square-valued-at-29-billion-in-ipo-short-of-expectations?utm_medium=email&utm_campaign=News+-+1119+Thursday&utm_content=News+-+1119+Thursday+CID_8ba44ca9bcced29cacc07f7e086f01c4&utm_source=BuzzFeed%20Newsletters&utm_term=.uxrLvq8pj#.amezg5KWJ
Here is a WSJ article where the WSJ somehow wanted to call this ratchet a “penalty”:

blogs.wsj.com/digits/2015/11/18/square-pays-93-million-penalty-to-some-investors-in-ipo/

As always, your thoughts and comments are welcome!

 

 

P.S. And, just in case this is relevant to you, here is a link to our new workshop “Debt vs. Equity Accounting for Complex Financial Instruments”. This new case-driven workshop will be presented five times next year.

www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z11c8lZ4k?ID=262917

Comment of the Week – Debt Versus Equity Issues on the Rise?

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The genesis of this post is actually a panel discussion from PLI’s 47th Annual Institute on Securities Regulation. This program is one of our major events in the CLE world. The roster of speakers is amazing, starting with a keynote address from Chair White and featuring so many SEC alums, current staffers and industry professionals that an SEC geek simply can’t resist the program.

Anyway, on the first day of the conference the first panel discussed capital market “health” in the current environment. One of the market developments they discussed was financing rounds companies complete shortly before an IPO. In the current environment more and more late round investors are demanding “price protection”. This “price protection” includes instruments like warrants with adjustable prices (ratchets or down-rounds) and preferred stock with adjustable conversions options.

(The staff does write comments about these kinds of instruments, and we have a few examples below.)

It turns out that sometimes the valuations used for these private placements shortly before an IPO don’t follow through to the valuations in the IPO. So the late round investors ask for price protection so they won’t seem to have overpaid shortly before an IPO. (This dovetails very nicely with the recent discussion in the financial press about how valuations for “unicorn” companies may be overstated in the current tech world.)

This is exactly the kind of price protection that has been common in emerging companies that have been far from the IPO process, and it is these kinds of instruments that have been the cause of so many restatements.

If you have ever attended any of our Midyear, Annual or Mid-Sized and Smaller Company SEC Reporting & FASB Forums you are familiar with the continuously updated list of restatement issues we discuss at those conferences. For the last seven years, the number one cause of restatements by public companies has been debt versus equity accounting. Instruments such as warrants with repricing provisions combined with the convoluted, complex accounting guidance in this area have caused more restatements than any other issue.

Being one of the few accountants in the Institute on Securities Regulation it was fascinating listening to the lawyers discuss these complex instruments. The discussion of disclosures that should surround these complex instruments and their unique features was deep and rich. No one however mentioned the accounting issues that they create, and the risk of restatement that goes along with this accounting complexity.

It was a great reminder that as accounting professionals we need to be on the watch for this issue and when we see it raise the accounting issues and assure they are dealt with effectively. This is one of the times when communication between finance, legal and accounting professionals is crucial.

If you would like to review an example of the accounting these instruments create, one of the participants on the panel was from BOX, a successful IPO which had this exact situation. In their first Form 10-K and their S-1 you can find a derivative liability on their balance sheet and a related fair value adjustment in their income statement related to redeemable preferred stock warrants they issued which were derivatives. You can find their Form 10-K at:

www.boxinvestorrelations.com/sec-filings

And, last, here are a couple of example comments. All of this really emphasizes the need to be aware of this issue and build the skills to recognize the issue and deal with it effectively.

It appears the exchangeable senior notes issued in August 2014 contain redemption features. Provide us your analysis that supports your conclusion that none of the redemption features are required to be bifurcated in accordance with ASC 815-15. Specifically address whether the debt involves a substantial discount in accordance with ASC 815-15-25-40 through [25-43].

We note your disclosure that the 1.25% Notes contain an embedded cash conversion option and that you have determined that this option is a derivative financial instrument that is required to be separated from the notes. Please provide us with the details of your analysis in determining that this conversion option should be accounted for separately as a derivative and refer to the specific accounting literature you relied on.

As always, your thoughts and comments are welcome!

P.S. And, just in case this is relevant to you, here is a link to our new workshop “Debt vs. Equity Accounting for Complex Financial Instruments”. This new case-driven workshop will be presented five times next year.

www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z11c8lZ4k?ID=262917