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Deciphering the accounting for equity-linked instruments · PwC's accounting podcast

0:00
SPEAKER_01: Thought Leadership from PWC's National Office.
0:06
SPEAKER_03: Welcome to PWC's Accounting Podcast.
0:09
SPEAKER_03: I'm Heather Horn.
0:11
SPEAKER_03: Today we wrap up this month's miniseries on financing transactions with an episode on equity-linked instruments, which are commonly used to issue shares, repurchase shares, or raise financing at reduced interest rates.
0:24
SPEAKER_03: From embedded derivatives to conversion options to indexation features, equity-linked instruments and the related accounting can get very complicated very quickly.
0:35
SPEAKER_03: In this episode, we discuss key judgments and how to evaluate them while highlighting common pitfalls to avoid.
0:49
SPEAKER_02: Probably in a way that your typical treasurer or banker may not think of these features being super important to them economically, but they can matter a lot to the accounting.
1:01
SPEAKER_02: So I think though that combination of complexity in the instrument and complexity in the accounting makes this a tough area.
1:21
SPEAKER_03: Brett and John both have the talent of making complex topics sound easy.
1:26
SPEAKER_03: So let's listen in as they share their knowledge and insights to help shed some light on this topic.
1:32
SPEAKER_03: John, Brett, welcome to the podcast for a topic that's very important and also very complicated.
1:38
SPEAKER_03: So I hope we are going to make a complicated topic easy with our discussion today.
1:44
SPEAKER_03: And that's talking about equity-linked instruments and some of the common pitfalls.
1:48
SPEAKER_03: And just as a quick preview, I'll remind the audience that this month is all, well, this year is all about some of our most popular guides and looking at some of the most popular chapters.
1:59
SPEAKER_03: So this is clearly an issue that is a lot of companies are dealing with.
2:03
SPEAKER_03: So I think it's a great conversation.
2:05
SPEAKER_03: But Brett, maybe just to start things off and take a step back, I think sometimes that helps to understand sort of motivation in these agreements and why companies are doing this.
2:15
SPEAKER_03: So why are companies issuing at these types of equity-linked instruments and what are some of the advantages?
2:22
SPEAKER_02: Yeah.
2:22
SPEAKER_02: So there's a variety of instruments we're going to talk about today, but just in general, I think companies think of equity linked instruments as a mechanism to either issue new shares or repurchase shares, but at a reduced cash rate of financing.
2:37
SPEAKER_02: So classic example, as a you could raise financing by issuing straight-term debt.
2:44
SPEAKER_02: A company may instead issue convertible debt.
2:47
SPEAKER_02: It gives the investor an option to participate in the equity of the issuer through that conversion option, but maintains the downside protection of being in a debt instrument.
2:58
SPEAKER_02: And I think that the inclusion of that conversion option allows the issuer to lower the cash interest rate on the debt.
3:05
SPEAKER_02: Another common equity and equity link instrument are warrants.
3:09
SPEAKER_02: So warrants are essentially written call options that allow an investor the option to exercise the warrant and receive underlying shares by paying, you know, generally a set strike price.
3:22
SPEAKER_02: So issuing the warrant for the company allows the entity to receive that premium up front, but not actually issue shares immediately.
3:31
SPEAKER_02: They're only going to be issued upon exercise.
3:34
SPEAKER_02: Sometimes we see these warrants being used to in lieu of cash in certain transactions.
3:40
SPEAKER_02: For instance, when you're borrowing debt, a company may issue warrants, freestanding warrants alongside that debt to the lender as compensation for fees that they otherwise would have had to pay in cash.
3:52
SPEAKER_02: And sometimes they're also used as compensation in a business combination.
3:57
SPEAKER_02: I think, like I mentioned, these types of instruments are issued by a wide range of companies in different circumstances.
4:04
SPEAKER_02: But I note that one common factor is often that that option value in them, whether it's standalone or whether it's economically reducing a borrowing rate, it tends to be higher when there's a higher degree of volatility in the share price.
4:20
SPEAKER_02: So think of private companies that have yet to go public, early growth stage public companies, you know, any type of company with a relatively volatile stock price has a lot of value in that option.
4:34
SPEAKER_02: And so they have kind of more economic value to use, whether it's a form of compensation or to reduce the cash interest rate.
4:43
SPEAKER_03: Although it's interesting, Brett, because you mentioned they really are used by a wide range of companies, but at least if I think of these types of instruments, you are thinking more of not like mature, long-standing public companies, but more of these smaller types of companies.
4:58
SPEAKER_03: But maybe that's not a fair perception.
5:01
SPEAKER_02: Yeah, I mean, I I think you see it across across all types of companies.
5:05
SPEAKER_02: We see very large companies do warrant transactions and and things like that too.
5:14
SPEAKER_00: I think you see it moving into higher quality companies as well.
5:18
SPEAKER_03: Yeah, that definitely makes sense because then it's more appealing to a wider range of companies to potentially explore this.
5:24
SPEAKER_03: Okay, that's helpful.
5:25
SPEAKER_03: So I already gave a a preview here that this is a more complicated area of accounting.
5:31
SPEAKER_03: But maybe just taking a step back before we get into some of the details, from your perspective as you're talking to companies and otherwise, how would you sort of set the stage of why this is a more complicated area?
5:44
SPEAKER_02: Um I think there's a number of things that that make it complicated.
5:48
SPEAKER_02: I think for starting, like these instruments can be complicated.
5:52
SPEAKER_02: There's a lot of different features in the instruments, some of which are like key to the economics of the instrument.
6:00
SPEAKER_02: Some of them are probably less key to the economics, but are have become pervasive or um you know to investors in them or to the company or you know, designed to address some possible contingency, possible event, and like you know, different um different, you know, contractual arrangements within them.
6:20
SPEAKER_02: And the in combination with very complicated accounting literature that um sometimes makes um a very has a very different accounting treatment depending on these fairly nuanced differences.
6:35
SPEAKER_02: And so I think we find ourselves in the minutiae very quickly in some of these arrangements, uh, probably in a way that your typical you know treasurer or banker may not think of you know these features being super important to them economically, but they can matter a lot to the accounting.
6:55
SPEAKER_02: So I think though that combination of complexity in the instrument and complexity in the accounting makes this a tough area.
7:03
SPEAKER_00: I I think also the standards you know have evolved over time on a rules-based basis.
7:09
SPEAKER_00: A lot of anti-abuse types of things in these, in the standards for these instruments, which you know we know that lawyers and investment bankers are very good at exploiting loopholes.
7:21
SPEAKER_00: So they look for those things.
7:23
SPEAKER_00: So that that makes it complicated as well.
7:25
SPEAKER_03: All right, so maybe we can start then by kind of walking through uh overview.
