Every year at about this time, we’ve just finished helping many of our Corporate Focus customers with questions that come up from their auditors and the finance team is looking forward to taking a break from equity compensation reporting. However, there is one question that we hear frequently at the tail end of these conversations, just as CFOs start to turn their attention to this year instead of last year. They want to know: “Do we need to do another Sec. 409A valuation of our common stock for the purposes of our next set of stock option grants?”
It’s typically in the context of finishing up last year’s financial statements which will now form the basis for considering whether the company’s valuation has changed and therefore the fair market value for stock option grants has changed from last year or last quarter. The simple answer is “Yes.” The primary question is whether based on your most recent financial statements that you just completed, you feel the company is worth the same amount as it was worth last year (or the last time you did a Sec. 409A valuation) or has it changed (hopefully in the right direction … more customers, more revenue, more employees, new markets)? Of course, if you have a recent, arms length transaction, you may know the valuation or you may have a recent third-party valuation.
So to be safe, smart and prepare for a future exit, it is worth every penny to get a valuation that complies with one of the safe harbor valuation methods or an update to your last one (which should cost a lot less). Hopefully, your equity is worth a lot more to your employees than the cost of an update to your last valuation.
Is it time and money that could be better spent elsewhere and a regulation that is applied to emerging-growth, privately-held companies based on the option backdating scandals from 2006 that applied to publicly-held companies? Absolutely. Is it smart to get a valuation that complies with one of the safe-harbors? Absolutely.
But luckily, Dave Broadwin, a partner at the law firm of Foley Hoag LLP, has written a short article that explains Sec. 409A very clearly and concisely: Sec. 409A Option Pricing Redux. And, if you want to understand the three valuation safe harbors, take a look at his earlier article called: Options and 409A — Sometimes the law is an ass. I recommend these articles to any CFO who wants to have just enough information to intelligently talk to his tax or legal advisers and make the right decision.
Our goal is to ensure that if you are doing your equity compensation reporting with
Corporate Focus that you also stay clear of any nasty tax consequences since that will certainly turn “incentive” stock options into a big, fat “disincentive” for you, your company and your employees.