In response to feedback from private company stakeholders, the Private Company Council noted that determining the fair value of traditional share-option awards at the grant date or at a modification date is costly and complex as private company equity shares often do not have an observable market price, as the shares are not actively traded. In determining the grant date value of the share-option awards, a valuation technique such as an option-pricing model is typically used in which the fair value of the equity shares is a required input.
In an effort to reduce the cost and complexity of the determination of the fair value of equity shares for private companies, the FASB has issued an Exposure Draft that would allow these companies to use a practical expedient in determining the equity share fair value. Under this practical expedient, the nonpublic entity would be allowed to determine the current price input of equity-classified share-option issued to employees and nonemployees using a valuation method in line with regulations of the U.S. Department of Treasury under the presumption of reasonableness requirements in Section 409A. Under these requirements, the nonpublic company would be allowed to use one of the following:
- Valuation from an independent appraisal within twelve months of the preceding grant date
- Valuation based on a formula that would be fair market value of the share, if used as part of a restriction that doesn’t lapse with respect to the share
- Valuation made reasonably and in good faith, which is evidenced by a written report that considers the relevant factors of the illiquid shares of a start-up corporation, as defined by the regulations
Nonpublic companies would be required to follow the presumption of reasonableness regulations, if the practical expedient is elected. As the second and third options listed above have limited availability, the first option of getting an independent appraisal will often be the method used by nonpublic entities. The Exposure Draft does align the requirements of both Topic 718 and of Section 409A; thus, a single valuation can be obtained to satisfy both requirements.
This Exposure Draft is not applicable to liability-classified awards. The practical expedient can be elected on an award-by-award basis. Prospective application for all qualifying awards granted or modified would be applied. The effective date will be determined based on stakeholder feedback, and early implementation would be permitted.
The comment deadline for the Exposure Draft is October 1, 2020. The full text of the Exposure Draft is available here.
Readers should not act upon information presented without individual professional consultation.