7:30
SPEAKER_03: And I think you started mentioning this, but let's kind of walk through the pieces, starting with okay, we have this question, is it freestanding or is it embedded?
7:38
SPEAKER_03: And then we can go from there.
7:40
SPEAKER_02: Yeah, I I I think that's the right first step to think about what what is this instrument I'm looking at, and is it a freestanding or is it embedded in something more complex?
7:51
SPEAKER_02: Um starting with freestanding, think of freestanding instruments as being entered into as a separate transaction or legally detachable and separately exercisable.
8:03
SPEAKER_02: Um I think common examples of something that we see as freestanding are warrants, for example.
8:09
SPEAKER_02: They're they're separate from other arrangements, they can be exercised separately, they're traded as their own instrument.
8:15
SPEAKER_02: In contrast, a conversion option within convertible debt would be embedded because the exercise of the conversion at the same time extinguishes the debt.
8:25
SPEAKER_02: The debt can't be traded without that conversion option.
8:28
SPEAKER_02: So other freestanding instruments we see are you know standalone derivative contracts, forward contracts, both written and purchased puts.
8:37
SPEAKER_03: And so then if we do conclude it's freestanding, then what's the next step?
8:42
SPEAKER_02: So next step is to think about whether that instrument is gonna be accounted for as a liability because it's in the scope of ASC 480, uh, which I know on this podcast series we're we keep talking about ASC 480, and everyone's gonna want to go and read it.
8:57
SPEAKER_03: Exactly.
8:58
SPEAKER_03: Some light nighttime reading.
9:01
SPEAKER_02: There's a number of ways that um an instrument can get caught and in 480 and and and uh treated as a liability.
9:09
SPEAKER_02: For example, instruments other than outstanding shares could be liabilities if there's an obligation to repurchase shares by transferring cash or or other assets in the future.
9:21
SPEAKER_02: Think of a written put option, for example, because the investor can require the issuer to buy back shares by paying cash.
9:30
SPEAKER_02: Um you could also have that arrangement in uh in a warrant where the warrant is exercisable into redeemable shares.
9:39
SPEAKER_02: In that case, the investor is in control of exercising the warrant, right?
9:43
SPEAKER_02: And then when the warrant gets exercised, the investor will own the redeemable share, which in some cases the company could have to pay cash outside of their control.
9:54
SPEAKER_02: So all of these arrangements are trying, or the literature is trying to capture situations where you could be required to transfer cash in in uh in in the future, either obligated or outside of your control.
10:09
SPEAKER_02: Um I also think uh you can become in the scope of um 480 if you have a contract to issue a variable number of shares based on a fixed monetary amount.
10:18
SPEAKER_02: Think of this as a forward sale contract to issue a million dollars worth of shares.
10:24
SPEAKER_02: I don't know how many shares that's going to be because it's gonna be dependent on the spot price of the shares at the settlement date.
10:30
SPEAKER_02: But we've fixed a monetary value of that, um, that's also gonna uh get pulled into a liability under 480.
10:38
SPEAKER_03: All right.
10:38
SPEAKER_03: So then if we say then if it's not in 480, then we're gonna move into our derivative guidance.
10:48
SPEAKER_03: And that is also the same place we would be looking if we're evaluating these embedded derivatives.
10:53
SPEAKER_02: That's right.
10:54
SPEAKER_02: Um I I think you know, kind of directly you start to think about um in the derivative guidance um ASC 81540 um and assess primarily scope exceptions for these equity link instruments.
11:08
SPEAKER_02: Um people are looking for do I need to market to market or will it qualify for um for an owned stock uh scope?
11:16
SPEAKER_02: So hoping for a scope exception, basically usually hoping for a scope exception.
11:20
SPEAKER_02: Um all of this is a little different, obviously, than when we're dealing with an embedded contract.
11:25
SPEAKER_02: Um when we're dealing with an embedded component, you have to first assess whether they need to be bifurcated from whatever they are embedded in.
11:34
SPEAKER_02: And I think we in this, when we talk about bifurcation, we this the language comes out of our mouth and we assume everyone understands bifurcation, but I know that's not always true.
11:46
SPEAKER_02: And think of bifurcation as just when you're looking at a contract and determining whether there's some piece of that contract that should be separated out and accounted for separately as a derivative instrument, usually uh mark-to-market.
11:58
SPEAKER_02: Um, and when you're looking at the bifurcation criteria, you're asking yourself whether that embedded component is clearly and closely related to the host contract, um, or if the entire hybrid instrument is um measured at fair value through income, um, or whether the embedded component must meet the, or whether the embedded component meets the definition of a derivative.
12:21
SPEAKER_02: So, you know, taking that um a step back, if the hybrid instrument is all measured at fair value, I don't have to worry about this.
12:29
SPEAKER_02: Um I can I can skip over the whole analysis.
12:32
SPEAKER_02: If that embedded component meets the definition of a derivative and is not considered clearly and closely related to the host contract, um, then it has to be bifurcated and accounted for separately.
12:43
SPEAKER_02: Um I think what we're gonna talk a lot about today is this own stock uh scope exception, uh, which is this guidance I mentioned in 81540.
12:53
SPEAKER_02: We often talk about it as as um indexation, because that the the probably the hardest part of this is determining whether that feature is indexed to your own stock.
13:04
SPEAKER_02: Um but once we go through that whole evaluation um and we we find these embedded components, then we're gonna be back to the same place where we left with freestanding instruments.
13:14
SPEAKER_03: All right, so I feel like we just ran through an entire podcast worth of content in what you just ran through.
13:21
SPEAKER_03: And we do have other resources and we can talk about that at the end for some of those particular points, because I do think then what we want to focus on today is specifically thinking, okay, now I'm analyzing this under this 81540.
13:38
SPEAKER_03: What should I be thinking about?
13:39
SPEAKER_03: And so, John, let me turn to you.
13:42
SPEAKER_00: Sure.
13:42
SPEAKER_00: Thanks, Heather.
13:43
SPEAKER_00: Um just as Brett just said, 81540 is re we we affectionately refer to that as the own stock scope exception.
13:50
SPEAKER_00: And that is the nirvana of equity-length instruments.
13:54
SPEAKER_00: Everybody's looking for the own stock scope exception.
13:56
SPEAKER_00: I think a key point.
13:58
SPEAKER_00: The own stock scope exception applies to both freestanding instruments and embedded instruments.
14:03
SPEAKER_00: For free-standing instruments, the um instrument uh again, this is instruments that are indexed to or potentially settled in the entity's own shares.
14:13
SPEAKER_00: For a freestanding instrument, even if that instrument, and a lot of people don't realize this, even if that instrument does not meet the definition of a derivative, if it's potentially settled into the entity in the entity's own shares, they still need to run it through 81540.
