There are several options currently out there for startups looking to structure investments. One of the more traditional and commonly known avenues to secure early-stage financing is via convertible notes. Another option that is becoming more common in the marketplace is SAFE (simple agreement for future equity).
The underlying concepts of a convertible note are well known, generally taking the form of a secured or unsecured short-term loan agreement with a stated interest rate and maturity date, which is then able to be converted into equity of the company upon a successful future round of funding (often at a discount).
Another option for early-stage financing that is becoming more and more common in the marketplace is the SAFE. Created by Y Combinator in 2013, The SAFE is unsecured financial instruments that allow investors to buy shares in a future priced round, but do not have interest rates or maturity dates associated with them. SAFE can also include terms similar to convertible notes, such as valuation caps and discounts, but these are not required and will likely be part of the negotiation process between investor and company. The form of this security offers a simpler alternative to the convertible note (the entire agreement is usually only five pages), however, the substance behind it can be extremely complex from a financial reporting perspective. SAFE does not have the traditional characteristics of legal form “debt”, with the absence of both interest rates and maturity dates, but that doesn’t necessarily mean that outstanding SAFEs should be classified as an equity instrument by default especially given the fact that there are often provisions within the agreement allowing the holder of a SAFE to demand repayment in cash under certain circumstances. Holders of these instruments may then consider liability treatment (a nuanced but meaningful difference from debt) as an option.
Understanding the fundamental mechanics of these instruments and their application with US GAAP is the only way to ensure the proper accounting treatment and disclosure and can be a critical accounting matter for your company. We’re here to help! If you have any questions on convertible notes or SAFE, please reach out to a member of Withum’s Technology Services Team at firstname.lastname@example.org or by filling out the form below.
Author: Ryan Shannon, CPA | email@example.com