Stock Option Valuation: How Hard Have They Made It?

Gary Levine - In a recent issue of the popular newsletter Softletter, Edward Pratesi, CPA of Brentmore Advisors, LLC, does an outstanding job in the article entitled: “Valuing Options While Running the Compliance Gauntlet” explaining the complicated interplay between FAS 123R and Sec. 409A in the context of determining the fair market value for privately-held companies of the common stock underlying an employee stock option. This is a critical input for qualified stock options where the option must be issued with a strike price equal to fair market value on the date of grant to comply with IRS Sec. 422 and can’t be issued at a discount if you want to avoid the penalties under Sec. 409A.

Pratesi explains the background behind both 123R and 409A and then articulates the valuation standards under each section and how they differ. As he articulates it:

It is important to note again the difference between FASB 123R and IRC Section 409A as they appear to be similar but approach the valuation of options and securities from different perspectives. FASB 123R concerns stock option valuations for financial reporting purposes and is measured using the issuing company’s perspective … IRC 409A is concerned with the issuance of stock based compensation … The objective is to ensure that the securities being granted … are granted at fair market value … Under either regimen, the value of the underlying security – the common stock – is critical in determining the value of the stock option.

He later explains that the inherent difference is that FAS 123R uses a “fair value” standard and looks to the AICPA practice aid “Valuation of Privately-Held Company Equity Securities Issued as Compensation.” Sec. 409A uses a “fair market value” standard and offers three safe harbors for valuation: a) the binding formula presumption; b) the independent appraisal presumption; and c) the illiquid start-up presumption. If the valuation satisfies one of these safe-harbor presumptions, then it is assumed to be “reasonable” for 409A purposes and the burden shifts to the IRS to prove that the valuation was not “a reasonable application of a reasonable valuation method.”

In the latter part of the two part article, the author offers a set of questions and answers that many companies will come across as they deal with valuation for the first time. A few of the highlights are:

Question: Which one of the above standards will impact us the most?

Answer: Since most privately-held technology based companies will be issuing stock options (and in many cases more than once a year), anticipate that a valuation of the underlying stock will be needed to meet IRS standards first and the financial reporting requirements under 123R second.

Question: If both the FASB and IRS require that our privately-held company be valued, can we have one valuation report prepared to meet both standards?

Answer: Maybe.

I have read dozens of articles on this issue over the past one to two years and strongly feel that for the CFO or stock plan administrator who is not a valuation expert, but needs to know just enough to be able to talk intelligently when considering the various options for common stock valuation in the context of equity compensation reporting, this article is a diamond in the rough and for that reason appreciate the publisher of Softletter making this article available to the public.

Gary D. Levine, President and CEO
Two Step Software, Inc.
www.CapitalizationMatters.com

This blog

by Gary Levine - Gary Levine is the CEO and Founder of Two Step Software which provides market leading solutions for stock plan administration and corporate governance. His perspective is based on 20 years of experience.

 

More from this blog

Bloggers crew

Steve Knowles has spent 25 years in business and practice in the UK, but he also worked in the states and the years haven't dulled his way of seeing an alternative view to everyone else, and every day is a new adventure.

42446

Joel M. Ungar, CPA is a lifelong resident of the Detroit area and a graduate of The University of Michigan. He is a principal with Silberstein Ungar, PLLC, a Top 15 auditor of SEC public reporting companies.

74654

Allan Boress, CPA, with over 25 years as a practitioner and consultant to the accounting profession. Mr. Boress is the author of 12 published books in 6 different languages, including a best-seller, The "I-Hate-Selling" Book.

47425

Larry Perry, CPA, CPA Firm Support Services, LLC, is the author of accounting and auditing manuals, author and presenter of live staff training seminars, and author of webcast and self-study CPE programs. He blogs about small audits, reviews, and compilations.

