Corporations depend on their CFOs to report "the numbers" each period. But what happens when these numbers are based on data that’s being tracked at the company's law firm—instead of internally?
When a company is initially formed, all of the legal and ownership records tend to be maintained by their law firm because, frankly, it's just easier. Over time, the organization begins to grow, and as it does, the complexity of its capital structure tends to grow as well. For example, as an enterprise gets its first round of angel or venture capital financing, it may issue convertible preferred stock and warrants and adopt an employee stock option plan.
The complexity typically relates to the company's capitalization table, its stock plan administration, and the reporting of equity compensation expense under FAS 123R. Each year or quarter, the CFO must determine—in addition to how much was paid in cash compensation and benefits to the company's employees—how much compensation was paid to employees who have stock options or other equity compensation.
The Current Approach No Longer Makes Sense
Although stock plan administration work can be outsourced by a company to its law firm, the equity compensation reporting normally isn’t, since it involves accounting work. And so, at the end of each year, it has been common practice for paralegals to send reports and spreadsheets to CFO clients who need to calculate their stock option related expense. The CFOs then take the information provided, add it to their own internal spreadsheets, and run the numbers for the period.
The problem? This typical approach has proven to be very difficult, time-consuming and error-prone. The challenge is that the data is being updated by the law firm while the accounting calculation that uses the data is being done by the company—each in their own separate system or set of spreadsheets. An uncoordinated system and a virtual recipe for disaster.
The Solution? One Consolidated System.
The solution is to bring the stock plan administration being done by the law firm and the equity compensation reporting being done by the CFO together seamlessly in a single, consolidated system. In this way, everyone is using the same set of live data and the information is real-time, accurate, and consistent. No time is wasted sending reports and spreadsheets back and forth while manually updating information that is being tracked and reported by one side or the other.
Here’s how this integrated approach works: At audit time, the CFO logs in to the stock plan administration and equity compensation reporting system that has been used by the paralegal at the law firm throughout the year. The CFO knows that all required changes for the year have been updated, since he or she has had access to the information all year and has updated the valuation variables on an ongoing basis.
To calculate the amount of equity compensation expense for the current period, the CFO simply presses a button or opens a report. Because the same formulas are used consistently throughout the system for every record and across each period for the expense calculation, as well as for the required financial statement disclosures, the CFO can be confident that it is 100% accurate.
Whether the consolidated system is at the law firm, at the client’s office, or somewhere in between is immaterial. What’s important is that everyone is using the same system. All parties can log in and work on the areas that are relevant to them, and everyone can see the data live and report on the information as their needs require.
A single system for stock plan administration and equity compensation reporting ensures that data is reviewed and kept up-to-date over the course of the reporting period. And because all of the information is already in the system well before the end of the reporting period, it avoids the typical mad rush at audit time.
Does this sound like a better method? It is. Does it sound too easy to be true? It's not. Many law firms and CFOs are already using this approach—and they're thrilled with the results. What a difference it can make at audit time (not to mention everybody’s stress levels). It's just a matter of working together.