Accounting for SAFE notes

SAFE notes are one of the preferred investing instruments in the startup world. SAFE (simple agreement for future equity) notes are an alternative to convertible notes, and SAFE notes are less complex. They are basically an agreement that allows investors to purchase equity in a startup at a negotiated price now, and the investor will receive the equity at some point in the future (called conversion). There’s no set time for conversion – it will happen when and if the company next raises capital. With that in mind, how do startups account for a SAFE note investment? Let’s look at some important accounting points.

Scott Orn and Healy Jones, Kruze Consulting
SCOTT ORN
KRUZE COO, FORMER VC
HEALY JONES
KRUZE VP, FORMER VC

Equity, not debt

SAFE notes are technically equity, not debt, and we account for them as equity on the balance sheet. This has important ramifications for investors who are trying to take advantage of the Qualified Small Business Stock (QSBS) exclusion. The exclusion can provide significant tax savings for qualified investments that are held for at least five years, based on when the stock was issued. 

With SAFE notes, that clock starts on the date of conversion. Recently some SAFE notes have incorporated a debt-like term stating that investors get paid back first, making SAFE notes more of a hybrid security. However, we still classify it as equity.

SAFE funds on the balance sheet

When funds come in from a SAFE note, they are added to cash as a debit. We also credit the SAFE notes line item in your balance sheet. Since SAFE notes don’t have a maturity date, they don’t have to be paid back in 12 or 24 months. They sit on the balance sheet in the equity portion until the company:

  • Is sold.
  • Raises a follow-on round of capital.
  • Isn’t successful and is dissolved.

If the company raises another round of capital, the SAFE notes will convert at a predetermined valuation cap. At that point the SAFE note entry will be removed and the amount will be credited to preferred equity. 

For example, a startup might have a SAFE note from an angel investor. A year later, the company may raise a Series A preferred round. To account for this event, the SAFE note entry will be removed and moved over to the preferred Series A line item in the equity portion of the balance sheet. 

If you have questions about accounting for SAFE notes, please contact us.

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