How to attract and retain workers in a seller's market

Early-stage startups must often contemplate the most practical way to raise capital for their business. If traditional debt and equity methods are not available, different avenues to raising capital must be considered. Here are four alternatives to traditional debt and equity transactions:

Simple Agreement for Future Equity (SAFE)

A SAFE provides rights to an investor for future equity in a company without determining a specific price per share at the time of the initial investment (date of agreement), nor does it provide for interest or a maturity date. A SAFE investor receives future equity shares when a priced round or investment event occurs (e.g., a Series A preferred stock financing round), typically at a discounted rate. SAFEs are intended to provide a simpler mechanism for startups to seek initial funding.

Convertible note

A convertible note is a hybrid security containing components of both debt and equity. The loan can be converted into either a predetermined or a variable number of equity shares at a later date, usually upon the occurrence of an event such as a financing round or liquidity event. In some cases, these are complex agreements that require more involvement from legal counsel.

Keep It Simple Security (KISS)

A KISS can be structured as either a debt or equity agreement. An investor provides funding to the company in exchange for the right to convert the instrument to equity upon a future event when an equity round is raised and preferred shares are issued. Like a SAFE, KISS agreements delay the need for a valuation and can minimize legal expenses. Unlike SAFEs, KISS notes do provide for an interest rate and a maturity date. KISS securities frequently include a Most Favored Nation clause, which provides that should a better deal be provided to new investors at a later date, they would need to revise the terms of the KISS investments to match the new preferable terms. These are sometimes seen in SAFEs and convertible notes as well. A KISS is generally viewed as more investor-friendly because of the protections it provides.

Redeemable preferred stock

A type of preferred stock that allows the issuer (the company) to buy back (call) the stock at a certain share price and retire it. The call feature can be beneficial for the company, as it can eliminate equity if it becomes too expensive. Aside from the redemption feature, it sometimes contains common provisions of preferred stock such as fixed dividends to the holder ahead of payments to holders of common stock. Another version of this, mandatorily redeemable preferred stock, includes a put feature that allows the investor to request the funds back at a specific date including a return. Depending on the provisions in the contract, mandatorily redeemable preferred stock may be classified as debt on a company’s balance sheet.

This is not an all-inclusive list. There are other non-traditional methods of financing, including, but not limited to, peer-to-peer lending, crowdfunding, and government grants. Selecting the appropriate methods of raising capital for your business involves the consideration of numerous factors. Current macroeconomic trends, the company’s industry, and long-term strategic objectives are examples of factors you may want to consider.

If you have questions about raising capital and the related business, accounting, and tax implications, please contact our professionals. We can also provide guidance on other alternatives to raising capital.

There is a growing interest in the business world for companies to reduce their Greenhouse Gas Emissions (GHG), particularly as Environmental Social Governance (ESG) initiatives become more commonplace. Many organizations have come to realize that their shareholders or other stakeholders are interested in knowing the extent of the organization’s social or environmental impacts. One step some organizations are taking to contribute to social and environmental responsibility is to reduce their carbon emissions—either through directly changing their business practices, purchasing carbon offsets, or both.

What can companies do to reduce their carbon footprint?

There are several ways that businesses can reduce their overall environmental impact. Companies often begin this journey by understanding what their carbon footprint is, which is the amount of emissions related to an organization’s direct and indirect activities. Generally, these emissions are measured in tons (for example, driving 2,500 miles generates a ton of carbon dioxide.) Since this process is voluntary, a company can consider measuring their footprint based upon a scope:

• Scope 1 relates to what the organization directly emits, such as through exhaust in automobiles used for business purposes.
• Scope 2 relates to carbon emissions specifically from energy production needed for the organization’s use, such as the electricity used to power their office.
• Scope 3 includes all other indirect carbon emissions, including all the participants in the supply chain of a product the company sells.

Regardless of the scope used, a company will generally set a goal of reducing their overall carbon footprint by a certain amount. They may choose to address this goal through a number of methods, such as switching to renewable energy or implementing other energy-reduction strategies. This is a great first step; however, most companies realize that gains in energy efficiencies can bring a company only so far toward their goal. It is generally at this point that companies consider using carbon offsets as a tool toward achieving their goal of reducing GHG.

What is a carbon offset?

