From start-up to IPO: how the accounting for a growing company's biggest decisions actually works — equity compensation, fundraising rounds, working capital, revenue recognition, and convertible debt. Interactive versions of the calculators I built for this course, from 30121: Accounting for Entrepreneurship.
Every form of equity compensation eventually hits the same three dates — grant, vest, and sale — but which of those dates triggers a taxable or book event, and at what price, depends entirely on the award type.
Actual shares granted up front but subject to forfeiture until they vest. Without a special election, the employee is taxed on the share's value only once it vests — not when it's granted.
An employee can elect to be taxed on restricted stock's value at grant instead of at vesting. If the stock appreciates before vesting, this locks in a lower ordinary-income hit today in exchange for more of the gain later being taxed at capital-gains rates.
Options that let the employee buy stock at a fixed strike price (S0). No ordinary income is triggered at exercise for regular tax purposes — the whole gain from strike price to eventual sale price is taxed at capital-gains rates, which is the main appeal of ISOs.
Options without ISOs' favorable tax treatment: the spread between the stock's value at exercise and the strike price is taxed as ordinary income at exercise, and only the appreciation after exercise is a capital gain.
The company usually gets a tax deduction (a cash-flow benefit, since it lowers the company's own taxes) exactly when the employee recognizes ordinary income — the two sides of the same transaction move together.
The core idea behind every one of these awards: whatever price the shares are valued at on the date ordinary income is recognized becomes the employee's new cost basis. Everything above that basis, earned after that date, is a capital gain instead — which is why when the taxable event happens matters as much as the award type itself.
Choose an award type and a single vesting date (T=0 grant, T=1 vest, T=2 sale). A two-tranche (50/50) vesting schedule follows the same logic applied separately to each half, at its own vest date.
| Date | Company cash flow | Company net income | Employee cash flow |
|---|---|---|---|
| T=0 (Grant) | — | — | — |
| T=1 (Vest) | — | — | — |
| T=2 (Sale) | — | — | — |
Every priced round comes down to the same sequence: agree on what the company is worth before the money comes in, add the new money, and back out how many new shares that buys — diluting everyone else in proportion.
What the company is agreed to be worth immediately before the new investment.
Pre-money valuation plus the new money coming in — what the company is worth right after the round closes.
The new investment as a share of the post-money valuation — this is the percentage of the fully-diluted company the round buys.
New rounds often require the founders to carve out (or "top up") an option pool for future hires before the round is priced — which dilutes existing holders just like a second, simultaneous investor would.
Every new share issued — whether to an investor or to an option pool — shrinks everyone else's percentage ownership, even though the number of shares they hold doesn't change.
The denominator is the part people trip over: it's not just "new shares = ownership % × old share count." Because the new shares themselves are part of the post-money share count, you have to solve for the number that makes the investor's shares work out to exactly their target percentage of the new, larger total — which is what dividing by (1 − ownership % sold) does algebraically.
Set option pool expansion to 0% for a simple priced round with no pool top-up.
Assumes the shares outstanding figure already includes any existing (unexpanded) option pool, and that the round has a single new investor.
In an acquisition, the buyer and seller usually agree on a "normal" level of working capital the business should be delivered with — and true up the purchase price after closing if the actual figure comes in above or below that target.
Current assets minus current liabilities — excluding cash and the current portion of long-term debt, which are treated as financing items rather than operating ones for this purpose.
A small cash buffer treated as part of normal operations (and so added back into working capital) rather than as excess cash sitting on the balance sheet.
The pre-agreed benchmark — typically the working capital at signing, scaled by a multiple — that actual working capital at close is measured against.
The dollar-for-dollar true-up: a working capital shortfall at close reduces the price the seller receives; a surplus increases it.
Enter the two periods' balance sheet figures — the initial (signing) period and the actual (sale/close) period.
A start-up's pro forma income statement is really just a set of operating assumptions — jobs per month, cost per job, headcount — chained together. The balance sheet below it is mostly bookkeeping: it has to balance, so cash becomes whatever plugs the difference.
Volume (jobs or items sold) times average price — the two assumptions that matter most, and the ones worth stress-testing first.
The direct, variable-with-volume costs of delivering the product: labor, materials, equipment, and depreciation tied to production.
Revenue left over after the direct cost of delivering it — before any of the company's fixed overhead.
On a forecasted balance sheet, cash is usually solved for last: Total Liabilities & Equity minus every other asset. If that number goes negative, the forecast is telling you the business needs more financing than assumed.
Nothing exotic here — the point of building it this way is that every line is tied to an assumption you can independently sanity-check (jobs per month, cost per job, headcount cost) rather than a single opaque "revenue" number pulled from thin air.
When a bundle mixes hardware and a subscription service, only the hardware portion is typically recognized right away — the subscription piece has to be earned over the life of the contract, which is where deferred revenue and monthly recurring revenue (MRR) come in.
To split a bundle's price across its components, weight the bundle price by each component's own stand-alone price relative to the sum of all components' stand-alone prices.
Cash (or a receivable) collected for a service not yet delivered — a liability until the company actually earns it by providing the service.
The subscription revenue a company can expect to collect in a typical month, treating one-time and non-recurring revenue separately.
Customers (or revenue) lost at renewal. Gross retention measures revenue kept from existing customers; net revenue retention also credits upsells, and can exceed 100%.
From the annual deferred revenue allocated to each subscription component of a bundle.
A convertible note is a loan that's designed never to be repaid in cash — it converts into equity at the next priced round, at a price set to reward the early lender for the risk they took before the company had a valuation at all.
The note-holder gets to convert at a percentage discount to whatever price new investors pay in the priced round.
A ceiling on the valuation used to price the note-holder's conversion — protecting them from converting at too high a price if the company's value has grown a lot since the note was issued.
The note converts at whichever mechanism — the discount or the cap — gives the note-holder the lower effective price per share (and therefore more shares).
D is the amount raised, i the note's interest rate, and t the time outstanding — interest just accrues onto the note rather than being paid in cash. DPS is the price per share the new round is priced at (based on the new pre-money valuation, NPMV); the note-holder gets the better of the discounted price or the valuation-cap price, whichever is lower.
Once a software project moves from research into formal, committed development, GAAP requires capitalizing those development costs as an asset — spreading the expense over the years the software will generate revenue, rather than hitting net income all at once.
Development costs incurred during the formal development phase, recorded as an intangible asset rather than an immediate expense.
Each period, the capitalized cost is amortized by the larger of a revenue-proportional method or a straight-line method — whichever recognizes more expense sooner.
Expensing the same costs immediately instead would front-load the entire hit to net income in the development period, rather than spreading it out.
The "max" rule exists so that a product earning revenue faster than its straight-line schedule assumed gets amortized (expensed) faster too — accounting tries not to let an asset's book value outrun the revenue it's actually generating.
A few recurring entries worth having on hand — mostly straightforward, but easy to fumble the account names on under exam pressure.