14:28
SPEAKER_03: Oh, I feel like we need to like underline and bold that because I don't think people are focused on that.
14:33
SPEAKER_00: People aren't, you know, a lot of times people aren't focused on that.
14:36
SPEAKER_00: We hear that a lot in our conversations.
14:38
SPEAKER_00: But once we determine that we do need to, you know, we we're looking to get the nirvana of the own stock scope exception.
14:45
SPEAKER_00: Uh really what it is is it it's a combination of two different it's got two different legs to the stool.
14:52
SPEAKER_00: The first is is the instrument indexed to the entity's own stock?
14:56
SPEAKER_00: Now that seems like it should be a really easy answer to question to answer.
15:01
SPEAKER_00: But as we're gonna find out, as we can do that.
15:04
SPEAKER_00: It's not.
15:05
SPEAKER_00: The second is should that contract be classified in equity?
15:09
SPEAKER_00: And there's some specific criteria that you need to think about when determining whether that contract needs to be um uh um should you know, earn the right to be classified in equity.
15:19
SPEAKER_00: And you need to pass both parts, both legs of the stool, in order to get the own stock scope exception.
15:27
SPEAKER_03: I am a little concerned about a stool with two legs, but maybe they're wide.
15:32
SPEAKER_02: So I actually think that's a great analogy because this stool definitely only has two legs.
15:38
SPEAKER_03: All right, so that's good.
15:39
SPEAKER_03: So we can keep going.
15:40
SPEAKER_03: I also am slightly offended that you're saying this is the nirvana of scope exceptions, because I think that could be normal purchase, normal sales, but that's another podcast.
15:48
SPEAKER_03: So we can keep going with this tool with two legs and nirvana.
15:52
SPEAKER_03: It's okay.
15:53
SPEAKER_00: In in our world.
15:54
SPEAKER_03: In your world.
15:54
SPEAKER_00: In our world, it's the nirvana.
15:56
SPEAKER_00: Okay.
15:56
SPEAKER_00: Um so again, as as as Brett said, if uh if for an embedded feature it has to meet the definition of a derivative.
16:04
SPEAKER_00: If it does meet the definition of a derivative and it's not clearly and closely related, we need it to we need to run it through both legs of the stool of uh of the A1540 analysis.
16:16
SPEAKER_00: Um to make things even more complicated, not only is there two criteria, one of the criteria has two steps.
16:24
SPEAKER_00: The first criteria is uh exercise contingencies.
16:28
SPEAKER_00: And think about an exercise contingency in an instrument as something that either shortens or lengthens uh the uh term of the instrument.
16:37
SPEAKER_00: So for example, a warrant could get automatically exercised in the event of a change of control, right?
16:43
SPEAKER_00: So that's going to exercise the instrument before it's full term.
16:48
SPEAKER_00: The uh second step in determining um whether um the instrument is indexed to own stock is um settlement adjustments.
16:59
SPEAKER_00: So you need to look at every um feature in an instrument that can adjust the settlement value of the instrument and evaluate that settlement adjustment in terms of whether it meets certain criteria in the standard ASCA 1540.
17:16
SPEAKER_03: All right.
17:17
SPEAKER_03: So basically we have two steps that are really three steps, so maybe that will make our stool slightly more stable here.
17:24
SPEAKER_03: But Fred, if I go to you then, I think a good place to start would be some of the things people should be looking out for when they're thinking about these exercise contingencies.
17:35
SPEAKER_02: Right.
17:36
SPEAKER_02: And and I think in general, I this this first step is considered to be the easier step to get through, but but there's still some nuances to think about.
17:44
SPEAKER_02: And the guidance is focused on um the view that an exercise contingency, like we're talking about, you know, should be okay, shouldn't prevent an instrument from being considered indexed to its own stock unless it's based on an observable market, other than the market for the issuer's stock, or on an observable index other than some index based solely on the issuer's operations.
18:10
SPEAKER_02: So common provisions that we see in equity link instruments that we consider step one events are a contingent exercise upon an IPO.
18:19
SPEAKER_02: So think of that.
18:20
SPEAKER_02: That's not an issue uh because the IPO is not an observable market or index.
18:26
SPEAKER_02: Right?
18:26
SPEAKER_02: You could have a contingent exercise upon reaching a certain stock price.
18:32
SPEAKER_02: This is not an issue because under the guidance, um it's based on an observable market, but the market is the issuer's stock price, which we said was okay.
18:44
SPEAKER_02: Uh you could have an um a contingent exercise upon reaching a revenue target.
18:49
SPEAKER_02: Again, generally not an issue under the guidance because it's based on observable index.
18:55
SPEAKER_02: The index is the issuer's operations, it's their own revenue target.
19:00
SPEAKER_02: Think of something that is a problem.
19:02
SPEAKER_02: If the exercise contingency is based on the S P 500 reaching a certain level, there you have an issue because you have an observable market other than the issuer's stock price.
19:14
SPEAKER_02: Um the other thing that we think about, John mentioned um under the step one analysis, is just a provision that lengthens or shortens this the settlement period.
19:22
SPEAKER_02: Again, as long as whatever is lengthening or shortened that period is not based on this observable market uh or index other than you know the issuer's stock or operations, generally not an issue under step one.
19:35
SPEAKER_02: And I think in general, like I I went through some of these features.
19:39
SPEAKER_02: It's general, we it's relatively uncommon that we see instruments fail, you know, because of step one.
19:45
SPEAKER_03: So you are you've done too many podcasts because you anticipated my next question was whether this was an issue.
19:51
SPEAKER_03: So, all right, so then we say we normally make it through step one.
19:55
SPEAKER_03: So then, John, going back to you, what are some of the things people should be looking out for in step two?
20:00
SPEAKER_00: Um sure, Heather.
20:02
SPEAKER_00: This is the area where, you know, as you said, we've seen most of the issues, and as a result, we spend a lot of time on this.
20:08
SPEAKER_00: It's a really, to be honest, it's a tedious process going through every feature, thinking about whether or not that feature can adjust the uh the settlement value of the instrument, and then determining whether it meets certain criteria that we'll talk about.
20:23
SPEAKER_00: But let's just talk about the basic concept um in the index to own stock model.
20:30
SPEAKER_00: It basically looks to the it's called the fixed-for-fixed rule, right?
20:35
SPEAKER_00: And basically what it says is that the settlement amount of an instrument should equal the difference between the fair value of a fixed number of shares and a fixed monetary amount.
20:44
SPEAKER_00: So for example, think about a warrant um that has a strike price of$15 and the stock is at trading at$20.
20:52
SPEAKER_00: The ultimate settlement value of that warrant has you know has an intrinsic value of$5.
