It is instructive to look at the aspect of control over a start-up and whether or not SAFE holders could force a cash payment or refund of their SAFE without the consent of the company`s current shareholders. The clear answer is that no, SAFE holders never force such a buyout. Co-founders typically own 100% or nearly 100% of the company`s outstanding shares, and therefore exercise full control over the company and have the ability to retain full control. SAFE holders could never force the withdrawal of their SAFE. The reality of full control over co-founder-owned start-ups strongly suggests that SAFERs should be accounted for as equity rather than debt. Even though the FASB has not yet published a specific standard on this topic, it is enough to assume that SAFERs will continue to be an attractive form of financing as long as companies look for easy ways to finance their activities. However, until a standards committee gets involved, it is up to the individual companies that offer SAFERs to evaluate the rewards on a case-by-case basis. While there may be clear benefits for financial statements in classifying SAFE premiums as equity as opposed to a liability, an entity must be careful to consider the details of the instruments it issues. The risk-return profile of SAFE investments is that of venture capital in a start-up in the start-up phase and not that of debt (including the promise of a specific payment within a certain period of time).
The goal of SAFE investors, of course, is for their SAFE investments to be converted into preferred shares if and when the start-ups in which they invest conduct preferred share financing. But SAFE holders face two very real risks that can sometimes prevent their goal from ever being achieved: The factors currently unknown in the above calculations are, of course, the share price of future preferred shares and the number of fully diluted outstanding shares at the time of safe conversion. (Caution: The arguments and positions in this article apply to the standard Y Combinator SAFE instrument. In some situations, some investors have successfully negotiated a mandatory redemption or redemption of their “SAFE” contracts. These agreements are not SAFE. They are “SAFE” only in name. In fact, these amended contracts are convertible debt contracts.) The stated conclusion of this part of the CSA is that, since the number of shares to be issued is not now explicitly identified as a fixed number, the actual number of shares to be issued in the future may be greater than what the Company has approved and is available for issuance at that time, and therefore the net statement of shares (a prerequisite for stock classification) is not under the control of the Company. While this argument is valid in the case of large publicly traded companies that must seek the approval of a large number of common shareholders before approving or issuing additional shares, it does not apply to small start-ups, where co-founders can exercise absolute control over all decisions and approve and issue shares at will.
This is another case where current accounting standards do not sufficiently understand or take into account the realities of the operation of SAFERs. To be eligible for the equity classification, “(must) the contract contain an explicit stock limit. The contract (must) contain an explicit limit on the number of actions to be delivered as part of an equity settlement. For SAFERs, the key variables that will affect the settlement amount are the price of the future preferred share as traded in the future preferred share funding round (if and when) and the conversion price, which depends on both the valuation cap traded in the SAFE agreement and the number of fully diluted outstanding shares. To be eligible for the equity classification, “no collateral needs to be required. There is no obligation in the contract to deposit a guarantee at any time or for any reason. »; SAFE agreements are designed to introduce simplicity for founders who raise capital at an early stage, while deferring the valuation to later stages. We then turn to paragraph 815-40-15-7E, which says, “. Fair value inputs of a fixed amount or stock option may include the company`s share price and additional variables, including one of the following variables: Tax consideration – If the convertible bond is converted into shares, investors may need to issue a Form 1099-INT/OID, depending on the terms of the conversion.
Therefore, it`s a good idea for your investors to fill out W9 forms to get their tax information when you close a financing round. SAFEIs are financing instruments in which angel or seed investors give money to start-ups in exchange for the possibility of their investment being converted into future shares – but only when certain future events occur. As a form of financing, funds from these agreements should be classified as follows: (i) debt; (ii) equity; or (iii) something in between – what`s called “mezzanine” or temporary equity. This is Article 1(a). It`s in the front and middle. This is the expected result in the normal course of things. Early stage investors and start-up founders understand and intend that, in the normal course of events, funds invested under SAFE instruments will be converted into preferred shares in future financing, both hoped and expected, in which newly created preferred shares will be issued. That is hope. That is the intention. But that`s never guaranteed.
Early stage investors in SAFE Take a big risk in the hope of significant returns. This is a high beta proposition. Tax Considerations: SAFE agreements are not considered income or sales when entered into or converted into preferred shares, so we generally disclose them as long-term liabilities on your tax return. If your SAFE Is reported as equity, it will be disclosed as additional paid-up capital for tax disclosure purposes. From an accounting point of view, care must be taken to ensure that none of the deposits are incorrectly recorded as turnover – surprisingly, this is more common than you might think. As accountants, we make many year-end adjustments to ensure that the movement of money from one location to another is properly recorded for financial statement disclosure and tax disclosure. It is also important to ensure that actual bank deposits are accompanied by convertible bond agreements, as bank/transfer fees can also lead to discrepancies. We need the FASB to rule on this issue, and the decision must be that SAFE (safe standard without guaranteed repayment obligation) be accounted for and reported as additional paid-up capital, part of the permanent equity. Here is the argument for fairness. Mandatory repayment refers to a specific depreciation plan, usually with accrued interest, if the financial instrument has not already been converted into equity. Mandatory redemption is more common for mandatory redeemable preferred shares.
SAFERs are not necessarily exchangeable. (Note that some investors in some companies have registered mandatory redemption features in their “SAFE”. But in these cases, such an instrument is just a “SAFE” in name – in reality, it`s a debt.) Classification of liabilities and, in general, recognition at market value, are required in the following situations: In the SEC`s view, SAFERs are considered better than debt than equity and should therefore be recognized as liabilities on the balance sheet. .