Cashing In by Checking Out

The motivation behind incentive pay at the startup level is that in order for the employees to strike it rich, the company must succeed by hitting certain milestones. This aligns employees’ personal goals with the company’s overall success. The slight misalignment of this structure, however, can lead to employee turnover at companies.

Market Participant Perspectives

We have published a collection of these posts in a book entitled “Market Participant Perspectives: Selections from Mercer Capital’s Financial Reporting Blog.” For our existing clients and blog subscribers, we hope that the book uncovers a post or two of interest that you might have missed the first time around. For clients that we haven’t met yet, there’s probably no better introduction to our team than the collection of posts in this book.

Windfall or Shortfall? Equity Compensation for Outside Service Providers

In a typical service provider-customer relationship, the provider delivers a service and the customer delivers cash. Upon delivery, both parties are happy and move along to the next transaction. However, a trend that gained popularity in the early 2000s adds an extra level of complexity to this seemingly simple business relationship – equity payments.

Non-GAAP Measures: Here to Stay?

The debate over the use of non-GAAP performance measures continues. Even as the prevalence of these items grows in the financial reports of public companies (and those that want to be), cautionary tales of the uses and abuses of such metrics garner headlines. A recent New York Times piece entitled “Fantasy Math Is Helping Companies Spin Losses Into Profits” pretty much sums up one side of the issue with its headline alone.

A Layperson’s Guide to the OPM: Everything You Always Wanted to Know About the OPM, But Were Afraid to Ask (Part 1)

The option pricing model, or OPM, is one of the shiniest new tools in the valuation specialist’s toolkit. While specialists have grown accustomed to working with the tool and have faith in the results of its use, many non-specialists remain wary, as the model – and its typical presentation – has all the trappings of a proverbial black box. The purpose of this post is to clarify the fundamental insight underlying the model and illustrate its application so that non-specialist users of valuation reports can gain greater comfort with the model. In Part 2, we will provide address some qualitative concerns regarding use of the method in practice.

Marking Illiquid Investments in Liquid Funds

As mutual fund flows continue to favor passive strategies, some active fund managers are beginning to look to alternative asset classes to augment returns and generate sustainable alpha. Since open-end funds need to calculate NAV on a daily basis, the inclusion of illiquid venture capital investments in liquid funds shines a brighter spotlight on fair value measurement.

Preferences and FinTech Valuations

Despite a strong year in the FinTech sector, IPO pricing is always tricky, especially in the tech space. In this post, we consider Square’s IPO and how preferences associated with shares affect valuations.

Crowdfunding: SEC Issues an Investor Bulletin

In prior blog posts, we noted a couple of regulatory changes that eased some restrictions on (relatively small) securities-based fundraising from a wide base of investors: Regulation A+ and crowdfunding. This blog post provides an update on crowdfunding, discussing the rules and risk items with valuation implications in the SEC’s investor bulletin.

Are IPOs the New Down Round?

There’s something about nature that abhors a vacuum. Right now that vacuum seems to be the imbalance between the public and private markets, with the latter attracting maybe too much interest since the credit crisis, at the expense of the former. Blame fair value accounting or Sarbanes-Oxley or the plaintiff’s bar, but it has been some time since being public was actually considered a good thing. With interest running high in the “alternative asset space” and cheap debt for LBOs, the costs of being public have not been particularly worthwhile. This situation is not sustainable, and was never meant to be. Family businesses can stay private forever, but institutional investors eventually need the kind of liquidity that can only come from the breadth of ownership afforded by established public markets. Valuations are never really proven until exposed to bids and asks.

The IRS Equity Compensation Audit Guide

What do IRS examiners look for when auditing filings with equity-based compensation plans? The IRS recently released its Equity (Stock)-Based Compensation Audit Techniques Guide, which offers an opportunity to see how the IRS views equity-based compensation arrangements. The guide is intended to assist IRS examiners, as well as to provide insight to corporate and individual taxpayers. Our overview of the Guide is presented in this post.

Unicorn Valuations: What’s Obvious Isn’t Real, and What’s Real Isn’t Obvious

In the two short years since Aileen Lee introduced the term “unicorn” into the VC parlance, the number of such companies has steadily increased from the 39 identified by Lee’s team at Cowboy Ventures to nearly 150 (and growing weekly) by most current estimates. Pundits and analysts have offered a variety of explanations for the phenomenon, with some identifying unicorns as the sign that the tech bubble of the late 1990s has returned under a different guise, others attributing the existence of such companies to structural changes in how innovation is funded in the economy, and the most intrepid of the group suggesting that the previously undreamt valuations are fully supported by the underlying fundamentals given the maturity and ubiquity of the internet, smart phones, tablets, and related technologies.

Look Before You Leap: Evaluating a Section 83(b) Election

It is easy to see how employees receiving restricted shares and making a Section 83(b) election can benefit if the price of the stock rises between the grant and vesting dates. An 83(b) election may appear especially appealing to (early stage) startup employees who tend to be (preter) naturally optimistic about the prospects of their employer companies. However, the benefits of a Section 83(b) election – especially after consideration of the risks involved – may be less significant than originally anticipated. Three conditions (often outside the control of the employees) must be met for an 83(b) election to provide a (risk-adjusted) advantage: (1) Securities awarded as compensation have relatively low values at the time of grant; (2) the exit event for the employer company, or other transactions that may provide liquidity to the employees, occurs at relatively high implied valuations; (3) employees remain employed at the granting company until the awards vest. This blog post will primarily address the first condition.

