Pricing Stock Options
By Kevin Vela
As I wrote last time, equity is currency for startups. As you launch your startup, you’ll likely be granting some equity to service providers throughout the life of your company.
Now, it’s critical to understand that anytime you grant equity, to anyone, that equity is going to have value. And in the U.S., in just about all instances, if you give someone something of value, the IRS will treat this as compensation and will tax it. Thus, you have to assign a price per share to all of your equity grants, so that you can determine the total value of the grant.
When you first launch your startup, this is pretty easy to do. Your startup likely doesn’t have any real value. I know you may feel differently, but in the eyes of the IRS, on day one, your startup isn’t likely to be worth what you paid to incorporate it. There are no revenues and likely no real assets other than whatever ideas you have contributed into the startup. Thus, typically you value your common stock shares at par value, which is listed on your charter (usually some nominal price like $.0001 per share). So if you granted someone 1,000,000 shares of common stock at $.0001 per share, the value of the grant would be $100.
The value of your startup will, however, increase as you raise capital, develop tangible intellectual property, or start to generate revenues. Once this happens, it wouldn’t be accurate, nor a good idea, to report that the value of your common shares was still $.0001. Determining an actual value is a bit trickier. Because there is not a reliable marketplace for startup shares, you need to rely on guidance from professionals to determine the value. Your startup lawyer or accountant should be able to point you in the right direction, but ultimately you need what’s known as a 409A valuation performed.
A 409A valuation is a formal report that tells you the value of your stock. “409A” refers to a section of the IRS code that deals with valuing non-qualified stock options. Fortunately for startups, 409A pricing has dropped precipitously over the past several years. For early-stage companies (i.e. raised less than $500k in capital) we like the Capshare 409A tool. For later stage companies, we prefer Carta’s 409A option. Note that it’s good practice to get a new 409A valuation done every year or subsequent to any significant events (like a capital raise or acquisition).
Finally, I want to be clear – given the IRS implications, this is not something to be cavalier about. Make sure you visit with your startup attorney or CPA before issuing any options.