Financing issues play an essential role in the early stages of start-ups. A Simple Agreement for Future Equity (SAFE) is used as mezzanine financing for startups and is also increasingly used in Austria. This is also accompanied by the balance sheet treatment of a SAFE in the annual financial statements.

What is a SAFE?

According to Austrian understanding, the SAFE can best be understood as a convertible loan. Under a SAFE, an investor agrees to make a cash payment to a startup in exchange for a contractual right to convert that amount into shares when a pre-agreed trigger event occurs (e.g. qualified financing round, sale of shares in the startup, IPO). In contrast to a convertible loan, a SAFE usually has an indefinite term and is interest-free.

The advantage of the SAFE is that it is a simpler form of financing that does not yet require a company valuation, as this is postponed until the following equity financing round.

Balance sheet recognition of SAFE in the annual financial statements

Differentiation between equity and debt capital

In order for a SAFE to be recognised in equity in the annual financial statements, certain conditions must be met (subordination, profit-related remuneration and loss participation, indefinite provision at the disposal). In this context, a case-by-case review of the contractual agreement is therefore necessary. If the conditions do not fully apply, the disclosure as debt capital would be decisive.

Subsequently, in connection with a SAFE basically classified as equity, the question arises what consequences are associated with the fact that the investor does not (yet) hold any shares in the startup at the time of the investment.

A disclosure as equity despite the existence of a so-called not-yet shareholder seems to be arguable – under certain conditions – on the basis of the represented view on the accounting treatment of profit participation rights, mandatory convertible bonds and hybrid bonds.

Also in the German literature, it is pointed out that the reporting of equity capital is not limited to „classic“ equity capital. It is also considered permissible for certain rights similar to equity to be reported under equity in the commercial and tax balance sheets.

Recognition of SAFE within equity in case of equity classification

If a SAFE is classified as equity in the startup’s annual financial statements, the question whether it is to be reported as share capital, capital reserve or a separate special item after the capital reserves:

• At the time of the granting of a SAFE, it is not shown in the share capital of a startup.
• In principle, further external financing in addition to the share capital, which the shareholders have made, is shown in the capital reserves. The cause must lie in the company relationship. Payments that are not caused by connections under company law (e.g. subsidies by third parties), are not part of the capital reserves in the balance sheet. Against this background, it is conceivable that SAFE payments are not shown under capital reserves.
• For this reason, a SAFE can only be reported as a separate item (e.g. with the designation „issue proceeds SAFE“) after the capital reserves.

Since the SAFE investments made are basically substantial amounts, an explanation of the agreements in the notes to the annual financial statements – stating the respective amounts and a brief explanation – is in any case required. This should be done even if the company is classified as a micro-corporation, since the additional information is appropriate for an external reader of financial statements.

Conclusio

In addition to convertible loans, SAFE’s have been popping up more often in the startup branch lately. The contractual arrangement is important for the accounting of the SAFE in the annual financial statements.

If reporting as equity is desired, attention should already be paid to the essential aspects during the drafting of the agreement in order to close interpretation gaps (e.g. when does the conversion take place, what are possible repayment scenarios, who bears the repayment obligation [investor vs company], term of the agreement, participation in losses [including liquidation]).

 

Authors:

Christoph Puchner, Managing Partner and Tax Advisor &
David Gloser, Managing Partner, Tax Advisor and Chartered Accountant from ECOVIS Austria, one of the leading tax consultants in Austria in the startup sector.