Accounting for SAFE notes – Part III

Accounting for SAFE notes highlights of Part I and Part II.

In Part I we gave a quick overview of key terms that are normally found within SAFE agreements. The most common key terms found within SAFE notes are:

  • Term – There is generally no maturity date specified within SAFEs
  • Interest – There is generally no interest required to be paid to the noteholder by the company
  • Conversion Terms:
    • Discount – The discount enables the SAFE note investor to participate in future equity rounds at a discount.
    • Valuation Cap – The Valuation Cap enables the investor to participate in future equity rounds based on the valuation of the company at the future date. The cap is to ensure that the investor can invest at a pre-determined valuation.

In Part II the accounting begins! The first two steps in the SAFE note accounting process:

  • Evaluating whether the notes are freestanding or embedded
  • Evaluating the host instrument

Now we will go over the third part in the evaluation process!

Evaluation under ASC 480

The third step in assessing the accounting for the SAFE notes is to evaluate them under ASC 480. 

Do the SAFE notes meet the guidance within ASC 480-10-25-4 (i.e. mandatorily redeemable instruments)?

A mandatorily redeemable financial instrument is an instrument issued in the form of shares that embodies an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur.  As SAFE notes are not issued in the form of shares and redemption is based on a conditional event, they are not mandatorily redeemable.  As such, this section of ASC 480 does not apply.

Do the SAFE notes meet the guidance within ASC 480-10-25-8 (i.e. obligation to repurchase an issuer’s equity shares by transferring assets)?

There are two components within ASC 480-10-25-8 that a financial instrument must align with to be accounted for under ASC 480 in this subsection.  First, it embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation.  Second, it requires or may require the issuer to settle the obligation by transferring assets.

SAFE notes meet the second criterion as they may be settled in cash at the holder’s option if a liquidity event (i.e. change of control, IPO) occurs, even if it is a conditional event.  In regard to the first criterion, SAFE notes must be evaluated to determine if they are indexed to entity’s own stock.  Essentially, this means that the settlement of the SAFE note is dictated by the underlying movement of the fair value of the entity’s own stock.  SAFE notes generally will meet this requirement as their settlement is usually only dictated by standard inputs into an option-model, such as the fair value of the entity’s stock.

Based on the above assessment, it appears that SAFE notes meet the criteria within ASC 480-10-25-8 and should be accounted for pursuant to ASC 480.  

To account for SAFE notes under ASC 480

As the SAFE notes are accounted for under ASC 480, they will be recorded initially at fair value.  Fair value is generally assumed to be the transaction price at issuance.  For instance, if a $50,000 SAFE note is issued, the fair value on the issuance date is assumed to be $50,000.  Under ASC 480, SAFE notes would be subsequently measured at fair value at the end of each reporting period with gains or losses recorded in earnings. 

About the author:

Brian Engelhardt is a partner at Balanced Solutions. Brian is a CPA, also was a Manager at PwC in the private company assurance group serving primarily service-companies in the Washington, DC metro area as well as Cleveland.  After leaving PwC after eight years, Brian ventured into accounting and finance consulting working primarily with technology companies. Learn more

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