Dilution clauses
Some options over own equity are structured such that the number of shares issued under the contract is variable but the consideration paid per share issued is fixed in the issuer’s functional currency. It is important to understand whether the number of own equity instruments delivered varies in response to the dilutive impact of bonus share issues or buy backs or in response to the outcome of other uncertain variables (e.g. the level of an index, price or rate).
IAS 32 and Section 12 of FRS 102 does not provide guidance on which types of anti-dilutive provisions result in the equity conversion feature failing equity treatment.
Financing arrangements
We regularly see technology companies using warrants to reduce immediate cash needs as part of financing arrangements. An example is where the transaction fee is replaced with the issuance of warrants to the lender. If a warrant agreement is entered into as part of a financing arrangement, the cost of the warrant may be viewed as a loan commitment fee paid by the entity to the lender, which may result in a prepayment being recognised.
It is important to understand the interaction between the warrants and the loan commitment. Management should consider whether the warrant agreements are assessed in isolation of the loan agreement or together and this would impact the subsequent accounting. A consideration for this may be the timing difference between the issue of the loan facility and the warrant instrument.
Contingent settlement clauses
There are a number of considerations over whether the contingent settlement clause results in a financial liability or equity classification. The following examples indicate the contingent settlement clause are more likely to result in an equity classification:
• the issuer has control over redemption
• the event is not genuine (event that is
extremely rare, highly abnormal and
very unlikely to occur)
Many anti-dilutive provisions are structured so as to 'make-whole' the holder of the warrant if specified events occur such that the holder of the warrant instrument remains in the same position relative to existing ordinary shareholders before and after the event. If this is the case, such provisions are not deemed to breach the fixed-for-fixed criterion. A different conclusion would be reached if the adjustment to the conversion ratio benefited the warrant holder at the expense of the existing ordinary shareholders.
Evelyn Partners view
As part of determining if the warrant should be treated on its own management may need to assess whether the loan facility terms are on an arms-length basis. Management may need specialist valuation assistance in determining what a market rate of interest would be for a similar debt instrument.
The accounting for the warrant instrument can get a little tricky, e.g. the recognition of the expense relating to the warrant is likely to be through an adjustment of the loan's effective interest rate.
Evelyn Partners view
Warrant agreements can sometimes be ambiguous and may lack clarity. Management should apply careful consideration towards the interpretation of clauses.
Management may need to engage their accounting advisers before signing up to warrants to ensure they understand the accounting implications.
Evelyn Partners view
Common implications over the accounting of warrants
There are a number of considerations over whether the contingent settlement clause results in a financial liability or equity classification. The following examples indicate the contingent settlement clause are more likely to result in an equity classification:
• the issuer has control over redemption
• the event is not genuine (event that is extremely rare,
highly abnormal and very unlikely to occur)
There are a number of considerations over whether the contingent settlement clause results in a financial liability or equity classification. The following examples indicate the contingent settlement clause are more likely to result in an equity classification:
• the issuer has control over redemption
• the event is not genuine (event that is extremely rare, highly abnormal
and very unlikely to occur)