The Unreported Complexity of Pre-IPO Compensation
Fred Whittlesey
Compensation Venture Group - a Washington Special Purpose Corporation (SPC)
Fledge LLC - the conscious company accelerator


The headline this week in the Journal of Accountancy was "FASB share-based payments standard challenges private companies" reporting that the Financial Accounting Foundation  review of FAS123(R) concluded that everything is fine...almost.

Of course, FAS123(R) is now ASC Topic 718 which I would have thought the Financial Accounting Foundation would be aware of.

They conclude that the rules:

• Ensure that the cost of equity awards is recognized.  Well, we all know that Black-Scholes, monte carlo simulation, and other techniques are merely angels-on-the-head-of-a-pin, but at least we have a number now.

• Increase comparability by eliminating the accounting choice of whether to report expense or not.  Clever.

• Converge, sort of, with IFRS2.  Except for those dozen or so major divergences from IFRS2 which will likely never be resolved. (And we are NOT adopting the metric system, either, so there.)

The report concludes: 

• Statement 123(R) achieved its expected benefits as Statement 123(R) adequately resolved all of the issues underlying its stated need 
  

Huh?  It resolved all of the issues, with the exception of those issues remaining unresolved?

What was most interesting, though, is their recognition that private companies have difficulty implementing this standard because "they often issue financial instruments for SBC (share-based compensation) awards that are highly structured and contain multiple features."

Those not familiar with current trends and practices in private company, particularly pre-IPO company, equity compensation would be flabbergasted at the variety of approaches being used.  Far from the old days of time-vested stock options with the copy-everybody-else vesting schedule (25% after one year, then monthly for 3 years), the innovative instruments being used just don't fit the mold.  They are difficult or impossible to value for accounting purposes, they often have uncertain tax consequences, they don't fit neatly into existing compensation survey formats (and thus go unreported and don't exist), and they're difficult to communicate and administer.  Effective?  We don't know yet.

And it's not just RSUs instead of options.  Performance-vested options, convertible debt, LLC interests - just to name a few. Many CEPs have not heard a lot of this.

So, the accountants are satisfied with their work.  And we have equity compensation chaos in the private company world. But those companies generally don't care very much, or do their investors, about what accountants think about their equity compensation plan. It's a very fun time in equity compensation design, broken free from the constraints of FAS123(R) driving public company equity design, and the start-ups and accountants agreeing to disagree.