20:58
SPEAKER_00: And that would be the difference between a fair value of the stock, a fixed number of shares, fair value of fixed number of shares of the stock, and a fixed monetary amount, which was the exercise price of$15.
21:09
SPEAKER_00: That's clean.
21:10
SPEAKER_00: Okay.
21:11
SPEAKER_00: However, the problem is virtually no equity-linked instruments are fixed for fixed.
21:18
SPEAKER_00: So effectively all of these instruments have adjustments for various things that can happen during the life of the instrument.
21:28
SPEAKER_00: So the standard allows us to examine those adjustments and determine whether the items that the or the provisions that are leading to those adjustments are variables that you would consider in the fair value of a forward or option on equity shares.
21:44
SPEAKER_00: And those items are stock price, number one.
21:48
SPEAKER_00: And then it refers the standard refers to what they what they call additional variables.
21:52
SPEAKER_00: And that distinction is important for a reason that we'll get to.
21:56
SPEAKER_00: Um those additional variables are things like.
22:00
SPEAKER_00: Like the term of the instrument, expected dividends on the instrument, stock borrow cost, volatility, interest rates, credit.
22:10
SPEAKER_00: And then there's one that's an interesting one, the ability to maintain a standard hedge position.
22:15
SPEAKER_03: John, before you go on, sorry, did you say stock borrow cost?
22:19
SPEAKER_03: Stock borrow cost.
22:20
SPEAKER_03: And can you just explain?
22:21
SPEAKER_03: Maybe all our listeners know, but I'm not sure I know what that is.
22:25
SPEAKER_00: So um an investment let's uh for example, if we enter into a trade with an investment bank, the investment bank is likely going to hedge their position.
22:34
SPEAKER_00: And when they hedge their position, many times they have to pay um a stock borrow cost.
22:39
SPEAKER_00: They'll go to a pension fund or something like that.
22:41
SPEAKER_03: Oh, so it is exactly what it sounds like.
22:44
SPEAKER_03: Okay.
22:44
SPEAKER_00: So if something were to impact the price of that stock borrow cost, what would lead to an adjustment on the settlement value of the instrument, then that would be an acceptable adjustment under um the standard.
22:56
SPEAKER_00: All right, keep going.
22:57
SPEAKER_00: Thank you.
22:58
SPEAKER_00: So the important thing is you you need to go through each of the things that the provisions that could adjust, think about what that provision is, how it's adjusting um the instrument, and whether it's one of these acceptable variables that you would say doesn't preclude the instrument from being considered indexed to its own stock.
23:17
SPEAKER_00: A couple of things to think about.
23:19
SPEAKER_00: There's no probability assessment here, right?
23:22
SPEAKER_00: It does not matter if the probability of the event leading to the adjustment occurring is 0.000001% chance it it impacts um the decision.
23:34
SPEAKER_00: The second thing, and people forget about this, um, in terms of the indexation aspect of the um owns uh you know um the own stock scope exception, it doesn't matter whether the thing that leads to the adjustment is within the control of the company.
23:49
SPEAKER_00: If it's um something that is adjusted valued that's not um one of the either stock price or one of the additional variables, it's it's a problem under the standard.
24:00
SPEAKER_00: So the adjustments, these adjustments, even if they relate to stock price or the additional variables, right, it's not it's not a free ride.
24:09
SPEAKER_00: Okay, right?
24:10
SPEAKER_00: It it it it has to be a commercially reasonable adjustment.
24:13
SPEAKER_00: And with respect to the additional variables, that's things other than stock price, um, there can't be leverage involved.
24:20
SPEAKER_00: So for example, if there were an adjustment and said, okay, volatility was X, and we're gonna adjust this instrument because of this thing that happened um two times the volatility, that that would be a problem under the standard.
24:35
SPEAKER_03: But you could have leverage with respect to the changes in the stock price?
24:38
SPEAKER_00: It it doesn't specifically say that, but it definitely implies it.
24:41
SPEAKER_03: Okay.
24:42
SPEAKER_03: All right.
24:42
SPEAKER_03: So that's the key point, though, between stock price and these other variables.
24:46
SPEAKER_03: Explicitly they say you cannot have leverage.
24:49
SPEAKER_03: Okay.
24:49
SPEAKER_00: That's important.
24:50
SPEAKER_00: So obviously that's a lot.
24:53
SPEAKER_00: We just talked about.
24:54
SPEAKER_00: Yes, fairly technical.
24:56
SPEAKER_00: So maybe if we talk about a couple of examples.
24:58
SPEAKER_00: So maybe we start with things that I call them good guys under the own stock scope exception, right?
25:05
SPEAKER_00: So let's think about a forward sale contract based on the average price of the stock over some period of time.
25:12
SPEAKER_00: Let's say it's six months.
25:14
SPEAKER_00: Usually the contracts that we see, usually that average price would be based on the average of the daily volume weighted average price of the stock over that period.
25:24
SPEAKER_00: It's often what we see.
25:25
SPEAKER_00: And certainly the settlement value adjusts, right, based on what happens to what?
25:31
SPEAKER_00: To stock price.
25:33
SPEAKER_00: So that would be, I guess I would call that a good guy, right?
25:36
SPEAKER_00: That's an that's an acceptable adjustment to the instrument.
25:39
SPEAKER_03: And just again, to bring our listeners back, that means you could qualify for this own stock scope exception.
25:47
SPEAKER_00: That feature would not preclude you.
25:49
SPEAKER_00: Yes.
25:50
SPEAKER_00: Okay.
25:50
SPEAKER_00: Um so the second thing to think about, uh, let's let's just say that we purchased a warrant on our own, uh, uh, an option on our own stock.
25:58
SPEAKER_00: And um that was, you know, the strike price was$10, but the obligation of the counterparty was capped at$15, just the settlement value.
26:08
SPEAKER_00: But what is it that's adjusting settlement value?
26:11
SPEAKER_00: Stock price.
26:12
SPEAKER_00: Stock price.
26:12
SPEAKER_00: So that again would be something that would be a good guy, acceptable, and not preclude um being considered um indexed to your own stock.
26:21
SPEAKER_00: Um, another common item that we see is referred to, you know, a lot of a lot usually they're referred to as standard anti-dilution adjustments.
26:30
SPEAKER_00: Sometimes they're not standard, even if they're in that provision.
26:33
SPEAKER_03: Okay.
26:34
SPEAKER_00: But these are things like stock splits, stock dividends.
26:37
SPEAKER_00: So if I have convertible debt, for example, with an exercise price and the company does a stock split.
26:42
SPEAKER_00: Typically that convertible debt instrument would have a provision that says we're going to adjust the exercise price or the number of shares.
26:50
SPEAKER_03: Yeah, it makes sense.
