Does 409A kill the IPO Bump?
Several Silicon Valley bloggers have been pondering the question of whether 409A rules are leading to the end of the IPO Bump. The IPO Bump refers to the difference in the exercise price of stock option grants and the offering price of an IPO. In particular, several companies, such as Facebook, have had trades in privately held common stock reported on sites such as Sharespost.com. For instance as one blogger, Don Dodge, put it “The effect of the 409A requirement, and the new movement of private investors buying vested stock options from employees, is that pre-IPO valuations, and thus the employee stock option prices are very close to the expected IPO price. So, how will there be a big bump in the stock price at IPO?” See Will Facebook have an IPO Bounce? Has 409A Changed the Game? for his full posting.
Two Cases: Tesla Motors and Fabrinet
Great question! However, the companies that have had their common shares trade on a pre-IPO basis (such as Facebook and Zynga) have not yet filed for IPOs. So we do not know whether their stock option grants in the months prior to an IPO will be at prices near, above, or below the levels determined in their 409A valuations.
However, looking at two relatively recent IPOs by venture-capital backed technology companies (Tesla Motors and Fabrinet), evidence of the IPO Bump can still be found. (I am not picking on them, I happened to have these companies’ SEC filings handy as I write this.) Both these companies issued stock options to employees with strike prices lower than their IPO offering prices.
Tesla Motors went public at $17.00 per share and is now trading above $24.00 per share. According to SEC filings, the company issued stock options at $6.63 per share six months before the IPO and $9.96 per share four months before the IPO.
Fabrinet went public at $10.00 per share and is now trading above $15.00 per share. According to its SEC filings, Fabrinet issued stock options at $5.75 per share in the six to eight month period before its IPO.
Those sound like pretty good Bumps.
Of course, most options are on multi-year vesting schedules. So employees won’t see any profit on their shares until they are exercised (and assuming the price of their shares does not decline).
What about Facebook?
Sharespost.com recently reported the sale of Facebook stock at a price of $20.00 per share which they equated to a $45.4 billion dollar valuation. Interestingly, according to state disclosures filed in November 2009 and January 2010, Facebook issued stock options for 27.5 million shares of common stock at a fair market value of $16.17 per share. Facebook executed a 5 for 1 stock split in October 2010, so these options would presumably be valued at $3.23 per share on a post split basis. At that time (December 2009) Sharespost.com reported a sale at $5.40 per share. According to Sharespost.com, in April 2010 the transaction price jumped to $10.00 per share and has increased since.
$3.23 to $20.00 sounds like a pretty good Bump. Of course, that depends on whether or not you believe Facebook will be worth $45 billion once it is listed on the public market. I couldn’t find any Facebook stock option disclosures that had been filed since January 2010. So I don’t know if there have been any more recent stock option grants or what their prices may be. There are press reports that a Facebook IPO may not occur before 2012. If Facebook has ceased issuing stock options, this would indicate at least a two-year period of time between the issued stock options and an IPO. So for Facebook, the IPO Bump may be on hold.
A company can always choose whether to issue stock options or use other compensation programs to provide incentives to management. However, stock options continue to be an important element of compensation for many companies. If a company does issue stock options in the months before an IPO, then the company should expect intense scrutiny by auditors and SEC staff. The perception of cheap stock issuances by the regulators threatens to dampen, if not kill, the IPO Bump.
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Bill Denebeim is a Vice President of The Brenner Group and has more than twenty years experience providing financial, regulatory and operational consulting services to executive management and investors of technology companies. Bill received his M.S. in Operations Research from Stanford University and his B.A. degree in Economics and English from the University of California at Berkeley. Bill is a holder of the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of San Francisco.
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