Raising capital—whether through debt, equity, or hybrid instruments—is a pivotal moment for any business. But too often, organizations focus heavily on legal and commercial terms while overlooking the accounting implications. The result? Misclassifications, audit challenges, or even restatements.
Here are the top five accounting and structuring considerations to keep in mind before executing your next financing deal:
1. Debt vs. Equity Classification Is Not Always Intuitive
The legal form of an instrument doesn’t determine its accounting treatment. Preferred stock with mandatory redemption features? Likely debt under U.S. GAAP. Preferred stock with optional redemption features? May require temporary equity classification for public entities under U.S. GAAP. Convertible notes with equity-like features? Doesn’t mean equity classification for the Convertible notes under U.S. GAAP.
Why it matters:
Incorrect classification can distort key financial ratios, mislead stakeholders, and trigger compliance issues with debt covenants or SEC reporting.
Tip: Involve accounting advisors early in term sheet review—not just post-closing.
2. Embedded Features Can Trigger Derivative Accounting
Conversion options, redemption rights, contingent interest features, and any other features that alter the cash flows of the financial instrument may be considered embedded derivatives under ASC 815. These features often require separate accounting, including fair value measurement and periodic revaluation.
Why it matters:
Unexpected fair value volatility can hit earnings hard and complicate financial statement disclosures.
Tip: Assess all embedded features during structuring—not just during documentation review.
3. Valuation Drives Recognition and Measurement
Fair value inputs affect initial measurement and ongoing accounting. Terms like detachable warrants, or embedded derivatives can lead to day-one or subsequent P&L impact or balance sheet complexity.
Why it matters:
Poor or unsupported valuations can lead to audit delays or pushback from regulators and investors.
Tip: Work with experienced valuation professionals familiar with capital structure nuances and audit standards.
4. Modifications vs. Extinguishments Have Big Accounting Consequences
Amending or refinancing existing instruments may trigger either troubled debt restructuring, modification accounting or full extinguishment (i.e., derecognizing old debt and recognizing new). The accounting outcome depends on quantitative and qualitative tests.
Why it matters:
Getting this wrong could result in misstated interest expense, improper gains/losses, or inappropriate balance sheet presentation.
Tip: Always perform a structured analysis before finalizing amendments to existing instruments.
5. Cross-Functional Alignment is Critical
Structuring decisions impact more than just accounting—there are legal, tax, treasury, and investor relations implications. Misalignment among teams often leads to post-deal cleanup or unintended consequences.
Why it matters:
Downstream implications can include restatements, tax inefficiencies, covenant breaches, and reputational risk.
Tip: Establish a deal team that includes technical accounting and tax experts from the start—not just deal counsel and bankers.
Conclusion
Debt and equity transactions are more than just capital events—they are accounting events. The complexity of today’s instruments demands a proactive and cross-disciplinary approach. By considering these five key areas up front, organizations can reduce risk, improve reporting quality, and strengthen investor confidence.
Bottom line: Don’t treat accounting as an afterthought. Make it a core part of your capital strategy.