26:51
SPEAKER_00: You know, convertible into to um to compensate for that split.
26:55
SPEAKER_00: In other words, it's just making the holder of the instrument whole.
26:58
SPEAKER_00: Those are acceptable adjustments as well.
27:01
SPEAKER_00: And finally, there's one that I know you love this one, Heather, right?
27:05
SPEAKER_00: It used to be a bad guy, you know, until oh, when was that?
27:09
SPEAKER_00: 2015, 16, something like that.
27:13
SPEAKER_03: 17 maybe.
27:14
SPEAKER_00: It's called the downround feature.
27:15
SPEAKER_03: Yeah, so it wouldn't be a podcast with you if we didn't talk about this.
27:19
SPEAKER_00: So a down round feature is a provision built in.
27:23
SPEAKER_00: Let's let's just say we have a convertible preferred stock instrument, and the investor, you know, buys the convertible preferred stock instrument with a thousand dollar stated value, it's got a conversion price of$15.
27:36
SPEAKER_00: And then the company goes out later on, and for whatever reason, the the fair value of their stock falls, let's say from$15 to$10.
27:46
SPEAKER_00: A down round provision would allow the strike price on that investor's convertible preferred stock to adjust from$15 to, did I say$15 to$15 to$10, sorry.
27:57
SPEAKER_00: Um, and that's a protection that you normally wouldn't see in an equity holder, right?
28:04
SPEAKER_00: Right.
28:04
SPEAKER_00: So I think prior to 2015 or 2016, you know, we considered that a bad guy.
28:10
SPEAKER_00: And we said that was something that would cause a problem and could potentially cause um separation of a conversion feature in it uh embedded in an instrument or liability classification.
28:22
SPEAKER_00: The um FASB did away with that and said, you know what, we're just going to create an exception, and down rounds are now good guys.
28:29
SPEAKER_00: They're okay.
28:29
SPEAKER_00: They don't preclude classification, um, uh equity classification in the instrument.
28:34
SPEAKER_00: I guess the only thing with respect to down rounds, I would say, is we see a lot of things that look and smell like down rounds, but when you dig deep into the definition of what a down round is, they don't meet that definition.
28:49
SPEAKER_00: So that's just one thing I would caution people to be careful about.
28:52
SPEAKER_00: Sometimes you you know you you need to focus on the details in this area.
28:56
SPEAKER_03: So one thing I have learned from you, uh John, on down rounds, that I can say that I was right about the date that it was issued, it was in 2017.
29:07
SPEAKER_03: Not 2015 or 2016, because I think it's been seven years that I've been trying to understand what these down rounds were.
29:14
SPEAKER_03: But I just did some quick research and it wasn't issued in 2017.
29:18
SPEAKER_02: So not nine years, because by nine you'll have it down.
29:21
SPEAKER_03: Exactly, exactly.
29:23
SPEAKER_00: All I know is it's out of the three-year period we typically worry about.
29:26
SPEAKER_03: Yes.
29:27
SPEAKER_03: Okay, that's that's fair enough.
29:28
SPEAKER_03: But I am very proud of myself that I did learn one thing from all of the discussions we've had.
29:33
SPEAKER_03: So um, and also I'm very interested here in the split, John, that you've done because you gave yourself a discussion of all these good guys and things that do not impact or preclude this uh application of the scope exception.
29:47
SPEAKER_03: But now, Brett, we're gonna go to you for some examples of things that would preclude applications.
29:53
SPEAKER_03: So, what are some of those things?
29:54
SPEAKER_02: I get the bad guys.
29:55
SPEAKER_02: Exactly.
29:56
SPEAKER_02: I'll give you uh maybe a couple examples.
29:58
SPEAKER_02: Um and one was a provision that we saw in a lot of the SPAC warrants that caused those instruments to fail indexation.
30:06
SPEAKER_02: And it was a provision that actually changed that settlement calculation on how it worked, depending on who held the warrant.
30:14
SPEAKER_02: So as the warrant got transferred, that settlement calculation would change.
30:18
SPEAKER_02: And this was a situation where it didn't have a huge impact on the settlement calculation.
30:23
SPEAKER_02: Um, you know, some of them would change um the period, the look back period for determining the stock price from a five-day look back period to a 10-day look back period.
30:34
SPEAKER_02: Um but the only thing that drove that change was um was dependent on who the the who the warrant holder was.
30:43
SPEAKER_02: Um and so the holder of the warrant is definitely not an input into a standard fix-for-fix forward contract.
30:50
SPEAKER_02: And so this was considered not to be uh an allowable settlement adjustment.
30:54
SPEAKER_02: Another common provision uh that we see index that can cause indexation issues are provisions that change the settlement amount based on what we call a fundamental change occurring.
31:05
SPEAKER_02: Um sometimes warrant agreements, there's a provision that upon a fundamental change, think of like a change in control of the company, the warrant holder is able to exercise the warrant early.
31:16
SPEAKER_02: And in those agreements, the warrant agreement will normally specify how that settlement is going to be calculated upon the early exercise due to that.
31:26
SPEAKER_02: Um oftentimes they'll it'll be based on a stock volatility assumption that could be the greater of the volatility at the inception of the contract or the current volatility at the time of the settlement.
31:40
SPEAKER_02: Um I think these provisions need to be examined very closely to figure out how the settlement calculation is adjusted because in some cases it introduces leverage, as John talked about, into that settlement calculation and would not be considered just a fair value settlement amount.
31:58
SPEAKER_02: I think that this example about um about this warrant provision and the early exercise brings back to that step one discussion we had.
32:07
SPEAKER_02: It's a it's an example where you have to analyze this provision under both steps.
32:11
SPEAKER_02: As I talked about earlier, um that fundamental event allows for early exercise.
32:16
SPEAKER_02: It's a step one event because it changes the timing of the settlement.
32:20
SPEAKER_02: And we said that would pass step one, but you don't get to put that provision aside and say, I already did it under step one.
32:27
SPEAKER_02: You may have to look at it under step two as well, because in addition to the timing, it's actually changing the settlement amount itself.
32:35
SPEAKER_03: All right, definitely a good reminder there.
32:37
SPEAKER_03: So then if we kind of put this all together, I know one of the instruments where these questions often come up would be convertible debt.
32:45
SPEAKER_03: And so, John, going back to you, if you were dealing with convertible debt, what are some of the specific things that you would need to look at for this indexation guidance?
32:56
SPEAKER_00: Yeah, just as an aside, we've had periods of time where convertible debt issuance was through the through the roof.
33:01
SPEAKER_00: I don't even remember back in the second and third quarter of 2020, we looked at so many convertible debt deals that year.
33:08
SPEAKER_00: It was incredible.
33:09
SPEAKER_00: I've actually been expecting that to happen again because those convertible debt deals are maturing.
