FASB Simplifies Valuation of Private Company Stock

Private companies face many challenges when determining the fair value of equity awards for accounting purposes. ASU 2021-07, issued by the FASB in October, aims to make one of those challenges a little easier.

Valuing Company Stock

Before companies can determine the fair value of their equity awards, they first must establish the value of their common stock. This is a critical input necessary to establish the fair value of all types of equity instruments. Valuing the stock of a public company is a straightforward process; the value is based on the prices at which the stock is currently trading.

But for private companies, establishing the value of their stock can be one of the most challenging components of award valuation. With no established market for their stock, private companies have few, if any, stock trades that the value can be based on.

To help companies address this challenge, the FASB issued ASU 2021-07, which updates ASC 718 to provide a practical expedient that private companies can utilize to determine the fair market value of their stock. This practical expedient can only be used when valuing awards that receive equity treatment under ASC 718; it is not available for the valuation of liability awards.

The Practical Expedient

Under ASU 2021-07, private companies “may use a value determined by the reasonable application of a reasonable valuation method.” So far, this doesn’t sound all that practical or expedient, but the ASU goes on to enumerate several factors that should be considered to ensure a reasonable stock valuation. These factors include the following:

• The value of the company’s tangible and intangible assets.
• Present value of the company’s anticipated future cash flows.
• The market value of the stock of similar companies.
• Recent sales of the company’s stock.
• Other relevant factors, such as control premiums or discounts for lack of marketability and whether the valuation is used for purposes that have a material economic effect on the company, its shareholders, or its creditors.
• Use of a consistent valuation method for other purposes for which the company’s stock is valued.

The ASU stipulates that a stock valuation is not reasonable in the following circumstances:

• The valuation fails to take into consideration all the available information material to the value of the company.
• The valuation fails to reflect information available after the date of the calculation that may materially affect the company’s value.
• The value was calculated more than 12 months prior to the date for which the valuation is being used (i.e., the grant date or modification date).

Section 409A

Perhaps most helpfully, the ASU notes that a valuation performed in accordance with Treas. Reg. §1.409A-1(b)(5)(iv)(B) is an example of a reasonable valuation, provided it meets the aforementioned conditions (i.e., factors to be considered in the valuation, completeness, and timing). Thus, private companies will generally be able to use their valuation obtained for Section 409A purposes when valuing options and awards under ASC 718.

Measurement-Date-by-Measurement-Date

If used, the practical expedient must be applied on a measurement-date-by-measurement-date basis, which means that it must be applied to all transactions (e.g., grants and modifications) that occur on the same date.

Transition

The practical expedient is effective prospectively for fiscal periods beginning after December 15, 2021 and for interim periods within fiscal years beginning after December 15, 2022. Early adoption is permitted.

Thanks to Elizabeth Dodge of Equity Plan Solutions for bringing the ASU to my attention.