Stock Options & Equity Compensation Valuations

Mergers & AcquisitionsEmployees are often given stock options or equity in a company as compensation. This requires its own set of reporting requirements to determine the value of the compensation given, because it must be reported to the IRS as well as on the company’s financial statement.

Specifically, FASB ASC Topic 718, Compensation – Stock Compensation, requires that the full fair value of an equity-based instrument be recorded as compensation expense. In addition, IRC §409A provides guidance on the tax treatment of equity-based instruments granted as compensation. This stock-related compensation must be valued using the most suitable methodologies, taking into consideration specific characteristics of the compensation.

BVC develops flexible, individualized financial models to provide comprehensive and well-supported valuations for options, stock incentive units, restricted stock and other equity instruments.

Many private companies, particularly those backed by venture capital or private equity investors, plan to generate a future return for their investors through the initial public offering (IPO) process. A key valuation issue with an IPO is the fair value of equity-based securities issued as compensation in the periods prior to the IPO. The value of stock prior to an IPO is almost always less and thus “cheap” in comparison to the subsequent IPO price. However, proper documentation of stock values in the periods preceding an IPO allows companies to support the fair values of their stock.

The valuation of pre-IPO companies is often made more challenging by rapid growth rates relative to more mature publicly traded companies and complex capital structures common in companies with venture capital and private equity investors

BVC works closely with companies and their auditors to review capital structures, business plans and the terms and conditions of equity-based compensation plans to determine the fair value of share grants and options.

BVC commonly performs the following services as part of an equity-based compensation engagement:

  • Valuation of the total equity of the business using appropriate methods, whether the traditional cost, market and income approaches, or unique techniques used with start-up companies.
  • Allocation of the value of the equity to different classes, such as preferred stock and common stock, and to other instruments, such as options, warrants and convertible debt. This is typically done using option pricing models, but may require a Monte Carlo simulation.
  • Valuation of the discrete options and warrants, when necessary, by selecting an appropriate option pricing technique, such as the Black-Scholes-Merton model or a binomial (lattice) model, after assessing the characteristics and terms of the specific instruments.



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