33:15
SPEAKER_03: Oh, and so then we're gonna see if they replace them with more.
33:24
SPEAKER_00: So it'll be interesting to see.
33:25
SPEAKER_03: Just to All right, so people need to bookmark this question.
33:28
SPEAKER_00: Sidebar, just see if I'm see, I'm see if I'm right about it.
33:30
SPEAKER_00: All right, so Chris of all.
33:31
SPEAKER_00: Okay.
33:32
SPEAKER_00: Similar to the way we talked about it before, when you're looking at a convertible debt instrument, you you need to look at every single exercise contingency, every single settlement adjustment in in the instrument, and evaluate them against stock price and the additional variables that we we talked about.
33:52
SPEAKER_00: So some common things that we see in convertible debt, for example, the probably the most common is um we call it a make-hole table, right?
34:01
SPEAKER_00: So typically investor invests in a convertible debt instrument.
34:04
SPEAKER_00: If he or she is a purely an economic animal, they're gonna wait till right before the conversion option expires before they exercise, right?
34:14
SPEAKER_00: Well, in the event of a change of control, sometimes they don't have that option, right?
34:18
SPEAKER_00: It it converts early.
34:21
SPEAKER_00: So um what happens if that happens, that you know, the convertible debt instrument, if they just simply converted in the event of the uh change of control, they would lose the time value associated with the additional period of time that uh the convertible debt would have been outstanding before maturity.
34:38
SPEAKER_00: And so the make hold table and these convertible debt instruments, in theory, are there to compensate the investor for that lost time value.
34:47
SPEAKER_00: And so there's a specific example in the standard that basically says these um make-hole tables do not preclude a convertible uh conversion option, a convertible dent instrument from being precluded from being indexed to the entity's own stock.
35:04
SPEAKER_00: But you just can't stop there.
35:06
SPEAKER_00: You need to kind of look at the you know how the um how the make-hole table is made up and ask some questions about whether it's really intended to just simply compensate the investor for lost time value.
35:19
SPEAKER_00: But typically what we see, they they typically don't cause a problem in the instruments because they're typically, you know, the the additional shares in conversion that are intended to compensate for time value are basically just based on stock price and time.
35:35
SPEAKER_00: And certain fixed variables, like the volatility of the instrument, is typically the volatility instrument at inception of the convertible debt instrument.
35:44
SPEAKER_00: And I think the the view is that that's acceptable in that table.
35:49
SPEAKER_00: Um and so typically those uh make-hole tables do not preclude, but you you you you just can't assume it.
35:55
SPEAKER_00: You've got to do that.
35:56
SPEAKER_03: Yes, you have to make sure you really understand.
35:58
SPEAKER_00: I have seen certain things in convertible debt instrument that can cause indexation problems.
36:04
SPEAKER_00: So one that vividly comes to mind, for example, is so a convertible debt instrument that got issued for an industrial company, and the investor in that convertible debt instrument wanted protection against certain environment environmental exposures of the company.
36:19
SPEAKER_00: And so they said one of the provisions in the agreement said, well, in the event this environmental issue exceed, you know, exceeds a loss of$20 million, we'll adjust the conversion price in a certain way.
36:33
SPEAKER_00: Clearly, you know, clearly, that was an easy call.
36:38
SPEAKER_04: Yes.
36:43
SPEAKER_00: Clearly, you know, the excess over$20 million on this environmental reliability is not a primary input into the fair value of an option or for it on equity shares.
36:53
SPEAKER_00: So you need to look for all of those things in an instrument.
36:57
SPEAKER_00: Um and sometimes, you know, I remember having the conversation with that engagement saying we probably could have structured a better way to do that.
37:05
SPEAKER_03: Yeah, I was just thinking, I guess this is the case you didn't see it until after the fact.
37:10
SPEAKER_00: Right, right.
37:10
SPEAKER_00: Yes, right.
37:11
SPEAKER_03: Wow.
37:12
SPEAKER_00: Um so another thing that we see um with convertible debt, and we've had lots of discussions internally and you know, um with the profession um about these, is they're called transactions typically entered into in conjunction with a convertible debt instrument.
37:30
SPEAKER_00: Um, cost-spread overlay, sometimes referred to bond hedges.
37:34
SPEAKER_00: Call-spread overlay typically refers to a purchase call and a written warrant.
37:39
SPEAKER_00: Um, and uh bond hedge typically refers to a capped call, which is basically the same thing combined into one single derivative instrument.
37:46
SPEAKER_00: But the intention of those instruments is to offset the dilution of um of the convertible debt instruments.
37:54
SPEAKER_00: So typically, let's say we issue a$1,000 bond um convertible at with an exercise price of$20.
38:02
SPEAKER_00: The company will go out and um enter into a call spread overlay and they'll purchase a call at$20 for the same notional as the convertible debt instrument, and write a call, call it$30.
38:15
SPEAKER_00: So what they're doing is synthetically raising the conversion price on the um uh on the bond.
38:21
SPEAKER_00: And for tax purposes, they can get integrated.
38:24
SPEAKER_00: The the separate transaction with an invest about investment bank can get integrated with that convertible debt instrument.
38:31
SPEAKER_00: So what happens is many of these call spread overlays, capped call transactions, usually it's the capped call transactions, when they when you have a change of control of the company, many times for in you know for the when the underlying convertible debt either disappears or gets converted, um the bond hedge also gets exercised.
38:55
SPEAKER_00: And so there are provisions in there that determine what the fair value of that uh capped call would be for the company.
39:03
SPEAKER_00: Sometimes we see that there may be separate agreements, um a side letter, for example, that gets produced that talks about um changing the settlement value of that uh derivative instrument, the capped call transaction.
39:19
SPEAKER_00: Many times the changes in settlement value revolve around the volatility assumption that they're using in that fair value calculation.
39:28
SPEAKER_00: So those things need to be looked at very closely because we have seen situations where um those adjustments in those side letters create adjustments that we wouldn't consider acceptable from an owned index to own stock perspective.
39:44
SPEAKER_00: So um my advice is just be very, very um careful and and um in evaluating those provisions.
39:52
SPEAKER_03: All right.
39:53
SPEAKER_03: So definitely a lot to think about there.
39:55
SPEAKER_03: And if I reorient us and go all the way back, I think when we started this discussion, we said there's sort of two parts to this.
40:03
SPEAKER_03: And one is to see if it's indexed to its own stock, and then you also have to look at classification.
40:08
SPEAKER_03: So we spent a lot of time talking about these two two steps within indexed to its own stock, but maybe now we can turn to classification.
40:15
SPEAKER_03: So, Brett, what would you be looking for there?
40:18
SPEAKER_02: Yeah, thanks for re-orienting us out of the rabbit hole of um.