87079
Sandra Wiley, COO and Shareholder, is ranked by Accounting Today as one of the 100 Most Influential People in Accounting as a result of her prominent role as an industry expert on HR and training as well as influence as a management and planning consultant. She is also a founding member of The CPA Consultant's Alliance. Sandra is a certified Kolbe™ trainer who advises firms on building balanced teams, managing employee conflict and hiring staff.
19935

Maria Calabrese, CIR, Human Resources manager for Fazio, Mannuzza, Roche, Tankel, LaPilusa, LLC in Cranford, New Jersey, Maria's topics revolve around the world of: Mentoring, Performance management, and The "Y Generation," a.k.a. "The whY generation".

54539

William Brighenti is a CPA, Certified QuickBooks ProAdvisor, and Certified [Business] Valuation Analyst, operating an accounting, tax, and QuickBooks consulting firm in Hartford, Connecticut, Accountants CPA Hartford.

79199

Ken Garen, CPA, is the co-founder and President of Universal Business Computing Company (www.ubcc.com), a software development firm of high-volume, high-productivity accounting and payroll technology.

24527

Eva Rosenberg, MBA, EA, is the publisher of TaxMama.com, and author of the weekly syndicated Ask TaxMama column. She provides answers to tax questions from taxpayers and tax professionals worldwide.

62935

Amy Vetter, CPA, CITP is the CPA Programs Leader for Intacct Corporation responsible for leading the CPA/BPO Partners nationally.

33910
Brian Strahle is the owner of LEVERAGE SALT, LLC where he provides state and local tax technical services to accounting firms, law firms and tax research organizations across the United States. He also writes a weekly column in Tax Analysts State tax Notes entitled, "The SALT Effect." For more info, visit his website: www.leveragestateandlocaltax.com
100936
Scott H. Cytron, ABC, is president of Cytron and Company, known for helping companies and organizations improve their bottom line through a hybrid of strategic public relations, communications, marketing programs and top-notch client service. An accredited consultant, Scott works with companies, organizations and individuals in professional services (accounting, finance, medical, legal, engineering), high-tech and B2B/B2C product/service sales.
25189

Rita Keller is a nationally known CPA firm management consultant, speaker, author, mentor and blogger. She has over 30 years hands-on experience in CPA firm management, marketing, technology and administrative operations.

51394
Stacy Kildal is the mom of two fantastic kids, an Advanced Certified QuickBooks ProAdvisor, Certified Enterprise Solutions ProAdvisor, Sleeter Group Certified Consultant, a nationally recognized member of the Intuit Trainer and Writer Network, and co-host of RadioFree QuickBooks.
27014
Michael Alter's blog specializes in providing practical advice to those who seek greater profitability and practice management tactics that enhance deeper client relationships.
31330

Sally Glick, CMO, Principal, Marketer of the Year in 2003 and AAM Hall of Famer in 2007, leads a lively discussion of the constantly expanding roles of marketing and the professional marketers that drive this initiative in accounting firms of all sizes.

98315

The IMA Young Professionals Blog features the insights of IMA’s Young Professionals Committee. Committee members share advice and experiences on careers, continuing education, work/life balance, and other issues affecting young accounting and finance professionals.

32515

FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI.

109201

Sue Anderson has 30 years of experience in continuing education for accountants. Currently she is the program director for online CPE provider CPE Link.

59634

Jim Fahey is COO of Apple Growth Partners, a regional CPA firm in Ohio. His focus is on the effective and efficient use of technology within the firm by all team members.

38558
Caleb Newquist is the Editor-in-Chief of Sift Media US, overseeing content for both AccountingWEB and Going Concern.
65494

Leita Hart-Fanta, CPA, CGFM, and CGAP is the author of "The Yellow Book Interpreted" and owner of Yellowbook-CPE.com a website devoted to training for governmental auditors.

91322

AccountingWEB is more than just a U.S. team of journalists and financial and technology experts - we have an international side, too! Members of our British team who publish AccountingWEB.co.uk share their ideas, insights, and perspectives from across the pond.

52405