How do startups account for equity and fundraising on the Balance Sheet?

Lately, we’ve had a lot of questions around How Startups Record Equity on the Balance Sheet. So let’s break it down. There are 2 ways that Startups Record Equity on the Balance Sheet.

1. The Official GAAP accounting way (time consuming and costly).
2. How Investors prefer to see it.

The Official GAAP accounting way:

a

So technically you’re supposed to report the Equity section in 3 accounts:

• Common Stock: most often this is employees and founders purchasing stock, then the general public once the company goes IPO
• Preferred Stock: most often this is the VCs and Angel Investors purchasing stock: should the company go belly up, their ownership is preferred and they’ll get their money back before Common Stockholders do
• Additional Paid in Capital (APIC): calculated as the (Issue Price – Par Value) * Basic Shares Outstanding. Financing Costs are netted against this account. For big public companies, calculating APIC is relatively easy to do: they have big accounting departments that can easily pull market/issue price, the par value and the Basic Shares Outstanding. But what about startups who are Seed, Series A-D? Calculating APIC is time consuming and costly… and has very little value to the management team or investors at this stage.

GAAP accounting for the cost of raising capital

A note on recording the legal fees associated with the fundraise (and heavens knows that it costs serious legal $$ these days to raise VC funding): legal and other DIRECT costs associated with an equity fund raise should be capitalized and netted against APIC. There is no need to amortize this permanent equity cost. On the off chance that your startup raises debt, those costs would be amortized, generally based on the length of the loan.

How Investors Prefer to See the Equity Section:

Record each fundraising round as a new Equity account and net the Financing Costs against it, as seen below.

• Common Stock: Common Stock purchases from the founders and employees still go against Common Stock, no matter which funding round you are in.
• Seed Series: Angel and VC funding (Less Seed Series Financing Costs)
• Series A: Angel and VC funding (Less Series A Financing Costs)
• Series B: Angel and VC funding (Less Series B Financing Costs)
• Et cetera….

If you haven’t really calculated APIC, don’t include it on your Balance Sheet because it give the impression that you’ve calculated the (Issue Price – Par Value) * Basic Shares Outstanding.

Notice that once fundraising round is closed, new funds aren’t added to it. New funds are placed in a new fundraising Equity account. I grayed out the numbers to show that the account essentially remains dormant once the round is closed. The picture above shows you what the Balance Sheet would look like in a Perfect World, ie all investors deposit their funds within a short window. But we all know that there are always some early jumpers and laggards, and some funding rounds that last many quarters and other instances where a Series B hits just 6 months after a Series A. So in Real Life, the Balance Sheet tends to look like the picture below. The lesson being is that you should check with your cap table, founders, lawyers and accountants about any potential overlap of funding and place the funds according to the prescribed funding rounds.

Why do investors prefer to see the Equity section this way?

Because it’s easily recognizable to them and is cost effective. Once you clear Series D, or your investors want to see APIC, or if your auditors demand it… then calculate APIC. It’ll take your accountants some time and will cost you $$$ (we’re happy to do the work if you’re happy to pay, but we also want to be hyper cognizant of cost/benefit relationships), but if it’s what the investors want, give the investors what they want.

Accounting for Capital Raising - Early-stage startup FAQ’s

What is the accounting treatment for capital raising costs?

When raising equity funding, the legal and other direct costs associated with an equity fund raise should be capitalized and netted against the equity sections’ Additional Paid in Capital account. You do not amortize the costs of raising equity. For debt, the costs should be amortized against the length of the loan.

How do you account for fundraising expenses?

For early-stage, VC fund raises, the company that raised funding should capitalize the direct costs of the fund raising and net against the APIC account on the balance sheet. Small, recurring expenses may be run through the P&L (talk to your CPA) but major expenses like the legal bill, which will usually arrive a month or two after you’d close the financing, need to be capitalized.

How to account for a venture capital investment?

If your company has raised venture capital funding, you’ll need to record the fund raise on your balance sheet and capitalize any financing costs directly associated with the VC round. See our notes above for the GAAP methodology - plus the way most VCs like to see the accounting of their investment on the balance sheet.

What about SAFEs or Converts?

Great question. We’ve written entire articles on both of these. The punchline is that SAFEs are equity and Convertible Notes are debt. Follow those links to find out more about how to record them on your balance sheet.