PIPEs, or “private investments in a public entity”, are becoming more common investments held by the funds industry as a result of the explosion of SPACs, or “special purpose acquisition companies” in recent years. But how are these PIPEs accounted for under ASC 946, and what other accounting and reporting challenges do they represent for investment companies?
My colleague, Chris Brundrett, had two recent posts discussing SPACs and some of the accounting and reporting issues associated with these entities. I want to shift attention to one of the accounting issues associated with investors in a SPAC.
Investment companies, including private equity funds and hedge funds, often invest in SPAC arrangements through PIPEs. SPACs may offer interest in a specified merger target through PIPE commitments. Under these instruments, the investment company enters into a commitment to buy shares in the merger target company. This commitment is subject to a number of contingencies such as obtaining a sufficient capital raise and shareholder approval of the merger. However, these PIPEs provide the SPAC with potentially important financing to complete a merger in excess of the amount of equity it has initially raised or in case investors opt to cash out their investment prior to the acquisition of the merger target.
So how are these commitments made by an investment company accounted for under ASC 946? While this issue will undoubtedly be covered in our 2021 Essential Update for the Investment Management Industry training, let’s have a sneak peek into the issue now!
The issue was discussed at the AICPA Investment Companies Expert Panel in November 2020 and again in January 2021. While ASC 946 is not definitive and therefore may be subject to interpretation, the Expert Panel suggests that PIPEs be recognized only when the commitment is legally binding. The timing of this recognition is therefore a legal determination rather than an accounting assessment. Once binding, it is believed that the PIPE may meet the definition of a financial instrument, a derivative, or other investment. No matter how it is defined, under each scenario it is measured at fair value each reporting period, with changes in fair value recognized through the Statement of Operations. Despite the existence of contingencies, this would not impact the recognition as a financial instrument, derivative, or other investment. Of course, the uncertainty surrounding the contingencies will impact the fair valuation of the instrument.
The issues do not stop there. There are other considerations that may arise:
Unit of account
Often the PIPE commitments are issues along with equity shares, calling into question the unit of account and whether the commitment should be measured separately from the equity shares (two units of account) or in combination (one unit of account). While the Expert Panel did not opine on this issue, it is likely going to depend on the specific arrangement and likely market participants for these interests. The long-standing principles of ASC 820 should be applied to make this determination.
Gross versus net presentation
The PIPE commitment is only a contingent for a period of time. Once the contingencies have been resolved, the PIPE becomes an obligation to fund the SPAC and take on a traditional investment in the entity. How should the PIPE be accounted for at the time the commitment becomes an “obligation”, but prior to settlement of the commitment?
For example, assume a fund holds a PIPE on January 1, 20X1 and is committed to pay $1 million upon approval of a merger by the shareholders. If shareholder approval occurs on May 15, 20X1 and the PIPE commitment is required to be settled within 2 months of approval (i.e. July 15, 20X1), how is the PIPE presented on June 30, 20X1?
The Expert Panel discussed two alternatives:
- Fair value accounting, net presentation – Since the PIPE is an investment, it is recorded at fair value and only upon funding (on July 15) would the “gross investment” be recognized, with a corresponding cash payment.
- Gross presentation – Once the fund is obligated to make the payment, it should be recognized as a “gross investment” and a corresponding liability. This is in-line with “trade date accounting”, but otherwise, seems to go against the fair value concept for investments.
The Expert Panel suggested that the determination of the unit of account may also impact this assessment. No decisions have been made and the panel will continue to discuss this issue.
In the meantime, SPACs continue to cause a diverse range of accounting and reporting issues, including those impacting the investment management industry. We will continue to follow developments on these issues and let you know what we find out!
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