March 24, 2017
409A Valuations & Equity Management: The Need for Forward Thinking
Posted by Armanino Financial Advisory Team
The process of developing a business to ultimate enterprise success includes anticipating and avoiding potential future road blocks through the development of high quality, supportable and defensible procedures as early in the business life cycle as possible. One critical factor in developing such a process for ultimate business success―whether defined by efficient audits, or, even better, a highly successful sale or IPO scenario―is completing quality 409A valuations and managing equity accounting with proven partners in the field.
As with any other component of the financial management process, 409A valuations and equity management require a great deal of attention to detail and proven effective judgement. In order to avoid problems when you least want them―such as when going through an audit, securing equity financing, or nearing public or private liquidity events―a successful approach will include utilizing the expertise of specialists in their respective fields in order to avoid common pitfalls. Various pitfalls due to a lack of quality valuation and equity management processes include expensive and time-consuming restating of financial statements, inefficient use of resources, and the potential impact on timing and pricing of equity transactions.
Here are some ways improperly handled valuation and equity accounting can impact you and your firm:
- Tax cost for you/your firm’s employees. If improperly priced options are issued, it may result in a future tax liability for employees who receive equity compensation. A lack of sound valuation and accounting can result in potentially large unexpected tax bills for employees who were granted options at below market value. Depending on the size of the mispricing, these tax bills can be significant to recipients.
- Potential acquisition red flags. In the acquisition process, acquiring parties will be on the lookout for items that could create unexpected costs and/or tax liabilities. A lack of sound valuation and equity accounting can create both real expenses in the due diligence process and perceptions of potential red flags as the acquirer considers the terms of its offer. When a potential sale is on the table, equity valuation and accounting red flags can result in significant costs and delays, as well as affecting bids that acquirers may make.
- IPO delays and/or missed windows. When a company nears a potential IPO and begins issuing public financial statements, the level of review increases substantially, both in terms of oversight via audit partners and the U.S. Securities and Exchange Commission (SEC). Improper valuations and poor equity management practices in the years preceding an IPO can result in costly, and sometimes fatal, delays in the IPO process.
When the time comes to potentially secure a sale or IPO liquidity event for the company you have devoted your time, energy and effort into building, it should be an extremely exciting period for you both professionally and personally. However, not having your valuation and equity management “ducks in a row” can cause unnecessary challenges for potential investors and/or acquirers, as well as auditors. At such times, when your company most needs you to be a strategic visionary, the last thing you want is to be stuck cleaning up unnecessary accounting issues that may have been avoided with proper planning and forward-looking resource allocation in earlier stages.
While there may be certain shortcuts that can be taken along the way in these areas, failing to think strategically and with a long-term vision, and not accessing expert resources at early stages, can create eventual real costs, resource bottlenecks and unnecessary delays, and may result in arduous review and cleanup work when you would least like to be dealing with such challenges.
Instead of putting off “the process” until later stages, it is a sound strategic investment to look ahead and engage quality professional advisory and value-added services early on. Such expertise can assist you in developing a sound process that can help you and your business navigate effectively and efficiently to and through a successful, rewarding and exciting liquidity event.
Forward thinking early on often makes a big difference.
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