Posts

, , ,

3 quick tips for streamlining your stock-based pay plans

Keep your employees motivated with stock-based compensation, the thinking goes, and you will be rewarded with high productivity and gains in your company’s growth track. What managers often fail to consider is that if they make mistakes along the way—and we’ve seen many when it comes to equity-based compensation plans—they could actually end up with low employee morale, putting a crimp in the pace of the performance-aligned goals they have set up.

Whenever a company has to amend awards previously made or restate their financial statements because of adjustments in equity-based comp, employees will naturally have concerns—even when the change has little, if any, financial impact on them.

The risk of dents in morale is just one of many consequences RoseRyan has observed while helping clients with issues in their equity-based pay strategies. You’d be amazed at the range of problems we have seen—many of them due to honest mistakes. In our experience, 9 out of 10 companies have had some issue with their underlying stock data that affects their stock-based compensation expense.

To prevent such problems at your company, consider these three tips the next time you evaluate your stock-based compensation strategy (we’ll get into more detail about this topic at our February 26 luncheon called Compensation for Private Companies: The Ins and Outs of Equity, which will be held at BayBio with Kyle Holm, associate partner at compensation consulting firm Radford).

Be obsessive about looking for modifications: Some modifications are obvious (say, repricing a stock option); some modifications are less so (say, allowing a consultant to keep options after you hire that person as an employee). Keep an eye out not only for board decisions but also for management decisions, material transactions, and liquidity events. The rule is, any change to the award or the award holder’s status should trigger consideration of accounting modifications.

Identifying that you have a modification is just the first challenge; the accounting can be tricky as well. How you account for the modification will depend on the type of modification. Variations include measuring the incremental value only, accelerating the expense, or valuing the new award and reversing the value associated with the original award. You also need to be sure you’re entering the modification in your equity system in a way that captures the appropriate modification accounting.

Make sure performance-based awards are on everyone’s radar: Performance-based awards are great tools for both retaining employees and motivating goal-driven behavior. But there is accounting risk here as well. With performance-based awards, companies must assess the probability of achieving the metrics at each reporting date and adjust the expense accordingly. This step often doesn’t happen. Maybe the board minutes lay out the performance goals associated with an award, but the stock administrator gets only a spreadsheet of grants to administer, with no indication that vesting is contingent. Or maybe the stock administrator is aware of the performance targets but doesn’t flag performance-based grants in the equity system, so the accounting team doesn’t know they exist. Such miscommunication can lead to overstated stock-based compensation expense.

Tie your 409A valuations to major grant dates: For private companies, the rule of thumb is to obtain a 409A valuation of your stock at least once a year, and in conjunction with major events such as financings, significant transactions, or material changes to the business. Some companies instead tend to do their 409A at the end of the year, just because they’re doing other valuations and financial decompressions at the same time. But think about this example, from one of our clients that approved a major grant to executives and employees in June 2011, six months after valuing its common stock at $1.25 per share for its annual 409A. By that point, the value of the stock had increased significantly—to $3—based on several design wins and other economic factors. While that’s a nice problem to have, they suddenly faced additional stock-based compensation expense and time-consuming updates to their equity system, among other issues.

It’s easy to think your equity-based compensation is under control; however, we have found time and again that it’s an ever-evolving tool that needs tending to, as your headcount grows, the complexity of your company expands, and situations evolve.

Get in the mode of reevaluating your pay strategy during the RoseRyan February 26 Lunch & Learn seminar about equity in South San Francisco. It will be geared toward private companies. Click here to register. And for more details about these best practices as well as some others to consider, also check out the RoseRyan intelligence report I wrote called Stock options: do you have a problem?.

Kelley Wall leads RoseRyan’s Technical Accounting Group, which provides technical accounting and SEC expertise to public and private companies on complex accounting matters and implementation of new accounting pronouncements. 

/by

RoseRyan videos deliver the big picture on IPOs, equity comp, and valuation

We know that making time to attend a seminar is tough in our over-scheduled lives. And reading presentation slides is rarely an ideal way to connect the dots of complex subjects. Maybe you’d like to expand your knowledge while wearing your sweats and eating popcorn? Well, now you can.

We’ve made getting guidance easy—with our videos, you can take in valuable information while propping your feet up on your desk or walking your way to fitness at your mobile workstation, if you insist on multitasking.

