IRC 409A

In 2005, the IRS published regulations under a new provision of the Internal Revenue Code, known as IRC 409A. These new rules imposed expensive taxes and penalties on both employers and employees if stock options were issued below "fair market value." Employers have to withhold payroll taxes. And employees face payment of taxes from current income for unrealized gains, plus a 20% penalty tax.

Public companies can be sure that they are issuing options at or above "fair market value" simply by looking at the market price for their stock. (The recent controversy about backdating options centers on companies that selected dates when the trading price was lower than on the date of actual option issuance.) But private companies cannot so easily know "fair market value." The proposed IRS regulations offer some assistance to them. IRC 409A created three "safe harbors": obtain a professional appraisal; perform an internal valuation meeting certain standards; or utilize an "buy-sell" agreement for all equity.

Using a "buy-sell" agreement is not practical for most emerging growth companies. And the standards for performing an internal valuation are high (the valuation must be performed by an officer or director with knowledge and experience in valuations and must employ specified techniques). So, most companies are obtaining an independent, professional appraisal.

SFAS 123R

In 2001, the Financial Accounting Standards Board revised its standard for the accounting of stock options issued as compensation, now known as SFAS 123R. Public companies were required to fully implement its provisions during 2006 and the accounting profession is pressing for implementation by private companies too.

Like IRC 409A, SFAS 123R requires that companies know the "fair value" at the time of issuing the options and at intervals thereafter (the FASB uses "fair value" instead of "fair market value," but has stated that they are consistent with one another). "Fair value" is best established by an independent, professional appraisal.

Appraisal Services

Pagemill Partners specializes in providing independent, professional appraisals to emerging growth companies. Unlike at traditional valuation firms, the professionals at Pagemill Partners understand technology and the special demands of rapid growth.

We use accepted valuation techniques, such as an analysis of discounted cash flows or comparisons to public or acquired company prices, to determine the value of the entire company. We then create a custom Black-Scholes model to allocate that value to the various classes of equity: preferred, common, options, and warrants. After applying an appropriate discount for lack of liquidity, we arrive at a "fair value."

A valuation report from Pagemill Partners complies with all of the requirements of both IRC 409A and SFAS 123R. Our clients have used our reports for their audits, tax reporting, and even SEC filings.

We can complete an appraisal in a very short time and without a large commitment of management time. Our fees are reasonable and are based mainly on the size and project of the complexity. We stand behind our work, whether in providing periodic updates or supporting a client in an audit.