409A Valuation in Singapore
This article will focus on the 409A valuation for companies in Singapore that are largely involved with the United States.
Singapore, the hub of Asia, is one of the most modern countries in the world. It is known for its commercial and financial centers, innovation-driven economy, and dynamic growth. Singapore is the most competitive Asian country in terms of business environment which provides businesses with a conducive and profitable climate. In regard to business in Singapore, 409A valuation is a process to determine the fair market value of a private company’s stock. While a Singapore-based company is in connection with the United States, a 409A valuation becomes even more important. This article will focus on the 409A valuation for companies in Singapore that are largely involved with the United States.
Singapore companies in the US
Singapore and the United States have had a flourishing economic relationship since the early 2000s. Over the past decades, Singapore has strengthened its position as a significant financial and business hub in Asia and the world. Singapore, which has a population of just under 6 million, is a significant member of the Association of Southeast Asian Nations (ASEAN) economic bloc due to its extraordinary capacity to draw foreign business partners and investment prospects. With the increasing number of Singapore companies in the US, the future potential for business cooperation between the two countries is promising.
Overview of the Singapore companies and business with the US
The US and Singapore Free Trade Agreement serve as the basis of this vibrant economic partnership between Singapore and the United States. With more than 4,200 American businesses operating in Singapore, many of which use the city or state as their regional headquarters for business operations throughout the Asia-Pacific area. The bilateral economic relationship between Singapore and the United States is strong and valuable to both countries.
Singapore was ranked 14th largest export market for the United States in 2020, importing over US$271.1 billion in goods. In addition to this, the US Foreign Direct Investment (FDI) in Singapore stood at US$270.8 billion in stock in 2020. As a result, the strong economic ties between the two countries provide an excellent foundation for economic cooperation.
Important US tax issues to know
Well, in the case of Singapore-based companies which conduct business in the United States or operate in the United States, you must take note of the US tax issues. The following are the important US tax rules:
- 83(b) election – Under the 83(b) election, the equities that have vesting conditions in the United States are considered taxable at the time of grant. Employees or startup founders that exercise the 83(b) election will pay tax on the fair market value of restricted shares at the time of grant.
- ASC 718 – ASC 718 applies to private companies where stock-based compensation is accounted for in accordance with 718. ASC 718 prescribes the measurement of compensation expense recognized in the statement of comprehensive income. Thus, accounting for stock-based compensation expenses under ASC 718 is important.
- ISO 100k – There is a limit that prohibits employees from treating exercisable options valued at more than $100,000 as incentive stock options (ISOs) in a particular year. This ISO 100k limits the number of options that can be exercised in the same year by an employee is $100,000.
- Form 3921 & 3922 – Form 3921 is used for the purpose of ISO exercises and Form 3922 for Employee Stock Purchase Plan (ESPP) share purchases. Both forms serve the same purpose, i.e. for reporting and filing the details of the purchase of stock options and ESPP. The filing of this form is necessary for the purpose of lawful tax treatment.
- Internal Revenue Code Section 409A – Private companies are subject to Internal Revenue Code Section 409A. In order to determine the fair market value (FMV) of common stocks, 409A valuation is required. It is a procedure to determine the FMV of the shares of a private company for various purposes.
409A valuation & Singapore Companies
In the United States, IRC Section 409A is used for the purpose of determining the fair market value (FMV) of common stocks of a private company. In the case of a company located in Singapore that is involved or has a connection with the United States, it becomes necessary to comply with the 409A valuation rules along with other tax provisions of the Internal Revenue Code.
What is 409A valuation/regulations?
A 409A valuation is a procedure to determine the FMV of shares of a private company for various legal, tax and financial purposes, such as equity compensation, stock options, employee stock purchases and other such financial items that involve the FMV of stock. Usually, 409A valuation must be conducted annually as per the IRC, or the process of 409A valuation can be carried out after a major financial event. Thus, it is necessary to comply with the IRC section 409A and other regulations to ensure that the company complies with all legal and financial requirements.
When is a 409A valuation required in Singapore?
There are various instances that require 409A valuation for Singapore. Following are some of the common situations:
US holding company with Singapore subsidiaries
Holding companies basically mean a company that is specifically incorporated with the purpose of purchasing, acquiring, or wanting to control another company. In this way, when such a company is established, it realizes itself and acts as a parent company of the acquired company. In the case of US-based holding companies having subsidiary companies in Singapore, the 409A valuation becomes necessary. The subsidiary in Singapore will have to determine the FMV of its stock using 409A valuation.
Singapore holding companies with US subsidiaries
Similar to the above example, Singapore holding companies own subsidiaries in the United States. These subsidiaries are involved with business operations in the United States, and thus, they must comply with all the 409A rules and regulations. Other than the 409A valuation, the subsidiaries in the United States should also adhere to the related tax filing and reporting obligations. This will ensure that the company receives preferential tax treatment due to the status of being a US subsidiary.
Singapore companies with US employees (Offering ESOP/other incentive plans)
Even though the company is not located in the United States, it is still required to assess the 409A valuation in the event that it has US employees. Generally, in the US, the value of stock-based compensation is derived on the basis of a 409A valuation. Thus, the same would apply to a US citizen who is working in a foreign country, including Singapore, in order to receive equity-based compensation.
