409a Valuation for Construction and Engineering Companies
Let’s find out the circumstances that trigger the need for a 409a valuation for Construction and Engineering Companies.
As a subset of the larger construction business, engineering construction focuses on the planning and building of infrastructure for manufacturing and other industrial uses. It includes onshore and offshore oil and gas infrastructure development, conventional and renewable power generation, processing and manufacturing facility building, and water and environmental improvement projects. Some of these businesses specialize in industrial infrastructure, while others provide residential or water infrastructure. Although they differ from one another in many ways, they all have commonalities.
Construction firms consider customer needs while evaluating building ideas and delivering services within the agreed-upon budget and schedule. But what determines the worth of these construction and engineering companies? The simple answer would be a 409 valuation. But there are a few challenges in performing 409a valuations for construction and engineering companies. Let’s find out the circumstances that trigger the need for a 409a valuation and the process in detail.
409a valuation and construction and engineering companies
Let’s suppose you’re the CEO of a budding construction and engineering firm and your goal is to hire the brightest minds in the industry. You’re off to a good start with a fantastic offering and an inspiring explanation of where you’re headed. However, building your core staff would be difficult without an attractive equity-based pay plan. That’s why it’s probably a good idea to provide stock options.
And therein lays the issue: it’s difficult for a private firm to give common stock options when it doesn’t yet have a stock price. A 409A valuation is a way to go if you wish not to get into problems with the IRS.
Brief overview of 409a valuation
To comply with Section 409A of the Internal Revenue Code, companies must conduct 409A valuations to ascertain the FMV of their shares. Stock options for workers are then set at a price based on the FMV. The goal of a 409A valuation is to establish the fair market value of your privately held company’s shares so that you may provide tax-free stock options to your workers. It is crucial to your company’s success and to avoid IRS problems that you acquire a 409A valuation that is precise and comprehensive.
Understand construction and engineering companies
In the realm of building, engineering construction is among the highest in terms of its significance on a worldwide scale. For one, it mirrors the civil engineering industry in being extraordinarily robust despite the worldwide recession and the precipitous decline in housing-related development. This means it will represent a sizeable slice of global building work during the coming decade.
Second, it plays an important part in the supply- and demand-side implementation of international energy strategy. Engineering construction delivers the world’s energy infrastructure (electricity, oil, and gas) and industrial processing facilities, which use a third of the world’s energy.
Relationships among stakeholders in engineering and construction companies are distinct from those seen in other types of construction. In engineering construction, stakeholder relationships are rather simpler to chart. Primary users of a project are the ones who are typically in charge of its commissioning. However, client and contractor roles typically mix on projects of this magnitude, requiring sophisticated governance for finance.
Circumstances that trigger the need for a 409a valuation
If you plan on giving your workers stock options, you should begin planning for a 409A valuation immediately. We suggest finding a trusted independent appraiser to aid with your 409A valuation before you ever discuss “stock options” with your staff.
A company’s first 409A valuation is often finalized during its first round of funding. Therefore, if a Series A is imminent, now would be the time to begin preparations. A head start is especially helpful since finding the correct appraiser and gathering all the necessary data and paperwork may take weeks or months.
Importance of complying with 409a regulations
Most people believe that a lower 409A valuation is preferable. There’s logic in this. When recruiting top talent, it helps to be able to provide stock options with a cheap exercise price, particularly if the employee is interested in growing with the company.
If your firm has the potential for rapid expansion in the next years, a little fluctuation in its stock price may not have much of an impact on your financial outlook.
Second, the IRS will not tolerate any kind of lack of seriousness in 409A values (and will impose penalties to prove it). The goal of obtaining safe-harbor status should take precedence over obtaining the lowest feasible valuation in this procedure.
Factors that affect the 409a valuation
Every 409A valuation is unique. The size and expense of these services depend heavily on the individual circumstances of each company. The price of a 409A value is based on the following five factors:
- Company Development Level – The 409A pricing has to be established after considering the development stage of your organization. This is because the number of investors, assets, and total worth of a firm will vary depending on its current stage of development.
- Organizational Size – The cost of complying with Section 409A may be affected by the company’s size, in particular the number of workers. Smaller organizations are easier to value than bigger ones since they have simpler operations.
- Share structure complexity – A company with a straightforward share structure just issues ordinary stock to its first investors. Small businesses, especially those just starting, often operate this way. The complexity of the share structure increases as the firm expands.
- The company’s line of business – Obviously, this might have an impact on the 409A value cost. Valuation services for more conventional enterprises, such as shipping and brick-and-mortar operations, are often more affordable. Profit projections are less of a guesswork game when dealing with their activities and movable goods.
- Time in business – Although one would assume that a 409A value for a startup would be inexpensive, the exact reverse is true. It is more difficult to forecast revenues for a startup and assign a value since there is no history of reliable operations to draw on.
