IRC 409A / ASC 718
For financial reporting purposes under ASC Topic 718, share-based payments to employees must be recognized in a company’s financial statements at their fair value. After the fair value as of the grant date of the equity compensation is determined, the cost is recognized over the period during which an employee is required to provide services in exchange for the award. IRC Section 409A regulates the tax treatment of certain stock-based compensation. Specifically, the exercise price of options must be greater than the share’s fair market value, otherwise significant taxes may be incurred. Valuations are frequently performed for the combined purpose of 409A and 718 compliance, serving to minimize the cost of complying with both requirements.
Delphi offers expertise in the specialized area of valuing stock-based compensation in the context of both simple and complex capital structures. We perform valuations for both private and public companies as related to many types of stock-based compensation, including:
- common stock for input into option valuation
- restricted shares
- stock appreciation rights (SARs) and phantom stock plans
- profits interests
- employee stock purchase plans
- common stock
- preferred stock
- convertible securities
We work closely with our clients’ management team to understand the life stage of the company, its capital structure, past rounds of financing, and future expectations in order to determine the best method to value and allocate the equity amongst the classes of stock.
Depending on the stage of the company, traditional valuation techniques such as an income or market approach, may not be easily applied. An updated Practice Aid titled the Valuation of Privately-Held Company Equity Securities Issued as Compensation was released in 2013. Often referred to as the “Cheap Stock Guide,” this document outlines the framework for valuing securities issued as compensation. For companies with complex capital structures consisting of multiple classes of stock with differing rights and claims on its equity, additional analysis is required. While there are many ways to value the common stock in such situations, the Practice Aid presents methods intended to cover a range of different scenarios. These include the current-value method (CVM), the option pricing method (OPM), the probability expected return method (PWERM), and hybrid methods.
When needed, we perform valuations of options and warrants, applying Black-Scholes, Binomial and lattice based models, or Monte-Carlo techniques as appropriate for each derivative.