Accounting for Convertible Notes, SAFEs, and Warrants: A Practical Guide for Startups

Thinking Ledger
Jun 14
3 min read

Updated: 2 days ago

Startups often rely on instruments like Convertible Notes, SAFEs, and Warrants during early fundraising rounds. While these tools simplify deal-making for investors and founders, they can get tricky from an accounting and financial reporting perspective.

In this article, we break down the key accounting considerations for each instrument, when to recognize them, and how they impact your balance sheet and income statement.

● What Are Convertible Notes, SAFEs, and Warrants?

● Key Accounting Questions to Ask

● Convertible Notes: Recognition and Accounting

● SAFEs: Are They Equity or Liability?

● Warrants: Valuation and Journal Entries

● Common Scenarios & Examples

● GAAP Considerations (ASC references)

● Final Checklist for Founders

What Are Convertible Notes, SAFEs, and Warrants?

Instrument	Summary	Typical Use Case
Convertible Note	Debt that converts into equity at a future event (e.g., Series A)	Early-stage bridge rounds
SAFE	Simple Agreement for Future Equity – similar to a convertible note but not debt	YC-backed startups; seed-stage deals
Warrant	A right to purchase equity at a specific price	Often issued as an investor sweetener

Key Accounting Questions to Ask

Before you decide how to treat these on your books, answer:

● Does the instrument meet the definition of a liability or equity?

● Are there embedded features that require separate accounting?

● Do any instruments qualify for derivative accounting (ASC 815)?

● Does the instrument accrue interest or require repayment?

Accounting for Convertible Notes

Key Characteristics

● Typically accrue interest

● Maturity date for repayment

● Convert upon future equity round or IPO

GAAP Treatment

● Initially recorded as debt (liability) on the balance sheet.

● Interest accrual using the effective interest method (ASC 835-30).

● Upon conversion, reclassify debt and interest to equity.

🧮 Example Journal Entry

Issuance of $100,000 convertible note with 8% interest:

Dr. Cash $100,000

Cr. Convertible Note Payable $100,000

Interest Accrual at year-end:

Dr. Interest Expense $8,000

Cr. Accrued Interest Payable $8,000

Upon Conversion into Equity:

Dr. Convertible Note Payable $100,000

Dr. Accrued Interest Payable $8,000

Cr. Common Stock / APIC $108,000

Accounting for SAFEs

Key Characteristics

● No interest or maturity date

● Converts into equity at a valuation cap or discount

● No repayment obligation

How to Classify?

● GAAP does not have a specific ASC for SAFEs.

● Treatment depends on the legal structure and terms.

⚠️ Most SAFEs are treated as liabilities under US GAAP (ASC 480) if there’s an obligation to issue a variable number of shares.

But:

● If it’s clear the SAFE will convert into a fixed number of shares upon a future event, it may be classified as equity.

Practical Tip:

When in doubt, treat as liability until conversion happens.

Accounting for Warrants

Key Characteristics

● May be issued alongside notes

● Entitles holder to buy equity at a set price

● May or may not be cash-settled

GAAP Treatment (ASC 815)

● If warrant terms are fixed and cashless, they’re often equity-classified.

● If terms are variable or can be settled in cash → liability classification.

Warrants must be fair valued using the Black-Scholes model or other pricing methods at the time of issuance.

🧮 Example Entry

Issuance of Warrants alongside a note:

Dr. Cash $100,000

Cr. Convertible Note Payable $90,000

Cr. Warrant Liability (fair value) $10,000

Reassess fair value at each reporting date if classified as liability.

Common Scenarios Startups Face

Scenario	Treatment Summary
SAFE converts into preferred shares	Reclassify liability to equity
Convertible note extended at maturity	Continue accrual and update amortization schedule
Warrants expire unexercised	Remove from books; any residual amount stays in APIC
Warrants exercised for shares	Debit warrant liability, credit common stock/APIC