A carbon offset, also called a carbon credit, is created when one company removes a unit of carbon from their business activity and is deemed to have generated an offset. Once certified, that offset can then be purchased by another company as a means of reducing its own carbon footprint. The carbon offset market is huge, and growing rapidly. In 2020, the market was estimated at approximately $2 billion, and it is expected to grow to $50B or much more by 2050.

Carbon offsets operate in a voluntary marketplace. While there are some exchanges available for purchasing offsets, most companies purchase credits through organizations that facilitate the certification of projects and determine the number of carbon credits produced. Common projects that generate offsets include reforestation, the capture and destruction of greenhouse gases, and renewable energy projects.

As expected with a rapidly emerging practice of using carbon offsets, the market is far from perfect. There are even reports that some carbon offsets may be worthless and actually contribute to increases in GHG. Given the complexities, it is important that the buyer conduct their own research in order to have an overall understanding of how the market works

Accounting for the purchase of carbon offsets: Two options

Once a company has set a goal for reducing their carbon footprint, has researched the carbon offset market, and purchased offsets to help meet their goal, then what? How are carbon credits accounted for on the company’s financial statements?

Regulating agencies are beginning to issue some guidance around carbon offsets, including:

• The SEC has proposed rules to enhance and standardize climate-related disclosures for investors for public traded companies.
• FASB recently added a project to its technical agenda to improve the recognition, measurement, presentation, and disclosure requirements for participants in compliance and voluntary programs that result in the creation of environmental credits and for the nongovernmental creators of environmental credits.

However, when it comes to accounting for offset credits, there is very little official guidance on how a company should account for the accumulation of carbon offsets and their use.

For companies acquiring carbon offsets, the accounting choices, at this point, boil down to either the purchase of an intangible asset or the purchase of inventory.

Carbon offsets as intangible assets

Per the ASC 350-30-20 glossary definition, intangible assets are "assets (not including financial assets) that lack physical substance." (The term intangible assets is used to refer to intangible assets other than goodwill.)”

The carbon credit does not have a physical form but could be treated as an asset. Therefore, it meets the definition of an intangible. For accounting record keeping, the acquisition of these would be at fair value, which in most cases would be the cost or price paid by the company. Since carbon offsets generally have an indefinite life, as intangible assets, they would not be subject to amortization in the event that the credit was held and not used for more than one operating cycle. Once the offset is claimed by the company, it is “decertified,” meaning it is removed from the registry and therefore no longer certified as an offset credit. At this point, the company would write off the value of this intangible asset and recognize an expense.

Carbon offsets as inventory

Alternatively, a company could consider the acquisition of carbon offsets as inventory.

Per US GAAP, inventory is defined as "the aggregate of those items of tangible personal property that have any of the following characteristics:

• Held for sale in the ordinary course of business
• In process of production for such a sale
• To be currently consumed in the production of goods or services to be available for sale."

While carbon offsets are not tangible personal property, they are tradable and could be held for sale in the event that the company wanted to speculate on trading these carbon credits rather than use them.

As inventory, their costs may be determined under any one of several assumptions as to the flow of cost factors, such as First-In-First-Out (FIFO), average, and Last-In-First-Out (LIFO). The major objective in selecting a method should be to choose the one which, under the circumstances, most clearly reflects periodic income.

If considered inventory, the cost would be subject to neither impairment nor amortization. As inventory, however, there would be a lower of cost or net realizable value consideration at each reporting deadline. Once de-certified and therefore used, the company would report a reduction of inventory and a debit to expense.

Once the company selects its accounting method as either intangibles or inventory, it should use the same method when retiring or selling off the carbon offset credit.

How to choose a method for accounting for carbon offsets

In the absence of specific accounting rules, the accounting policy used by a company will generally come down to the specific facts and circumstances of the arrangements giving rise to these carbon offset credits and how the company plans to utilize the carbon offset credits.

Through thoughtful financial statement disclosures, a company can keep the readers of their financial statements informed of their practice and how those practices impact its overall financial statements.

In conclusion, carbon offsets offer companies a way to meet their ESG goals by purchasing credits from other companies that are reducing their carbon emissions. These steps can help a company claim social and environmental responsibility. But, on the accounting side, the rules are vague. BerryDunn’s Commercial Team has extensive experience working with clients who have purchased carbon offsets and can advise you on the best approach for your business. Contact our team to schedule a conversation.