Equity compensation plans are an important means of motivating and retaining key employees and valuations play a key role. IRC Section 409A (“Section 409A”) generally imposes adverse tax consequences on recipients of stock option grants with an exercise price less than fair market value of the underlying stock on the date of grant. Section 409A valuations are frequently used for ASC 718, Compensation, Stock Compensation, reporting purposes in connection with a firm’s audit.

While under-valuations can lead to adverse tax consequences, overvaluations also have adverse consequences. Whether due to a poorly prepared valuation or as a result of a decline in a company’s stock price, ineffective incentive plans can reduce employee motivation and lead to increased employee turnover. The COVID-19 Pandemic and its adverse impact on asset prices suggests many incentive plans will be less effective. Compensation committees, CEOs and CFOs that manage stock option plans or other incentive plans should think carefully about the need for a current valuation given the changing environment.

In addition to the tax and motivation risks noted, mis-valuations for financial reporting purposes can delay the filing of financial statements, delay an IPO or put management at risk of an internal control deficiency.

Developing supportable valuations is more difficult than ever. Recent interest rate declines could suggest a reduction in discount rates and an increase in value—an unexpected result given the overall increase in the risk of many investments. Developing valuation multiples is more difficult as well. Although stock prices are down, many firms may see their valuation multiples increase due to large declines in earnings—a 20 percent decline in a stock price and a 50 percent decline in earnings results in higher pricing multiples compared to those observed prior to the Pandemic.

In addition to common stock, many early stage companies have multiple classes of preferred stock with complex rights. The complex capital structures create added valuation complexity. Possible “down” financing rounds further complicate the preparation of defensible valuations.

In addition to declines in the value of businesses, valuation discounts for the lack of control and limited marketability of interests in privately held entities are important considerations that reduce the fair market value of assets. Supportable discounts for control and marketability have increased. Key reasons include increased risk as reflected in higher market volatility, expected delays in the time until an exit event, reductions in M&A activity and availability of financing among other factors.

Our Globalview Advisors’ professionals have decades of experience performing and defending valuations prepared for tax and financial reporting, transaction and litigation support purposes. Given this experience, we bring deep knowledge of the IRC 409A, ASC 718 and fair value measurement standard requirements for financial reporting. We also have a deep knowledge of the audit review process and audit documentation requirements.

About Globalview Advisors

Globalview Advisors offers financial valuations and transaction advisory services for publicly listed and privately owned/unquoted companies in the U.S., the U.K., Europe, Asia, and other locations globally.

The firm’s services encompass valuations of businesses, intangible assets, debt, equity, and derivative instruments for:

The firm’s transaction advisory services are primarily rendered for:

Contact Information

For more information, please contact Michael Haghighat, ASA at +1 (949) 475-2801 or mhaghighat@globalviewadvisors.com or Raymond Rath, ASA, CEIV™, CFA®  at +1 (949) 475-2808 or rrath@globalviewadvisors.com.