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

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Kruze Consulting Startup Q&A Author
Vanessa Kruze Founder, CPA

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 way (time consuming and costly).
  2. How Investors prefer to see it.

 

The Official GAAP way:

In a GAAP world

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.

 

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….

In a perfect world

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.

In real life

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.

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