Convertible notes, SAFEs, and the features inside them: what is a liability, what bifurcates, what the interest really costs, and what happens when the instrument converts, amends, or settles.
We classify each instrument at issuance, in one memo covering the liability, the derivatives, and the EPS.
What convertible accounting requires, and where instruments separate
Key takeaways
What it is. Convertible notes, SAFEs, and warrants classified through three standards in order: ASC 480 for instruments that are liabilities in their entirety, ASC 815 for embedded derivatives, and ASC 470-20 for the note itself. Since ASU 2020-06, most notes are one liability at amortized cost.
Where it breaks. SAFEs and discounted-conversion notes that trip ASC 480, redemption and conversion features that bifurcate, down-round terms, and amendments that turn into extinguishments.
How we help. We classify each instrument at issuance in one memo covering the liability, the derivatives, and the EPS, then handle the conversions, amendments, and settlements that follow.
Convertible instruments are where growth companies’ balance sheets get complicated: bridge notes stacked across rounds, SAFEs with caps and discounts, embedded features that may be derivatives, and an EPS calculation that punishes the whole structure. ASU 2020-06 simplified the debt side considerably, and practice promptly refilled the space with SAFE variants and structured terms.
This page runs the analysis in the order we perform it, instrument by instrument. The one-memo-per-instrument standard, covering classification, derivatives, and EPS together, is described on our technical accounting page; here is what goes inside those memos.
The standard
Three gates, tested in order
Classification runs through three standards in order. ASC 480 asks whether the whole instrument is a liability, which catches SAFEs and notes that settle a fixed dollar value in a variable number of shares. ASC 815 asks whether an embedded feature bifurcates as a derivative. ASC 470-20 handles the rare substantial-premium case. No at every gate, which is where most notes land since ASU 2020-06, means one liability at amortized cost. We run the gates on every instrument, document the answer, and classify the warrants issued alongside under ASC 480 and 815-40.
The three classification gates for an issued convertible note, in testing order. Illustrative and not exhaustive.
The update
What ASU 2020-06 changed
The update collapsed five separation models into three outcomes. The beneficial conversion feature and cash conversion models are gone; what remains is the single-liability default, bifurcation when ASC 815-15 requires it, and the rare substantial premium to equity. Diluted EPS moved with it: the if-converted method is now required. The update also eased the ASC 815-40 conditions for classifying conversion features and warrants as equity. Instruments issued under the old models still generate questions in comparatives and modifications, which is where much of our work sits.
Five separation models reduced to three outcomes, and the EPS change that came with it.
This is for you if
SAFEs or convertible notes are on the balance sheet without classification memos.
A bridge is being extended or repriced and nobody has run the modification tests.
The auditors asked for the embedded derivative analysis and it does not exist.
A priced round, audit, or filing is about to test the whole stack at once.
What you get
Classification memos ASC 480, the bifurcation tests, and the equity-classification analysis, tabulated feature by feature.
The tranche workpaper Proceeds, allocations, effective yields, and unamortized balances, rolled every close.
Event support Modification and inducement tests before amendments sign, and settlement accounting computed from the workpaper.
EPS and disclosure The if-converted model built alongside the memo, and the disclosure set for the footnotes.
How We Help
What we deliver
On a convertible instrument engagement, you get one memo per instrument that answers everything at once.
Classification memosASC 480, the bifurcation tests, and the equity-classification analysis, tabulated feature by feature.
The tranche workpaperProceeds, allocations, effective yields, and unamortized balances, rolled every close.
Event supportModification and inducement tests before amendments sign, and settlement accounting computed from the workpaper.
EPS and disclosureThe if-converted model built alongside the memo, and the disclosure set for the footnotes.
When companies bring us in
SAFEs or convertible notes are on the balance sheet without classification memos.
A bridge is being extended or repriced and nobody has run the modification tests.
The auditors asked for the embedded derivative analysis and it does not exist.
A priced round, audit, or filing is about to test the whole stack at once.
