Valuation of Private Company Stock Options

Proposed regulations under Internal Revenue Code Section 409A are expected to significantly impact the need for private companies to support their determination of fair market value in setting exercise prices for stock options and other stock based compensation.

While there are a number of exceptions and safe harbor provisions in the proposed regulations, they are largely based on a presumption that fair market value has been determined on a reasonable basis using recognized methods and adequate documentation.

If an exercise price is found to be less than fair market value, adverse tax consequences for the recipient can include taxation at the time of vesting rather than at the exercise date and a 20% penalty. The company would have tax withholding responsibilities at the time of vesting and potentially for additional amounts if the stock value increases over time.

Companies can support their determination that exercise prices are set at fair market value by using one of the following methods:

Independent Appraisal - A valuation by a qualified independent appraiser as of a date that is no more than 12 months before the transaction date.

Inside Written Valuation – Companies that have been in business for ten years or less and are not expected to undergo a change in control or go public within 12 months may rely on a written report by someone who is not independent of the company, such as a CFO or board member, if such person has significant knowledge and experience or training in performing similar valuations.

Formula Valuation - A valuation based upon a formula such as a percentage of company revenues. This method can only be used under rather narrow conditions that will likely make it unavailable to most emerging growth companies.

The Financial Valuation Group provides independent appraisal and valuation consulting services through our network of 12 U.S. offices. We can perform the timely independent appraisals companies need to support their determination of fair market value for stock option pricing. We can also provide consulting assistance to companies that prefer to prepare inside valuations.

The Financial Valuation Group's staff of full-time consultants and appraisers brings together a strong combination of professional expertise and training.  CPAs, MBAs, ASAs, economists, engineers, JDs and MAIs unite their disciplines with their consulting and entrepreneurial experience as business people.  This mix of professional business experience provides the firm with comprehensive skills and business acumen.  The backgrounds of our professionals encompass a wide range of consulting and valuation experiences, which span many industries resulting in the ability to quickly and accurately assess your consulting/economic requirements from a practical standpoint.