Stock-based compensation valuations for audited US GAAP financial statements — using Black-Scholes-Merton, Lattice, and Monte Carlo models.
Accounting Standards Codification (ASC) Topic 718, issued by the Financial Accounting Standards Board (FASB), prescribes how companies should account for stock-based compensation to employees — for example stock options or profits interests in limited liability companies — in compliance with U.S. Generally Accepted Accounting Principles (GAAP). With respect to equity awards such as stock options issued to employees, their value must be accounted for as an expense in the income statement. Similar rules for non-employees are provided in ASC Topic 505-10.
GAAP accounting is used for audited financial statements in the United States but is not a requirement for all companies. Very early stage companies, such as those in a Seed funding stage, will often not have audited financial statements given the cost and time involved. However, companies in later stages of development or established companies with multiple investors will generally have audited financial statements and will therefore need to consider ASC 718 if they provide equity incentives to their staff.
For valuations under ASC 718 the valuation standard used is Fair Value, as defined in ASC 820 — Fair Value Measurement. This standard is in many ways similar to Fair Market Value as defined by the IRS, but does have some material differences.
To discuss your ASC 718 valuation needs please email us at windeye@windeyepartners.com or contact Certified Valuation Analyst Michael Guthammar on telephone (929) 223-2935.
In order to value grants of standard stock options under ASC 718, the Black-Scholes-Merton (BSM) option model is normally used. The current stock price and exercise price are commonly derived from a recent 409A valuation for the company. The model requires the following inputs:
| Input | How It Is Determined |
|---|---|
| Stock Price | Current fair market value of common stock, typically derived from a recent 409A valuation. |
| Exercise Price | The strike price of the options being granted, also typically set at the 409A fair market value. |
| Time to Maturity | Based on vesting schedule and expected exercise behavior — rather than the contractual term of the options. |
| Risk-Free Rate | U.S. Treasury yield corresponding to the expected time to maturity. |
| Volatility | Derived from an analysis of the equity volatility of guideline public companies in the same or similar sector. |
| Dividend Yield | Only applicable for companies that pay dividends; typically zero for early-stage private companies. |
For non-standard options and other forms of equity awards, the Black-Scholes-Merton model cannot be used. Instead, a Lattice (e.g. binomial) model or Monte Carlo simulation is required. Windeye Partners has experience with all three approaches:
The standard model for plain-vanilla stock options. Efficient and auditor-accepted, using a single expected term assumption rather than modeling exercise behavior explicitly.
More flexible than BSM — accommodates specific assumptions for suboptimal exercise behavior and post-vesting termination, suited to awards with non-standard features.
Required for awards that depend on external market conditions, such as performance shares tied to total shareholder return (TSR). Models thousands of possible outcomes.
Once the Fair Value of the equity awards has been determined, the compensation expense for the company can be calculated, with the total value amortized over the vesting period. For example, if stock options have a 4-year monthly vesting schedule, the annual expense recognized in the income statement will represent 25% of the total equity award Fair Value.
Windeye Partners provides the valuation inputs and fair value conclusions required by your auditors, prepared in a format consistent with FASB ASC 718 and AICPA guidance.
Contact Windeye Partners to learn how we can assist you.