Accounting for SAFE (Simple Agreement for Future Equity) Notes

By the end of this lesson, accountants will be able to accurately account for SAFE notes in a company’s financial statements.

1. Introduction to SAFE Notes
2. Definition and Purpose

1. SAFE: Simple Agreement for Future Equity
2. Created by Y Combinator as an alternative to convertible notes
3. Provides investors the right to receive equity in the company during a future financing event (e.g., Series A)
4. No maturity date or interest, unlike convertible notes
5. Advantages for startups

1. Simplicity
2. Flexibility
3. Less legal and administrative overhead

1. Key Components of SAFE Notes
2. Valuation cap

1. Maximum company valuation at which the SAFE note will convert
2. Protects investors from excessive dilution during conversion
3. Discount rate

1. The percentage reduction applied to the price per share during conversion
2. Rewards early investors for taking on more risk
3. Pro-rata rights

1. Allows SAFE note investors to maintain their ownership percentage in the company during future funding rounds
2. Not always included in a SAFE agreement

III. Accounting for SAFE Notes

1. General approach

1. SAFE notes are considered equity instruments
2. Accounted for as a separate equity class (e.g., “SAFE Equity”)
3. Initially recorded at the cash received from investors
4. Recording SAFE notes

1. Debit “Cash” account for the amount received from investors
2. Credit “SAFE Equity” account for the same amount
3. Accounting for conversion events

1. Determine conversion terms (valuation cap, discount rate, and/or pro-rata rights)
2. Calculate the number of shares issued to SAFE investors
3. Record conversion by debiting “SAFE Equity” account and crediting “Common Stock” and/or “Preferred Stock” accounts
4. Accounting for liquidation events

1. If SAFE note is not converted to equity before a liquidation event, the investor may receive a payout
2. Record payout by debiting “SAFE Equity” account and crediting “Cash” account

1. Disclosure Requirements
2. Financial statement notes should include:

1. Description of the SAFE notes and their key terms
2. Number and value of SAFE notes outstanding
3. Effects of conversion or liquidation events on the financial statements

 

Example: Accounting for SAFE Notes on Financial Statements 

Let’s assume that a startup company issues a SAFE note with a valuation cap of $5 million and a discount rate of 20%. The investor provides $100,000 in exchange for the SAFE note.

1. Initial Issuance of SAFE Note

The initial accounting entry for the issuance of the SAFE note is as follows:

Date	Account Title	Debit	Credit
2024-04-11	Cash	100,000

 

| SAFE Equity | | 100,000

1. Conversion Event

Assume the startup goes through a Series A financing round at a pre-money valuation of $4 million, with a share price of $10 per share. Given the valuation cap, the SAFE note will convert at the lower valuation. The discount rate will also apply, leading to a share price of $8 for the SAFE note holder ($10 * (1 – 20%)). The number of shares issued to the SAFE investor will be 12,500 ($100,000 / $8).

The accounting entry for the conversion of the SAFE note is as follows:

Date	Account Title	Debit	Credit
YYYY-MM-DD	SAFE Equity	100,000

Common Stock | | 100,000

III. Balance Sheet

The balance sheet will reflect the changes in the equity section after the SAFE note issuance and subsequent conversion:

Equity:

• Common Stock: $100,000 (post-conversion)
• SAFE Equity: $0 (post-conversion)

1. Statement of Cash Flows

The issuance of the SAFE note will be reflected in the cash flows from financing activities section:

Financing Activities:

• Proceeds from SAFE note: $100,000

1. Statement of Stockholders’ Equity

The changes in stockholders’ equity due to the issuance and conversion of the SAFE note will be shown in the statement of stockholders’ equity:

• Beginning balance: $0
• Issuance of SAFE note: $100,000
• Conversion of SAFE note: ($100,000)
• Ending balance: $100,000 (post-conversion)

Please note that the dates for the conversion event and the financial statements (e.g., YYYY-MM-DD) should be replaced with the actual dates when the events occurred and the statements are prepared.

 

1. Conclusion

Accounting for SAFE notes can be straightforward, but it is important to understand their unique characteristics and properly disclose them in financial statements. By following these guidelines, accountants will ensure accurate financial reporting and compliance with accounting standards.

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