When looking at the potential options of equity versus debt financing, companies should assess the impact on the financial statements under both options.
Equity financing involves raising capital by issuing shares or units, thus diluting ownership but avoiding immediate repayment obligations like a traditional debt instrument. There may be repurchase features, especially if it is considered mandatorily redeemable; however, the obligation is structured differently. Typically, with equity financing, a cash payment to the holder will not occur until a sale of the Company. In contrast, debt financing will require cash payments of both the principal and interest to meet debt service obligations. The choice between the two options requires considerable thought and different accounting implications exist for both.
Equity and debt financing are not always as simple as one may think. Multiple instruments have characteristics of both equity and debt financing, which include but are not limited to preferred stock, including mandatorily redeemable stock, warrants, profits interests (depending on the characteristics outlined in the agreements), SAFE notes and more.
In deciding between equity and debt financing, companies should consider not only the regulatory environment and investor expectations but also the accounting implications of each. When instruments have both equity and debt characteristics, the accounting can be quite complicated. Most times, guidance is considered to determine if there are embedded conversion options that must be valued, if remeasurement needs to be performed at fair value each period, whether the financial instruments meet the definition of a derivative, and more. By understanding the implications of each type of financing, companies can optimize their capital structure, enhance financial stability and foster long-term success. Analyzing these types of features can be quite complex, and Schneider Down’s Emerging Technology Group is here to assist you.
About Schneider Downs Emerging Technology Services
Schneider Downs understands the ever-changing landscape and business challenges facing companies focused on emerging technologies and software. Our clients represent a wide range of organizations, from emerging growth companies to large mature companies, and we are well-versed in the unique challenges they face. Our team of seasoned professionals has experience working with emerging technology companies in all phases of their evolution.
To learn more, visit our Emerging Technology page.