40:23
SPEAKER_03: Yeah, and I think we could have kept going, right?
40:25
SPEAKER_00: So could have been more.
40:27
SPEAKER_02: Um But like you said, I think um, you know, the this other aspect I'm gonna talk about, it's important um both when you're dealing with an embedded instrument to be able to qualify for the derivative scope exception.
40:40
SPEAKER_02: It's also important for a freestanding instrument um because in order to get um equity, it needs to uh qualify for equity classification.
40:49
SPEAKER_02: Um and this is gonna be all about understanding the settlement provisions in the contract, um, uh mainly about whether the instrument's gonna settle in cash or in shares.
41:00
SPEAKER_02: And I think the quick takeaway from this is that cash settlement is a problem uh and share settlement is okay.
41:08
SPEAKER_02: So if you take away, if you want to like stop listening for five minutes, like that's your that's your your key takeaway here.
41:14
SPEAKER_02: I should have given that at the end to draw into this.
41:18
SPEAKER_02: But um maybe we go through an explanation of what I mean by by cash or a share settlement.
41:25
SPEAKER_02: So let's think about a situation where a company is issued 10 warrants that have a$10 strike price and the underlying share is worth$20.
41:36
SPEAKER_02: So the first settlement um method that we see is gross physical delivery.
41:41
SPEAKER_02: That means that the shares themselves are going to be delivered in exchange for the full amount of cash in order to pay the stock price.
41:48
SPEAKER_02: So in my example, the holder will pay$100 cash, that's you know, 10 warrants times the$10 strike price to exercise those 10 warrants, and they'll receive 10 shares.
42:00
SPEAKER_02: And those 10 shares each have a value of$20, they get their fair value of$200.
42:05
SPEAKER_02: That's great.
42:05
SPEAKER_02: The second method we see is a net share settlement, where um shares are delivered but only based on the current value of that equity link instrument, in this case the warrant.
42:16
SPEAKER_02: So we said there's a$10 strike price, the underlying share is worth$20, the value of that warrant is the net$10.
42:26
SPEAKER_02: In a net share settlement, uh each um the warrant in a net share settlement, the issuer is going to deliver five shares because they're worth$20 each to deliver that$100 of total value.
42:39
SPEAKER_02: So it's it's the net amount is the$100 and it's being compensated in in share delivery.
42:46
SPEAKER_02: No cash is being delivered at all.
42:48
SPEAKER_02: The third settlement option uh that we see is net cash settlement, which just means the issuer is going to pay the intrinsic value of the of that warrant to the holder in cash.
42:58
SPEAKER_02: So in my example, they would just deliver the$100 of cash to the holder.
43:03
SPEAKER_02: And as we said, that is the that that's the problematic scenario.
43:07
SPEAKER_02: Gross physical settlement, net share settlement are both acceptable under the guidance to get equity classification or to meet the scope exception because only shares are being delivered.
43:17
SPEAKER_02: The cash settlement would result in that instrument having to be classified as an asset or liability and and would be marked to market.
43:25
SPEAKER_02: We also see scenarios where the contract actually provides the issuer the choice of how to settle.
43:30
SPEAKER_02: And as long as that uh provision is is within the company's control, um, you can still achieve equity classification.
43:38
SPEAKER_02: That would be okay.
43:40
SPEAKER_02: In general, you have to you have to consider all possible settlement scenarios here, even ones that are contingent or unlikely to occur.
43:47
SPEAKER_02: So we see this frequently where there is a problematic settlement feature.
43:52
SPEAKER_02: Cash settlement is outside of the issuer's control in any of those scenarios.
43:57
SPEAKER_02: It's an issue under the guidance, regardless of regardless of the case.
44:00
SPEAKER_02: Of probability.
44:01
SPEAKER_02: And I think in general, this equity classification seems a little more straightforward than that complicated indexation guidance that we went through.
44:09
SPEAKER_02: But I think that this consideration of all possible settlement scenarios is that's what makes this complicated.
44:15
SPEAKER_02: John was talking earlier about having to dig through the contracts to figure this out.
44:19
SPEAKER_02: And this is where you've got to do some digging.
44:22
SPEAKER_02: A common area where we see issues is what happens when there's a change in control.
44:27
SPEAKER_02: It's fairly common that under a change in control, the these equity link instrument holders can exercise their instruments for either for cash or other assets.
44:37
SPEAKER_02: And normally this would be an issue under the guidance, as I said, you know, cash settlement is a problem.
44:43
SPEAKER_02: But there's a limited exception, actually, that says solely in a change of control that if the equity link instrument holder receives the same form of consideration as all other equity holders that participate in that change in control transaction, then equity classification is not prohibited.
45:02
SPEAKER_02: Think of it as a as an exception.
45:04
SPEAKER_02: As long as you're getting the same comp the same consideration everyone else is getting, it's okay.
45:10
SPEAKER_02: But this is only under a change in control.
45:13
SPEAKER_02: So this is another issue that we saw in the SPAC warrants that the SEC objected to because there is a there is actually could be a tender offer that triggered that provision in the warrants that didn't result in a change in control.
45:27
SPEAKER_02: And so this this provision, this exception is viewed narrowly.
45:31
SPEAKER_02: There actually has to be a change in control in order for that exception to apply.
45:36
SPEAKER_02: The other example that I'll give you of a problematic situation we've seen pop up lately that that relates to this equity classification is what we call buy-in provisions in agreements.
45:48
SPEAKER_02: So in this in this situation, if the holder exercises the equilink instrument and for any reason the issuer fails to deliver the shares within a small window, typically like say three business days, then the holder has the right to go into the market to purchase the shares that they otherwise would have received upon exercise.
46:08
SPEAKER_02: Seems like a reasonable provision because you know I was supposed to receive shares, I didn't, so I gotta go get them.
46:15
SPEAKER_02: And under this provision, the issuer then must reimburse the holder for the amount of cash or the amount that they paid for the shares in cash, but that's essentially cash settling the instrument.
46:26
SPEAKER_02: So even though we said like, well, that it's just it's unlikely that they're gonna be uh unable to deliver the shares, it's a remote contingency.
46:35
SPEAKER_02: Um in that situation they're not 100% in control of the ability to deliver shares, but in general, that that uh potential cash settlement provision would cause an issue meeting that equity classification.
46:49
SPEAKER_02: It's another example where this isn't gonna be front and center to the economics of the transaction, it's gonna be buried in the detail.
46:57
SPEAKER_00: Yeah.
46:58
SPEAKER_00: There's that's the you know, the the hard part about this part of the analysis is from a legal perspective, you know, a lawyer put that in there to protect the investor, right?
47:09
SPEAKER_00: The probability is pretty low.
