Looking to raise capital?
Don't forget the accounting!
You can save a lot of tears and frustration further down the track by including the impact of the accounting outcomes in your due diligence process for raising capital.
There can be some surprising accounting outcomes when undertaking what may appear to be straight forward transactions.
When raising equity or debt it is important to consider the key terms of the instruments. For many instruments the answer may be obvious. The issue of ordinary shares for cash will likely be equity. A bank loan will likely be a liability. Where however, there are more complex situations and particularly where there are loans with options to convert to equity, some seemingly innocuous terms may cause:
- an instrument to be classified as a liability rather than equity even if on the face of it there is no obligation to pay out cash
- an instrument to be classified partly as a liability and partly as equity due to mandatory dividend payments or an equity conversion option
- an 'embedded derivative' being created requiring the instrument to be separated into two liabilities with the derivative liability being measured at fair value with the changes in fair value recognised in profit or loss if this is not 'closely related'
- an instrument to be classified as a liability with share price movements effectively being recognised in profit or loss!
Understanding the terms will be key to the classification of the instrument as debt or equity (or both!).