Why are 409a valuations important for construction and engineering companies?
Because of their sheer size, engineering construction projects need intricate governance for finance (e.g., several joint ventures), which frequently leads to a blurring of the lines between client and contractor. Engineering construction differs from other construction industries in structural and contextual ways, but their effects on managing construction have not been examined. Different strategies may be required in engineering construction to address issues of management, complexity, partnership, project administration, identification of stakeholders, management of personnel, efficiency, and constructability. These constraints are exactly why an accurate 409a valuation is required for construction and engineering companies.
Challenges of performing 409a valuations for construction and engineering companies
Construction and engineering firms face their own set of issues when it comes to doing 409a valuations. Some of the obstacles are as follows.
- Complexities in determining the value of assets and liabilities – Valuing assets calls for expert knowledge of the relevant sector and an in-depth examination of the item’s value generators. In the construction industry, for instance, specialized equipment may serve a specific function, making it difficult to locate sales data that is directly comparable.
- Market volatility and its impact on valuations – The need for architectural and engineering services is very sensitive to the state of the economy and to the policies of various governments. Because of this, estimating future income and expenses may be difficult.
Best practices for conducting 409a valuations for construction and engineering companies
Valuing stock options following Section 409A is essential for avoiding undue taxation of employee compensation. It’s a complicated procedure that should only be handled by an experienced appraiser, but the benefits it brings to the business and its workers are well worth the effort. Adhering to the following best practices can bring about great value to the process.
- Ensuring accuracy and reliability – The 409a valuation should be reviewed and updated regularly since the worth of a firm might fluctuate over time. This may assist keep the company’s equity reward schemes in line with applicable laws and regulations, as well as keep the value as precise and dependable as possible.
- Adhering to regulatory requirements – The Internal Revenue Service mandates that a Section 409a valuation be revised at least once each year, or after any material change that might affect the worth of the corporation. If the corporation wants to keep its equity compensation plans in line with the law, it should update them regularly.
- Engaging a qualified valuation expert – If you want to be confident that your 409a valuation is correct, credible, and in line with regulations, you should hire a professional. Choosing a professional that has both industry knowledge and a history of producing accurate appraisals is essential.
What are the potential consequences of failing to comply with 409a regulations?
The IRS may impose fines if your company’s value does not comply with their requirements. The IRS is not expected to audit the vast majority of new businesses. Nonetheless, the Internal Revenue Service (IRS) may conduct an audit of your company as you expand and near an exit event. In the long run, it will be more efficient for you to choose a supplier of valuation services who has expertise right from the beginning.
Penalties and fees in terms of non-compliance for your workers and investors are the following:
- All deferred pay for the current and prior years is fully taxable as of the day they were earned.
- Interest must be paid on the adjusted tax liability.
- All postponed payments are subject to an extra 20% tax.
All NQDC arrangements that are subject to 409A rules will be liable to tax and penalty by the IRS if an operational error occurs. This includes severance packages, executive employment contracts, pay deferral plans, and even informal incentive schemes. If your company holds multiple sets of NQDC options for stock or SARs, just because your current set violates IRC 409A will not automatically trigger the invalidation of the others.
Best practices for ensuring compliance with 409a regulations
An NQDC plan has to be aware of and follow the requirements of Internal Revenue Code Section 409A. Guidelines, norms, and best practices that are generally accepted include:
- Maintaining accurate and up-to-date financial records – It is critical for 409a compliance to have reliable and up-to-date financial records. In addition to laying the groundwork for valuations to be consistent and compliant with regulatory standards, this technique also offers essential data for management to make informed decisions. Financial records need to be precise, thorough, and up-to-date, thus setting up internal controls is crucial.
- Regularly reviewing and updating the valuation – The IRS demands a 409a valuation update at least yearly or after a major event that might affect the company’s worth. Regular modifications may keep the company’s compensation for shares schemes legal. The 409a valuation is more likely to be up-to-date if it is reviewed and revised regularly. A company’s worth might alter owing to industrial, economic, or financial issues.
- Seeking guidance from qualified professionals – The fair market price must be determined following Section 409A, and you should hire an experienced third party to assess to ensure its accuracy. There are several competent assessment organizations available for hiring, and it is customary for a startup’s chief financial officer to deal with or modify the specifics.
Get a 409a valuation for your construction and engineering company from Eqvista!
Getting a 409a valuation on construction and engineering companies is crucial to meeting regulatory obligations and structuring your equity compensation schemes. But it takes specialist knowledge and skill to perform a value for such businesses. Eqvista is an online business that provides 409a valuations for the building and engineering industries by using a team of certified valuation specialists with experience in those fields. With Eqvista’s help, you can rest assured knowing that the valuation reports will be precise, trustworthy, and in line with applicable regulations, allowing you to proceed with your company’s compensation plans. Have doubts regarding our pricing and offers? Call us today!