47:11
SPEAKER_00: But we see a lot of that in the you know analysis to whether something should go in equity that is you know protective in nature but can cause a problem.
47:21
SPEAKER_03: So definitely a lot to think about.
47:22
SPEAKER_03: I think, Brad, you've gone through a lot of scenarios.
47:25
SPEAKER_03: I I think there are some other criteria that also do need to be met, maybe less judgmental, though.
47:31
SPEAKER_02: Yeah, I think I we see them um they're probably less interpretive, but they're still in in the guidance.
47:37
SPEAKER_02: Um the paragraph is 815-4025-10, if someone's wants to pull up.
47:43
SPEAKER_02: Um But like you said, they're they're less judgmental, but they're still important.
47:47
SPEAKER_02: Things like ensuring that the entity has enough um authorized and unissued shares to settle the contract.
47:54
SPEAKER_02: Um the contract generally has to have an explicit share limit.
47:58
SPEAKER_02: Um, there can't be required cash payments if the entity file fails to file with the SEC or um looking for cash-settled top-off provisions, those would also be a problem.
48:09
SPEAKER_03: All right.
48:10
SPEAKER_03: So definitely a lot of different pieces for companies to think about.
48:14
SPEAKER_03: And maybe to bring this all back together, John, I'll go back to you.
48:18
SPEAKER_03: So let's take our two potential paths.
48:21
SPEAKER_03: One is I made it all the way through this.
48:24
SPEAKER_03: Where do I end up?
48:25
SPEAKER_03: And what if I got kicked out at some one of the places along the way?
48:30
SPEAKER_00: Well, if you made it through, um, then the contract that you're speaking about, if it's a freestanding contract, can get classified in equity.
48:37
SPEAKER_00: If it's an embedded derivative, it doesn't need to be separated from the host contract.
48:42
SPEAKER_03: So no wonder it's nirvana.
48:44
SPEAKER_00: It's nirvana.
48:45
SPEAKER_03: Yes, there you go.
48:47
SPEAKER_00: Well, you know, if you do, if you if you don't make it through, and it's a freestanding instrument, you're gonna be classified as an asset and liability.
48:54
SPEAKER_00: And because this is a contract that's indexed to the company's stock, changes in the company stock price are gonna get run through PL.
49:02
SPEAKER_00: And I haven't met the CFO yet that thinks that's a good idea.
49:07
SPEAKER_04: Definitely not.
49:10
SPEAKER_00: So that's you know, that's you know the problem with the with with um you know with this type of instrument.
49:17
SPEAKER_00: And the fact that some very insignificant economically features can trigger that, you know, can be traumatic.
49:26
SPEAKER_03: Yeah.
49:26
SPEAKER_03: And so you said that's for freestanding, but it would be the same.
49:29
SPEAKER_03: So then your embedded would have to be bifurcated.
49:31
SPEAKER_00: That's right.
49:32
SPEAKER_00: And in an embedded instrument, you have one other out with an embedded instrument, um, and that is if it's clearly and closely related to the host.
49:40
SPEAKER_00: So you can have an embedded derivative, meets the definition of a derivative, has an indexation problem, but it's clearly and closely related, and you can still difficult.
49:52
SPEAKER_00: Make it through by the skinny OT.
49:53
SPEAKER_03: Yes, that's a potentially difficult route as well.
49:56
SPEAKER_03: And so just again, from a practical point of view, when people do as I'm gonna use the word get kicked out and they don't wind up in Nirvana, then do you see that contracts are getting renegotiated and changed, or are companies just dealing with this accounting outcome?
50:11
SPEAKER_00: I would say typically they deal with the accounting outcome, but we have you know, we have certainly seen people trying um try and renegotiate the contract, which you know, um are you gonna pay real money?
50:24
SPEAKER_03: Yeah, to like avoid an accounting outcome.
50:27
SPEAKER_02: And sometimes these contracts have a relatively short yes duration.
50:31
SPEAKER_02: And so yes, you're marking them to market, but if you don't have a really volatile stock price during those during that period, sometimes it may not be a material change to the PL.
50:41
SPEAKER_03: Yeah, and I I guess something you can definitely explain when you're talking about your mDNA in terms of what's impacting your PL.
50:48
SPEAKER_03: So all right, definitely a lot to think about.
50:51
SPEAKER_03: You guys both are experienced.
50:52
SPEAKER_03: You know, I like to end things by just asking for words of wisdom.
50:56
SPEAKER_03: And so maybe on this one, Brett, I'll start with you.
50:58
SPEAKER_03: Just if someone's dealing with this, what what's your number one piece of advice?
51:03
SPEAKER_02: Uh I think my first piece of advice is make sure you have all the contracts.
51:07
SPEAKER_02: John talked about side letters.
51:09
SPEAKER_02: Uh, make sure you've got those in front of you and can go through them probably with lawyers and accountants with a fine-tooth comb.
51:17
SPEAKER_02: Um, it's not something that you can just uh focus on the primary features or the most likely outcomes.
51:23
SPEAKER_02: You're really going paragraph by paragraph through those arrangements using some, you know, creativity, putting on your your thinking cap of like even these remote scenarios where they change settlement provisions, et cetera, like we've talked about, um, making sure you're going through those thoroughly.
51:39
SPEAKER_03: All right, that's helpful.
51:40
SPEAKER_03: And John, how about from your perspective?
51:42
SPEAKER_00: You know, I I would say honestly, don't go it alone.
51:45
SPEAKER_00: I mean, you know, Brett and I do this every day, all day, all year, right?
51:50
SPEAKER_00: And so we we we see a lot of contracts, we see a lot of provisions.
51:54
SPEAKER_00: You know, if you know you're a controller of a company or uh just on an engagement team, you're more of a generalist.
52:00
SPEAKER_00: Um, you know, experienced eyes are valuable in terms of analyzing these contracts.
52:05
SPEAKER_00: That would be my advice.
52:06
SPEAKER_03: Yeah, and I mean, because obviously, again, there are so many pitfalls.
52:09
SPEAKER_03: So maybe my final piece would be to not go out alone and see all the contracts before they're all signed.
52:15
SPEAKER_03: So that there is still an opportunity to at least understand the outcome of what's being agreed to.
52:21
SPEAKER_03: So, well, it's uh as always a pleasure to talk to you.
52:24
SPEAKER_03: I do think complicated may have been the theme for today's podcast, but definitely you made it very interesting and a lot for companies to think about.
52:32
SPEAKER_03: So thank you.
52:33
SPEAKER_00: Thanks.
52:33
SPEAKER_00: Thank you.
52:35
SPEAKER_03: That's our show for today.
52:37
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52:57
SPEAKER_03: From Thought Leadership at PwC, I'm Heather Horn.
53:01
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