Check out videos of our three most recent seminars:

IPO Bound? New Strategies, New Ideas and Tips for Success

IPO ahead? Learn the dos and don’ts at key stages and get legal, finance and auditor perspectives on how to get your house in order, tell your business story, nail your S-1 and hit your runway. (This program provides great business advice, even if an IPO’s not in your future.)

Equity Compensation: End-to-End Strategies for Private Companies

Whether your plans are for growth or a lucrative exit, don’t let thorny equity compensation design and execution issues ground them. Get legal, HR, accounting and industry perspectives on setting yourself up for success, avoiding common pitfalls and planning for an M&A deal or IPO.

Valuation Metrics and Drivers in Today’s Economy

Whatever your goals, a high valuation is a top priority. Demystify the valuation equation and understand market variables, business model economics, and analyst and investor perspectives; develop a valuation strategy; and avoid mistakes and deal breakers.

/by
,

Year-end heads-up: don’t let equity issues take you by surprise at audit time

December 31 is fast approaching. Can audits be far behind? Every year as we help our clients maneuver through the audit process, it seems that one of the areas that can cause significant difficulties is equity. It’s not so much the basics, like recording the issuance of 5 million shares of Series C preferred at $3 a share, or the exercise of a stock option, but the “little” issues that don’t pop up until the financial statements are actually being prepared and the footnote disclosures drafted. Things like stock option modifications (that’s a modification?!), accounting for nonemployee options (what do we remeasure and when?), common stock valuations (we did a 409A valuation in October; why do we need another?) and warrants (what do you mean, the warrants are liabilities?). Let’s take a closer look at these issues.

Stock option modifications

Everyone recognizes that a stock option repricing is an option modification. But a lot of other transactions are also considered modifications—and as such have accounting consequences—including extending the post-termination exercise period; exchanging stock options for other types of awards, such as restricted stock units; and changing the option holder’s status from consultant to employee (or vice versa). Altering the vesting terms of an option or other award can also trigger accounting ramifications. In some cases, only the timing of the expense may be affected. In other cases, including accelerating vesting at termination or changing performance criteria, the value of the option must be remeasured, and additional expense may result.

Accounting for nonemployee options

In general, the measurement date for a nonemployee option is the vest date, not the grant date. So technically, you should remeasure nonemployee options on each vesting date, which can be a rather daunting task if your options vest monthly. Fortunately, most auditors are okay with quarterly remeasurement. However, if you are calculating all remeasurements at year’s end, you may discover unexpected issues related to common stock valuations (see below). Also keep in mind that not all software is created equal when it comes to managing nonemployee stock options. Testing your system by manually recalculating expense for a sample of nonemployee options is always a good practice.

Another thing to remember: once each option tranche has vested, the vested shares are no longer subject to remeasurement. We occasionally see situations in which a company has continued to remeasure all shares until the option is fully vested. This practice misstates expense, frequently overstating it.

Common stock valuations

How often do you really need to have a common stock valuation, also referred to as a 409A valuation, performed? The answer is one of those very definite “it depends.” If your company is relatively stable, an annual valuation may be sufficient for both tax and accounting purposes. But if your company is dynamic and reaching significant milestones, you will likely need 409A valuations more frequently. Let’s say you closed your Series C round in September and had a 409A valuation performed in conjunction with that event. In December, your company achieved a significant milestone, like introducing a new product or receiving a favorable result on its Phase III trial. The December milestone increased your company’s value and likely requires a new 409A valuation. Performing the valuation contemporaneously and proactively is best. Dealing with it when your auditors request it usually adds significant time to the audit and could add to the cost of the valuation if the valuation firm has to expedite its work to meet your timelines.

Warrants

Warrants could easily be the subject of an entire article, but here are a few things to be aware of for now. Companies frequently issue warrants for preferred or common stock in connection with debt agreements (bridge loans, term loans, lease lines, and so on) or equity offerings. In all cases, the proceeds that the company receives must be allocated between the warrants and the base loan or equity offering. If the warrants are for preferred shares and there’s any possibility your company will redeem the underlying preferred shares for cash, the warrants are considered liability instruments and must be revalued at each balance sheet date with the change in value flowing through the statement of operations. In addition, if the base loan is convertible into equity, as is generally the case with bridge loans, the warrant will usually create a beneficial conversion feature because of the allocation of a portion of the proceeds to the warrant. Addressing these situations can be confusing and time consuming. Best practice is to discuss them with your accounting advisors before actually sealing the deal so that any accounting issues can be addressed up front.

