Are you a founder looking at doing a secondary sales transaction? If so, this article is a must-read. Today we’re answering the question: how does a secondary transaction get reported on ASC 718 stock option expense?
The quick answer is that a secondary transaction should not impact your ASC 718 reporting. However, going forward, It potentially can impact your 409a.
The logic being, that if there is a market made in the common stock that is far above what the 409a valuation is, you need to take a hard look at the situation. Think “ is that 409a accurate enough? Is it outdated? Should we be getting a new 409a if other people are willing to pay a lot more for that common stock than what the stock option price is determined by the 409a?”
So, that’s not always the case. Oftentimes, investors could have different motives for paying up. They buy common stock in a secondary transaction and pay more than the recent 409a valuation. Maybe they were not able to get into a company via preferred stock transactions? Maybe the VCs just got boxed out? So they’ll, therefore, irrationally pay whatever it takes to at least get into a company.
Also, there are negative situations when a founder does not execute, or does not get along with the team. There is then a premium put on buying that founder’s shares so that you can get them out of the company. By doing so, the founder who may not get along with everyone, still walks away with proceeds and a lot of value. The team can then concentrate and not have to worry about a potential personality issue or something like that.
Those are some of the reasons why people would pay more than the 409a valuation and you could rationalize why it should not impact the future 409a valuation.
But again, this is a good one to talk to your lawyer or your accounting firm, like Kruze about. You can also discuss this with your valuation provider because there’s always extenuating circumstances in these situations.
The big takeaway is that a secondary is just not going to impact your ASC 718 reporting. This is good news for you.
As always, if you have any questions on this, feel free to contact Kruze. We have a dedicated tax team willing and happy to help you out.