One of the most challenging areas of startup accounting is the equity section of the balance sheet. The equity section is where you track the financial transactions related to all your fundraises.
Don’t feel overwhelmed if you find this confusing. Even experienced founders find equity accounting perplexing.
The 7 Most Common Equity Questions We Hear From Founders
Here are the most common equity accounting questions we see from our early-stage founders and startups:
1. How do we account for founder shares?
Founder shares are common shares. Debit cash and credit common shares for the amount paid.
2. What about fundraising costs (e.g. legal fees)?
Book these fees as a debit to equity fundraising expenses. The costs offset the gross amount raised on the balance sheet. For $1M raised and $20K in fees, the equity account will net to $980K on the balance sheet.
3. Is a SAFE equity or debt?
There is no official guidance yet. Many view SAFEs as equity. We recommend classifying SAFEs as equity.
4. What is stock compensation expense?
This non-cash expense reflects the value of stock options or restricted stock grants. Though complicated to calculate, many startups get a pass on this, especially pre-Series B. Carta provides guidance on calculation.
5. What is APIC?
APIC is “additional paid-in capital,” the amount paid for shares above the par value. Have separate APIC accounts for common and preferred shares. Similar to stock comp expense, most startups get a pass on worrying about splitting APIC and par value on the balance sheet.
6. Separate accounts for different rounds?
Yes, have separate equity accounts for different funding rounds (e.g. Series Seed vs. Series A) with different share classes, terms and values. This reconciles the cap table and financials. Don’t create separate accounts for each investor, though.
7. Tax implications of a secondary sale?
This is a whole different conversation and depends on the specific situation. In short, yes there are usually tax implications, especially for the shareholders. Consult a tax expert.
Keep it Simple and be Transparent
The advice above suits most startups between Seed and Series B. Most startups should use a light, simplified approach. Our goal with our clients is (mostly) GAAP compliant for those clients not yet needing a formal audit. Focus on what matters to your investors and board.
In closing, keep things simple and transparent and communicate with the board. The board will likely accept a hybrid approach (GAAP compliant and not-quite GAAP) for now if you commit to more formal GAAP later when you have the resources. You can almost always come back later when you have more funds to get things perfectly in line with GAAP as you ready for an IPO.
If you would like to go a little deeper, here are a few resources I used: