How do you select a 409a valuation firm to provide the issue price of stock options? This article will dive into the reasons why a 409a valuation is required and what questions should be asked when interviewing a 409a valuation firm.
As an owner of a valuation firm, I have heard time and time again, “I promised stock options to my employees and have yet to deliver”. Issuing stock options should be simple, but due to IRC Section 409a, created through the American Jobs Creation Act of 2004, employers simply cannot issue options with an exercise price that “feels right”. The US Government wants its share of taxable income at the time of exercising stock options.
Within the United States, equity compensation plans require businesses to ensure the targeted exercise price is supported by the fair market value of a business’s common stock as of the option grant date. If a company desires to issue options or any other form of deferred compensation to its employees, the company must seek an expert adviser who will give a fair/conservative assessment.
How should companies go about selecting an adviser among the hundreds and even thousands of valuation firms in the country? According to the IRS, a firm should have significant experience, which the IRS defines as at least five years of relevant experience in business valuations. The AICPA Practice AID suggests that companies select a valuation specialist with profession certifications (for example: ABV, CPA, CVA). In addition, a company should consider the provider’s reputation, a simple Google search should be sufficient, but new cap table management companies, like Carta or Capshare, work with providers to prepare 409a valuations for clients. Lastly, review the provider’s experience.
Beyond the suggestions from the AICPA, companies should do the following:
Ask if the provider has had a 409a report audited.
Though quantity is not directly correlated with experience, ask if the provider has had experience working with clients in a particular industry.
Ask for a sample report.
Overall, the IRS takes the 409a Valuation seriously. Undervaluing the company, or not having a 409a performed can lead to severe penalties imposed by the IRS. In contrast, overvaluing the company will cause employees to recognize less income than they otherwise would have. Determining the fair market value and the value per Common Stock share, is a tightrope walk for providers, but an experienced provider understands how to maneuver across and deliver reports that satisfy both parties.
Time to circle back to the issue I presented towards the beginning of this post, if you’ve promised stock options to employee’s, deliver on that promise. Your employees will appreciate your integrity.
If you are looking for a provider, I have worked as a 409a valuation provider and now dozens of firms that provide this service. I am happy to give you a list of firms that may be able to assist. Give me a call at (925) 787-9608.