Other situations for 409A valuation in Singapore
There are a few more situations for 409A valuation in Singapore. These may include the following:
- ESOP in Singapore – ESOP or Employee Stock Option Plan is a form of equity compensation which offers the employees of the company the right to buy company shares at a predetermined price with a particular holding period. It helps to motivate and retain employees to stay with the company and build up loyalty. Thus, it is important for the company to assess the 409A valuation and issue such share options to its employees in a legal and tax-compliant manner.
- Is ESOP regulated in Singapore? – As a common form of employee compensation in Singapore, there are various rules that govern ESOPs in Singapore. The concept of ESOP typically remains the same in most countries around the world. However, there are several tax laws, reporting requirements, and other rules that differ from country to country.
- Transfer of Shares involving US shareholders – Typically, the transfer of shares is restricted in privately owned companies. However, there are certain situations where a transfer of ownership is permitted. So, when shares are transferred to a US shareholder, such transfer will have to comply with the rules and regulations of the US. In the event of a transfer, both parties must sign the paperwork once the form is completed.
Importance of 409A valuation
In the United States, the Internal Revenue Service (IRS) governs the 409A valuations of stocks. Unlike public companies, private companies are not listed on the stock exchange and therefore the market value cannot be determined. With the help of 409A valuations, the company may easily determine the fair market value of its stocks. Here are a few more reasons why it is important to use 409A valuations:
- Safe harbor status – Private corporations must adhere to a structure set forth in Section 409A when valuing private shares. With a few exceptions, the IRS will assume that the value was performed by an unrelated or independent entity, creating a safe harbor.
- Defining the fair market value of shares – The 409A valuation allows the assignment of the fair market value to the shares held by a private company. As a matter of fact, in private companies, there are no external forces that can be used to determine the FMV of shares. This is where the 409A valuations come in handy.
- The fair value of the company – FMV of the stock in private companies can be used for the purpose of granting stock-based compensation, calculating the tax obligation related to shares, and for other business transactions where the FMV of the stock is required to be disclosed.
Consequences of not complying with 409A while issuing shares
Well, have you ever wondered what happens if you fail to comply with Section 409A? The IRS can impose heavy penalties for non-compliance and can even disrupt the workplace, including the company and its employees. It is recommended that all private companies should consider 409A valuation and ensure that it is carried out in a timely manner.
Following are some of the common tax penalties in relation to non-compliance with 409A:
- Employees must pay income tax and a 20% penalty on any deferred vested amounts under the Nonqualified Deferred compensation (NQDC) plan as of the last day of the vesting year, even if payments are made in subsequent years.
- From the vesting date on, failed compensation is subject to a premium interest tax of 1% over the federal underpayment penalty rate. Employees who understate their income may be subject to additional penalties. Additionally, the state may levy fines on employees.
409A valuation methods
Now that we have covered the basic principles, let us discuss the methods of 409A valuation. Numerous 409A valuation methods can be used to determine the FMV of the stock. However, the following are some of the most common approaches of 409A valuation:
- Asset approach – The asset approach to valuation uses a company’s total assets and liabilities to estimate its fair market worth. When valuing the company’s stock in an acquisition or proposed merger, the asset method is typically used. With this approach, the assets are calculated first, followed by the calculation of liabilities. Further, the difference between the assets and liabilities results in the net asset value (NAV) based on which the FMV of the shares is determined.
- Market approach – Using the company’s similar peers, the market approach to valuation is employed to estimate fair market value. In other terms, the value of a firm is decided by comparing it to other businesses that share similar traits and financial results. After creating forecasts with the use of its financial data, the valuator finally establishes the FMV of the company’s stock. This method is typically used by businesses seeking to determine the worth of a potential acquisition.
- Income approach – The income approach is used to determine a stock’s fair market value based on future cash flows. The process of the income-based method is carried out by using the company’s forecasted income which is discounted back to present value using the company’s weighted average cost of capital. This method is useful only for companies that are expected to generate positive cash flows as per the projection. The income approach is also referred to as Discounted Cash Flow or DCF.
- Backsolve approach – For 409A valuation, the backsolve approach is one of the most reliable approaches. This approach is the best choice for businesses with complicated capital structures that must determine and validate the stock’s fair market value. The backsolve approach might be specifically used for options pricing in privately held companies. This method is highly accurate and simple to use, making it an excellent choice for valuing equity compensation.
Calculation for 409A valuation for Singapore
Malloxor Ltd., which is an e-commerce company specializing in fashion, has executives and senior managers who are expats and US citizens. Because of their citizenship, these staff members need to declare tax back in the US for their stock options that they plan to exercise in the future. In order to determine the strike price on these options, Malloxor Ltd. conducted a 409A valuation to find the value and exercise price for their ESOPs.
This is how their basic cap table looks like:
After getting a 409A valuation done, the resulting value was calculated as follows:
With the total valuation of the company at $10,360,000 after the DLOM, and capital structure with 33,750,000 shares, after processing the valuation through a waterfall analysis, the final share price was calculated as:
After the valuation, Malloxor Ltd. was able to issue its stock options according to its ESOP plan at a strike price of $0.21 to its US staff.
Get a 409A valuation for your Singapore company with Eqvista!
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