Wrap up

Before you say good-bye to 2012, do two things. First, review your equity transactions, stock option records, board minutes and other relevant documents to determine whether any of the transactions or situations I’ve described occurred during the year. Then discuss your findings with your accounting advisors, equity service providers or both to ensure that the proper accounting treatment has been applied. You will certainly be better prepared for your audit, and you may save yourself from some significant headaches and maybe even some audit fees.

 

/by
,

New report: sober up your equity compensation accounting

Stock options in Silicon Valley are like free drinks in Las Vegas—and accounting for equity-based compensation often gets treated with the breezy inattention of a gambler ordering another round. But eventually some kind of tab will come due. Think company money and time, restatements and increased auditors’ scrutiny.

Our new report, Stock Options: Do You Have a Problem? by Kelley Wall of RoseRyan’s Technical Accounting Group walks you through the issues we see regularly and tells you how to get clean.

Don’t think this applies to you? Equity-related restatements most often stem from honest mistakes—and they’re more common than you might think. Why? Some companies aren’t fully aware of accounting requirements. Others have incomplete or broken internal processes. And some rely on equity systems with parameters and limitations they don’t really understand.

Let’s take one example. Stock-based awards to employees and nonemployees are accounted for differently. No big deal—but the problem we’ve observed is that companies fail to identify nonemployee recipients as nonemployees. Perhaps the stock administrator assumes all the grantees on a list of option grants are employees. Or the equity administrator doesn’t set up the system to identify both the individual and the grant as nonemployee. Or the accounting department doesn’t realize there are nonemployee awards, so it doesn’t ask for nonemployee stock-based compensation expense reports. In each case, the result is an understatement of expense.

You can avoid this and many other costly accounting mistakes by adopting our recommended best practices in the areas of communication, valuation, modifications/special arrangements and forfeiture rate estimation.

Don’t become yet another sobering example of a painful accounting breakdown. Check out our report to ensure that your equity compensation practices are up to snuff.

/by

Why are stock options so difficult to account for?

I attended the recent Stock Options Solutions annual conference for executives and stock plan staff from private companies targeting a liquidity event. One of my major quests was to identify why so many companies get caught up in stock option problems, which I have found to be an issue for our small, midsize and large clients.

There were 21 panels throughout the day and about 150 attendees. The sessions covered quite a range of topics, including ESPP essentials, international equity and tax accounting. I attended these panels:

  • Stock Plan Vendor Analysis, Selection and Implementation – Perfecting the Process
  • The IPO Abyss: Splunk-ing through the Challenges of Equity and Executive Compensation
  • Get Ready to Rumble: Making Your Equity Plan Data IPO-Ready
  • Avoiding Pre-IPO Financial Reporting Mistakes that Cause Post-IPO Restatements
  • Stock Options, RSUs and Other Awards: Key Considerations for Emerging Companies

In the pursuit of my quest, these three areas stuck out to me:

  1. Executive compensation is an art and a science. There is a fine line between controlling windfalls and motivating management and employees. It is vitally important to have critical data and support (as well as documentation) for how executives are compensated with stock. The compensation committee is a complex group that balances investor control with equitable compensation. It appears that directors’ fees are up due to added regulatory risk and complexity, and the overall allocation of stock as compensation has made things more complex, leading to the potential for more mistakes.
  2. Pre-IPO mistakes in equity can be made on even the simplest calculations. In many examples at the conference, simple spreadsheets calculated options incorrectly, leading to errors in proper accounting treatment. In addition, timing of the valuation (409A) can have a significant impact depending on how often options are being awarded.
  3. The type of rewards your company will utilize requires careful thought. Should you use restricted stock units? Incentive stock options? Something else? It is critical to design a proper system that allocates the intended percent of the pool that executives, employees and investors receive. Many fear the power institutional shareholders have based on their ability to scrutinize compensation once a company files its S1.

Confusion about properly accounting for stock options is usually based on the following issues:

  • The accounting rules are changing too fast.
  • Employees administering the options leave the position or the company.
  • There are inadequate records of the grants.
  • The source information is in many different locations.

The good news is that all of this can be managed with proper systems and processes, and the proper human interaction. The key is to juggle the growth of your company with the needs of a first-class stock option recording system, and to maintain the discipline to review it on a regular basis—ideally quarterly.

/by