Who Wants Bad 409a Compliance?
We spend our days immersed in IRC 409a valuations, advising clients and those charged with overseeing clients’ 409a compliance. If you are among the fortunate few who have not encountered this IRS rule, one of its provisions requires employers to issue stock options and SARs with exercise prices set to no less than fair market value – and have defensible and reasonable argument as to the methodology used for determining fair market value or face significant penalties and interest.
A valuation firm’s ability to positively make the case before tax or accounting auditors is an important criterion to selecting the valuator; however, often lost in the discussion is whether the outcome meets the good intentions of management. Most incentive equity awards are intended to be just that – an incentive. One of the key components to that incentive calculation is the exercise price set for the award. Ultimately, the size of the incentive will be measured by the difference between the exercise price and sale price for any particular grant, so getting the exercise price right makes a difference.
A Proper 409a Achieves a Balance
An award priced too high fails to provide an incentive to the recipient. An award priced too low will fail accounting and tax audit and result in significant penalties, interest, expenses, and perhaps more importantly, will be extremely demoralizing on other recipients, whose incentive awards may also be at risk of forfeiture.
Bottom line, there is good compliance (which provides the intended incentive and will stand up to challenge) and bad compliance (which provides no incentive or fails audit). The best chance for good compliance involves early engagement with a qualified, experienced valuator familiar with 409a’s intricacies and traps who knows how to defend his/her valuation.
John Heath is Executive Vice President, Valuations & Financial Advisory Services of The Brenner Group. John joined The Brenner Group® in 1994 and manages the firm’s Valuations and Financial Advisory Services Groups. John has more than thirty-five years of experience in corporate finance, and has assisted more than 600 companies with financing, public underwritings, mergers, acquisitions, and valuations. Prior to joining The Brenner Group, John held executive management positions at Smith Barney, The First National Bank of Chicago, and Price Waterhouse. He received an MBA in Finance from The Wharton School of Business, and a BA degree from the University of Pennsylvania. John is a member and Accredited Senior Appraiser of the American Society of Appraisers and a member of the Appraisal Issues Task Force.
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