In part I we gave a brief overview of certain terms that are within Simple Agreements for Future Equity (SAFE) notes. Now in this second part of our three part series we go through the first two steps in accounting for them.
Evaluating whether the SAFE notes are freestanding or embedded
The first step in evaluating the SAFE notes to determine whether they are freestanding or embedded instruments. Per the ASC Master Glossary, a freestanding financial instrument is an instrument that meets either of the following conditions:
- It is entered into separately and apart from any of the entity’s other financial instruments or equity transactions.
- It is entered into in conjunction with some other transaction and is legally detachable and separately exercisable.
SAFE notes that issued separately from other financial instruments would be considered freestanding. If a SAFE note happens to be embedded within another financial instrument (i.e. debt or preferred stock agreement), it may be considered embedded if certain terms apply. However, usually this is rare for SAFE notes as they are issued separate from other financial instruments and, thus, are considered freestanding.
Evaluating the host instrument
The second step in evaluating the SAFE notes is to determine whether the SAFE note is a debt host, equity host, or neither. Debt hosts are generally issued in the legal form of debt, while equity hosts are generally issued in the legal form of shares. In evaluating SAFE notes, they generally aren’t issued in the legal form of debt and are clearly not in the legal form of shares (even though they may convert to shares at a later point in time). Additionally, SAFE notes do not have a maturity date, repayment schedule, or interest rate, which are typical terms in debt instruments. Based on this evaluation, it appears that SAFE notes are not in the form of a debt host or an equity host. As they are not in the form of a debt host (Accounting Standards Codification (ASC) 470: Debt), they should be initially evaluated under ASC 480: Distinguishing Liabilities from Equity.
The third step in evaluating SAFE notes will be to evaluate the note within the context of ASC 480.
About the author:
Brian Engelhardt is a partner at Balanced Solutions. Brian is a CPA, also began his career 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
To learn more about Safe Contracts & our accounting services, contact us here.