OID (original issue discount) arises when debt is issued for less than its redemption amount — the discount compensates the lender and is generally treated as interest over the instrument’s life.

How it works

A company issues a $1M face note for $950K cash — $50K OID. U.S. tax rules typically require the holder to include OID in income annually under accrual methods, and the issuer may deduct corresponding interest over time, subject to complexity limits on below-market or convertible instruments.

Convertible notes with valuation caps and discounts blend debt and equity features; OID calculations interact with conversion at qualified financing. Zero-coupon structures carry OID entirely as accreted interest until maturity or conversion.

Accounting mirrors tax conceptually: liability increases toward face value as interest expense accrues on the balance sheet for straight debt.

Why it matters

• Founders: Compare effective borrowing cost including OID versus venture debt with warrants. Legal and tax counsel should structure notes to align cash flow with tax obligations.
• Investors: Funds track OID for taxable income timing — recognizing income before cash can affect LP K-1s on private credit holdings, separate from equity fund returns.

Common mistake

Ignoring OID when comparing note versus SAFE economics. A deep issue discount changes investor IRR even if nominal coupon is zero.

Related ideas

See also note conversion math, KISS note, convertible debt, and accrual accounting.