Our Experience
Where we have done this work
Engagement Notes
Bridge stacks cleaned up before the priced round
Instrument-by-instrument memos for companies carrying layered bridges: notes with variable-share conversion tested through 815-40, SAFEs classified at issuance with fair value processes stood up, warrant allocations and effective yields rebuilt into a tranche workpaper, and the diluted share math delivered to the negotiation as well as the footnote.
Engagement Notes
Amendments, inducements, and settlements done right
Settlement-event support across the lifecycle: bridge extensions run through the 10% and conversion-option tests before signing, induced conversions expensed at the inducement's fair value rather than buried in equity, and fair-value-option elections evaluated for short-lived instruments where mark-to-market was the simpler truth.
The Detail
The gaps, and how we close each one
Issue 01
The post-2020-06 model: fewer pieces, sharper edgesASU 2020-06
The old world separated convertible debt into pieces, beneficial conversion features, cash conversion equity components, and the amortization noise they created. ASU 2020-06 removed most of that, but the simplification has boundaries, and instruments still fragment when specific features are present.
The treatment
Under the current model, a convertible note is accounted for as a single liability at amortized cost: no beneficial conversion feature, no cash conversion equity split, no day-one discount from the conversion option, which lowers reported interest expense and simplifies the ledger. The instrument still separates in two situations: an embedded conversion (or other) feature that requires bifurcation as a derivative under ASC 815-15, or issuance with genuinely detachable instruments, warrants sold with the note allocate proceeds first, at fair value or relative fair value depending on the warrants’ own classification, creating debt discount before the note’s analysis even begins. The fair value option remains available at inception, instrument by instrument and irrevocable, replacing all of this with mark-to-market, credit-risk changes to OCI, an election that suits short-lived bridges and complicates everything else. The instrument memo starts by placing the note in this map, because every later conclusion depends on the square it lands in.
What we do: We place each instrument in the post-2020-06 map at issuance, including the warrant allocation and any fair value election.
Issue 02
Embedded features: what bifurcates and what does notASC 815-15 / 815-40
Inside a convertible note live features with derivative potential: the conversion option itself, redemption rights, contingent interest, and make-whole provisions. Each is tested, and a feature that fails the tests turns into a fair-value liability remeasured through earnings for the life of the note.
The treatment
Bifurcate an embedded feature when it is not clearly and closely related to the debt host, would be a derivative standalone, and the hybrid is not already at fair value. The conversion option escapes bifurcation only if, standing alone, it would qualify for the scope exception: indexed to the entity’s own stock under the 815-40 two-step (an exercise contingency not based on the stock or the note, and settlement adjustments limited to inputs of a fixed-for-fixed model, where post-2017-11 down-round features no longer taint indexation, though their triggering books a dividend-like charge) and equity-classifiable (share settlement within authorized limits, no cash-out events outside the entity’s control, no holder-dependent terms). Variable-share conversions at a discount to a future price, the bridge-note standard, fail fixed-for-fixed and bifurcate or push the whole instrument to fair value. Redemption features bifurcate when payoffs are leveraged or contingently exercisable in ways not clearly and closely related to interest and credit; plain par puts and calls typically pass. The features inventory, tested one by one with the conclusion tabulated, is the memo’s core exhibit.
What we do: We test every embedded feature and tabulate the conclusions in one features inventory per instrument.
Issue 03
SAFEs: why the simple agreement is usually a liabilityASC 480
SAFEs were designed to avoid debt, no interest, no maturity, and founders assume that makes them equity. The accounting usually disagrees: most SAFE terms create an obligation the framework classifies as a liability, remeasured at fair value, with the volatility that implies.
