SAFEs and convertible notes

A convertible note is debt until it converts, carried at amortized cost with interest accrued, and its conversion features, discounts, and valuation caps are evaluated for embedded derivatives under ASC 815. After ASU 2020-06 eliminated the beneficial conversion feature model, most notes are accounted for as a single liability unless a feature must be bifurcated. Some companies elect the fair value option and remeasure the whole note each period.

A SAFE is not debt and not clearly equity. Because it typically settles in a variable number of shares at a future price, many companies classify it as a liability under ASC 480 and remeasure it at fair value, with changes in the income statement. Others reach an equity conclusion depending on the specific terms. The conclusion should be written down at issuance, not discovered at the first audit.

On conversion, the carrying amount plus any accrued interest and derivative balances is reclassified to the preferred stock issued, and any difference is recognized in earnings. Companies with several rounds of notes and SAFEs should expect the auditors to rebuild the entire history.