Equity compensation can be a significant factor in attracting and retaining talent. Lately a lot of attention is being given to effective compensation strategy, investor expectations and shareholder dilution. Philosophies have evolved and rules and regulations have changed, but one thing that remains constant is there are often surprises in the accounting for stock awards. We see start-up companies struggling to get the accounting right, and we see struggles in public companies with well-designed internal control systems, too.
What not to do
Many of these challenges can be avoided simply by paying attention to the details. Getting the paperwork right sounds easy, but you’d be surprised at what can happen. Here are a few of the most common errors to be on the lookout for:
- The number of shares to be granted is a mystery, because the number of shares in the grant paperwork doesn’t agree with the number of shares approved in the board minutes.
- There is confusion over when the employee started work. It’s not uncommon for employment start dates to be revised between the time the offer letter is sent out and the day the employee actually shows up. Granting stock to someone before they are an employee can cause problems; the accounting for option grants to employees is different than the accounting for option grants to nonemployees. And some stock plans prohibit granting options to nonemployees.
- Stock is granted without proper approval. Understand (and communicate) who is authorized to grant stock or options. Having a clear stock grant policy is critical—as is making sure people understand it and follow it.
We also see data entry errors, which include:
- Grant date or option strike price are entered incorrectly.
- Vesting schedules are entered incorrectly (for example, a grant is entered as vesting ratably over four years instead of having a one-year cliff).
- The grant is not input or is input twice.
- Paperwork is not processed on a timely basis. This applies to inputting new grants as well as cancelling grants for terminated employees.
Keep accounting in the loop
Reconciliations are your friend. Make sure to reconcile your stock records to the transfer agent records as part of your monthly close process. Compare new hire listings to stock grant records, and termination listings to stock cancellation records. Double-check data input to source documents.
Modifications can have major accounting implications, including significant current P&L expense. Oftentimes companies make decisions about stock option modifications without considering the accounting implications. A good practice is to have your accounting department analyze modifications and compute the potential P&L impact before a decision is made. The stock options may still be modified because that makes business sense, but everyone will understand the amount of the additional expense before the modifications are approved.
And remember: a stock option grant modification is any change to the terms after the stock is granted; these include changing the number of granted shares, altering vesting terms and repricing options. (It’s not unusual for a CEO to agree to modifications with a terminating executive without discussing it with accounting—and that can result in huge P&L impacts that could have been prevented.)
Because stock is part of employee compensation, errors are a double whammy. They can have a significant impact on employee morale and motivation, for example, if employees don’t get what they thought they were getting, or if a grant has significant tax implications for them. Errors can also impact the company financially because incorrect data can affect the computation of stock-based compensation expense.
The good news is these problems can be avoided with education, discipline and communication. A good place to start is our upcoming seminar at the end of October.