Equity-Based Compensation: Are Non-GAAP Earnings Misleading?

During the 1990s debate over the status of stock options as a corporate expense, the big technology companies argued passionately that, since stock option grants to employees don’t ding the corporate checkbook, they should not be recognized as an expense. Despite winning the initial battle (SFAS 123), the tech companies ultimately lost the war (SFAS 123R). Regardless of the ongoing debate about how best to measure earnings, stock-based compensation is a tool used by companies of all sizes and in all industries. In order to deliver the most reliable information to investors, companies need to carefully evaluate the value of such compensation packages when granted.

New Rules Aim to Claw Back Incentive-Based Pay

On July 1, the SEC proposed new rules to require public companies to clawback certain types of incentive-based executive compensation if the award was improperly given due to accounting misstatements. For example, if an executive received a bonus based on the company achieving a revenue target and it is subsequently determined that revenue was misstated, the bonus would be subject to clawback.

8 Things You Need to Know About Section 409A

Section 409A applies to all companies offering nonqualified deferred compensation plans to employees. We are not attorneys, so we will leave the legal minutiae of that definition for others to grapple with, noting only that generally speaking, a deferred compensation plan is an arrangement whereby an employee (“service provider” in 409A parlance) receives compensation in a later tax year than that in which the compensation was earned. “Nonqualified” plans exclude 401(k) and other “qualified” plans.

How to Value Venture Capital Portfolio Investments

In this post we describe our process when providing periodic fair value marks for venture capital fund investments in pre-public companies. This process includes examining the most recent financing round economics, adjusting valuation inputs the measurement date, measuring fair value, and reconciling and testing for reasonableness.

Rest and Vest

Estimating the fair value of stock-based compensation and accounting for it properly can be complex. This post discusses the “rest and vest” scenario through the lens of the HBO program, Silicon Valley.

Why Quality Matters in Valuation for Equity Compensation Grants

For privately held companies (particularly those sponsored by private equity and venture capital funds), getting the valuation process right the first time for equity compensation grant compliance is always the least expensive route in terms of both direct and indirect cost.

Consequences of Calcified Cap Charts: A Few Thoughts on Startup Equity-Based Compensation

In a prior blog post, we noted a plethora of pricing indications observed around Box, Inc.’s (NYSE: BOX) initial public offering and asked the question, “Which price is right?” The prices (and implied valuations) that a business venture can obtain in future funding rounds, and in the public markets, are important considerations from the perspective of VCs and other investors. Unlike most mature public companies, however, startups have a predilection for complex capital structures, which introduces a degree of opacity that makes simple inference from headline numbers (however correct, however precise) difficult. A future funding round or exit event can result in varying outcomes for the multiple classes of securities with dissimilar rights and protections. This blog post will focus on the impact of (relatively steep) pre-public pricing on equity granted as employee compensation, usually the junior-most security in a startup capital stack.

Noncompete Agreements for Section 280G Compliance

Golden parachute payments have long been a controversial topic. These payments, typically occurring when a public company undergoes a change-in-control, can result in huge windfalls for senior executives and in some cases draw the ire of political activists and shareholder advisory groups. Golden parachute payments can also lead to significant tax consequences for both the company and the individual. Strategies to mitigate these tax risks include careful design of compensation agreements and consideration of noncompete agreements to reduce the likelihood of additional excise taxes.

How to Value a Company Planning to IPO

After the markets closed on September 18th, Chinese technology giant Alibaba priced the shares for its long-awaited IPO at $68 per share, higher than the previously expected range of between $60 and $66 per share. When measuring the fair value of equity-based compensation granted prior to an IPO, should the expected IPO price range or even the actual IPO price be indicative of the fair value of the shares at the time of the grant? Alibaba’s Form F-1/A dated September 15, 2014 notes that the company issued both options and restricted stock units up through September 5th. According to the company, the fair value of Alibaba’s ordinary shares was $59.00 for the most recent grant.

Review Finds Equity-Based Compensation Reporting Works as Intended

Equity-based compensation (stocks, options, or something more exotic) is a useful tool for firms to hire and retain employees. Through shared ownership, such remuneration is commonly thought to align the incentives of employees, firms and other shareholders. In the case of startups, equity-based compensation can be particularly effective as it allows younger firms to conserve cash and obtain a greater degree of employee buy-in while competing effectively with much larger, established entities to acquire talent. Equity based compensation is attractive also because of the flexibility in structuring pay – human resources personnel and compensation experts are able to continually tinker terms and conditions to tailor awards to promote short, medium or long term goals of firms.

Rest and Vest

Estimating the fair value of stock-based compensation and accounting for it properly can be complex. This post discusses the “rest and vest” scenario through the lens of the HBO program, Silicon Valley.