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Accounting Rules for a Simple Agreement for Future Equity Raising Concerns, FASB Private Company Panel Says

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Firms have raised concerns to the FASB’s private company advisers about the complexity of reporting a Simple Agreement for Future Equity (SAFE)—a type of investment used to fund startups, according to Sept. 12, 2023, board advisory discussions.

There is diversity in practice about whether to classify a SAFE under ASC 480, Distinguishing Liabilities from Equity or as a liability under ASC 815-40, Derivatives and Hedging–Contracts in Entity’s Own Equity, now that these agreements have increased in use, Private Company Council (PCC) members said.

“I think most of these things end up as a liability,” Michael Cheng, national professional practice partner for Frazier & Deeter LLC, said. “The problem is you can’t really fast forward to that [answer] unless you prove that there is no equity component to it and I think that that’s what generates some of the difficulty in accounting for it,” he said. “And there’s just general push back. You talk to a lot of investors and reporting entities they will tell you that this is equity and it’s almost a non starter.”

The PCC is composed of a panel of 12 members who work with the FASB to develop accounting rules and amendments for privately held companies. U.S. GAAP may need a practical expedient for SAFEs as those agreements have become more prominent in use over the past 10 years, the discussions indicated. A practical expedient is a shortcut to an accounting answer.

“These sound simple – it’s in their title – but there are some concerns about the complexity of accounting issues that are involved with a proper way to treat those and if there is an opportunity for the PCC to explore a practical expedient,” said Jeremy Dillard, partner with SingerLewak LLP. “Most of it seems to be as you work through the gauntlet of GAAP guidance requirements that you most of the time end up as a liability, and whether there is a practical expedient that could be developed that just automatically takes you there.”

The tension in the topic is that people who issue them believe they are equity but the accounting process does not confirm that. “I think when you go through the accounting you very rarely end up there and that’s where there is a lot of diversity in practice because people who have them sometimes don’t navigate that guidance all the way through,” PCC Chair Candace Wright said.

No decisions were made on the issue during PCC discussions.

Since being developed in 2013, SAFEs have grown in popularity over the last few years especially with venture capital funds and investors in startups, but there is no specialized guidance in GAAP on the topic and that “has led to discrepancy on how SAFEs should be accounted for at the time of issuance,” according an analysis  by CPA firm PYA.

SAFEs “allow a company to receive cash without the legal costs typically associated with traditional convertible debt or equity raises,” PYA explains. They generally “contain provisions that detail how the award can be converted to a future equity stake in the company, often at a discount to what other investors would be required to pay. These provisions are typically triggered by defined conversion events, such as future equity raises or acquisition by another company.”

 

This article originally appeared in the September 13, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.

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