Stock Options for Startups

Stock options have made a lot of people rich, and given a lot of people headaches.  In the startup community, stock options are necessary to attract talent, provide value, and retain critical human capital.  But there are more pitfalls in accounting for options than Minnesota has lakes. Accounting guidance states that stock options, whether issued in public or private companies, are valued at the grant date.  Calculating the fair value of an option for a public company is rather easy if you know what you’re doing, but private companies aren't so lucky.  In order to determine the fair value, one of the inputs you will need to know is the value of underlying stock on the grant date.  However, if there is no buying/selling in a freely trading market, how is one to know what the fair value is?  Here are a few suggestions to calculate the value of your startups common stock if you don't have a formal valuation done by an expert:

  1. What is the per share value of the last sale to a third party.  When a willing third party buyer and willing seller exchange cash or other value for shares, the value of those shares can be considered fair value.
  2. Use metrics within your industry.  Did two of your competitors just sell their companies for 2x top line revenue or 5x EBIDA.  If you have comparables that can be applied to your company that is also a good starting point.  Make sure to discount as appropriate for lack of marketability, etc.

The bottom line is when you start issuing options; contact a qualified accountant to assist you in stock option accounting.  Lawyers can draft option plans, and may be able to advise you on some tax issues, but accountants are needed to tell you how those options affect your company.  As a final word of wisdom, contact your accountant before issuing options, rather than after.  Suggestions on the strike price and potential dilution can significantly improve the functionality of those options without negatively impacting the company.

dbbmckennon is a full service CPA firm with offices in Orange County and San Diego focused on providing quality accounting and consulting services at reasonable rates. For additional complimentary information regarding this topic or other questions you may have please call one of dbbmckennon‘s offices located in Southern California or contact us here.