The treatment
Run ASC 480 first: a SAFE that embodies an obligation to issue a variable number of shares based predominantly on a fixed monetary amount (the discount-to-next-round mechanic pointing at a fixed dollar claim), or that includes cash settlement in a liquidity event or dissolution the holder can effectively compel, is a liability at fair value with changes through earnings. Post-money SAFEs with valuation caps still typically land there, because the cap-or-discount structure and the change-of-control cash-out defeat the fixed-for-fixed and equity-classification tests a preferred-stock analogy would need. The practical consequences: a growing company marks its SAFEs up as it succeeds, recording losses on the way to the priced round; conversion at the round settles the liability into the preferred issued, measured at settlement; and the fair value process (scenario or hybrid models tracking the next-round terms) needs support each reporting date. Crowdfunded SAFE variants add repurchase and proxy features that reinforce the conclusion. Classify at issuance and disclose the remeasurement policy; discovering the liability during diligence is the expensive path.
What we do: We classify the SAFE at issuance, stand up the fair value process, and brief the founders on the mark-up dynamic before the audit does.
From our engagements: The SAFE mark-up-as-you-succeed dynamic is the conversation we have with every founder before their first audit: the loss is the accounting working correctly, and the memo written at issuance is what keeps it from becoming a negotiation with the auditors at year-end.
Carrying instruments without memos? Talk to us before the audit, the amendment, or the round.
Effective interest: discounts, issuance costs, and PIKASC 835-30
The stated coupon is rarely the cost of the money. Warrant allocations, original issue discount, lender fees, third-party costs, and PIK toggles all fold into a yield, and the effective interest mechanics are where convertible ledgers drift out of reconciliation.
The treatment
Present debt issuance costs and discounts as direct deductions from the carrying amount and amortize both into interest expense under the effective interest method, computing one yield off net proceeds after every allocation: OID, warrant fair value carved out at issuance, and fees paid to the lender (which are discount) versus third-party costs (issuance costs, same presentation, same amortization). PIK interest accrues at the effective rate and capitalizes into principal, compounding the base the next period’s interest accrues on the larger balance; PIK-toggle instruments accrue on the expected settlement pattern with true-ups when elections differ. Fair-value-option instruments skip all of this, expensing issuance costs immediately and reporting no separate interest accretion. The tranche-level debt workpaper, proceeds, allocations, effective rate, unamortized balances, rolled every close, is the artifact that makes conversions and payoffs computable later, and the one most often missing when we arrive.
What we do: We build the tranche-level workpaper with one effective yield per instrument, rolled every close.
Issue 05
Conversions, amendments, and extinguishmentsASC 470-20 / 470-50
Every convertible eventually does something: converts per its terms, converts early because the company sweetened the deal, amends in a bridge extension, or gets repaid. Each path has different accounting, and the induced-conversion and modification rules are the two most frequently missed.
The treatment
A conversion per the original terms settles the carrying amount into equity with no gain or loss, the reward for the 2020-06 single-instrument model. An induced conversion, extra shares, cash sweeteners, or temporarily improved terms offered to trigger conversion, expenses the fair value of the inducement (everything transferred beyond the original terms) immediately. Amendments run the ASC 470-50 framework: the 10% cash flow test, plus, for convertibles, a change in the fair value of the conversion option of 10% or more also forces extinguishment treatment, the test teams forget when a bridge extension reprices the cap; extinguishments derecognize at fair value with gain or loss, modifications fold lender fees into a new yield. Repayment and settlement of fair-value-option instruments true up through earnings at settlement. Map the exit path in the original memo, because the accounting at settlement is determined by documentation created at issuance.
What we do: We run the modification and inducement tests before amendments are signed and compute the settlement accounting from the workpaper.
Issue 06
EPS: if-converted, no exceptions, and the disclosure that followsASC 260
ASU 2020-06 traded balance-sheet simplicity for EPS severity: convertible instruments now run through diluted EPS on the if-converted method, presumed share-settled, and the old treasury-stock relief for cash-settlement intentions is gone. The dilution surprises issuers who modeled the note but not the denominator.
