The Financial Accounting Standards Board (FASB) has issued an Exposure Draft regarding an update to Accounting Principles Generally Accepted in the United States of America (U.S. GAAP) to address the fair value determination of private company stock in connection with equity awards. The draft is a refreshing common sense compromise for entities that qualify as private companies that under current GAAP must either obtain separate valuations for financial statement and tax compliance purposes or obtain a single valuation report to serve both purposes and risk falling short for one or the other set of standards. The proposed update allows a business valuation prepared for tax purposes to qualify for GAAP.
The practical expedient in this proposed update would allow a nonpublic entity to determine the current price of a share underlying an equity-classified share-option award using a valuation method performed in accordance with the presumption of reasonableness requirements of Section 409A of the Internal Revenue Code. Those regulations allow for the use of any one of the following three methods to meet the presumption of reasonableness requirements:
- A valuation determined by an independent appraisal within the 12 months preceding the grant date.
- A valuation based on a formula that, if used as part of a non-lapse restriction with respect to the share, would be considered the fair market value of the share.
- A valuation made reasonably and in good faith and evidenced by a written report that considers the relevant factors of the illiquid stock of a start-up corporation (as defined in the regulations).
The proposed update recognizes that a valuation performed in accordance with the IRS regulations uses a fair market value standard and acknowledges that this is similar to the fair value standard required by GAAP. The FASB is willing to allow for this difference as a practical expedient.
The current proposal applies only to equity-classified share-option awards, but in the Questions for Respondents is requesting input from practitioners and other interested parties regarding the application of this expedient to other equity based compensation arrangements (e.g., unvested shares).