The treatment
Apply if-converted to every convertible: add back the instrument’s after-tax interest to the numerator, add the full conversion shares to the denominator from the later of issuance or period start, and include the effect unless antidilutive, with share settlement presumed regardless of stated cash-settlement intent or combination features. Contingently convertible instruments enter the calculation when the contingency’s conditions are met based on period-end facts. Liability-classified SAFEs and bifurcated features contribute differently: their remeasurement already runs through the numerator, and their share-settled outcomes join the denominator under the same if-converted logic once issuable. Two-class complications arise when converts participate in dividends. The disclosures then carry the detail: conversion terms and prices, shares issuable, the interest and issuance-cost amounts, and, for fair-value-option instruments, the credit-risk portion in OCI. We build the EPS model alongside the instrument memo, because the diluted share count is a deal-negotiation number as well as a filing artifact.
What we do: We build the if-converted model alongside the instrument memo, so dilution is a negotiation input, not a filing surprise.
FAQ
Frequently asked questions
Are SAFEs debt or equity?
Usually neither in the colloquial sense: most SAFE terms classify as liabilities at fair value under ASC 480, remeasured through earnings until they convert. The mark-up as the company succeeds is the model working, and the memo at issuance is what keeps year-end calm.
Did ASU 2020-06 eliminate bifurcation?
No. It eliminated the beneficial conversion and cash conversion separations, but embedded features still bifurcate when they fail the clearly-and-closely-related and 815-40 tests. Variable-share discount conversions, the bridge-note standard, still fragment or force fair value.
Our bridge note was extended and the cap lowered. Is that a modification?
Run both tests: the 10% cash flow test and the 10% change in the conversion option's fair value. A repriced cap frequently trips the second, making the extension an extinguishment with gain or loss, which is why we test before the amendment is signed.
Can we avoid diluted EPS impact by settling conversions in cash?
Not anymore. If-converted applies with share settlement presumed, regardless of intent or combination settlement features. The dilution is modeled up front or discovered in the first EPS calculation, and up front is cheaper.
When does the fair value option make sense?
For short-lived bridges and instruments whose features would fragment badly: one fair value line replaces bifurcation, discount amortization, and settlement mechanics, at the cost of earnings volatility and instrument-specific credit risk routing to OCI. It is irrevocable, so we model both paths before electing.
What happened to the beneficial conversion feature after ASU 2020-06?
The BCF model, which recognized an in-the-money conversion feature as a discount amortized to interest, was eliminated for most instruments by ASU 2020-06. Convertible notes are now generally a single liability. Confirm which guidance applies to your instruments, because older notes and templates still reference the retired model.
When is a warrant classified as a liability rather than equity?
When it fails the equity-classification conditions, primarily the fixed-for-fixed test requiring both the share count and the strike to be fixed in the functional currency. Cash-settlement features, certain down-round provisions, holder-dependent terms, and functional-currency mismatches for foreign private issuers all push warrants to liability treatment with fair-value remeasurement.
We have multiple tranches of convertible notes. Do you handle complex cap tables?
Yes. We analyze each instrument individually, prepare its entries and schedules, and produce a consolidated view of the cap table’s accounting, which is exactly the cleanup a pre-IPO company needs before the S-1. The tranche-level workpaper is what makes conversions and payoffs computable later.
Do you work with foreign companies or international operations?
Yes. We regularly work with foreign private issuers and cross-border structures, including IFRS reporting, US GAAP reconciliations, and multi-entity consolidations across domestic and international subsidiaries.
How quickly can you get started?
Usually within a few days of finalizing the engagement: a brief discovery session, a clear statement of work, and secure access setup. We do not run lengthy intake procedures that delay the actual work.
Sources & authorities
Primary sources for this page
ASC 470-20, Debt with Conversion Features. How convertible notes are separated, measured, and accreted.
The simplified model. FASB ASU 2020-06, which removed most separation models and changed diluted EPS for convertible instruments.
Own-equity and embedded derivatives. ASC 815-40 on whether a conversion feature is indexed to the entity’s own stock.
This page summarizes FASB accounting standards and SEC guidance for general information, and is not accounting or legal advice. Standards change; confirm the current text before you rely on it.
