ASC 718 – Stock Option Expense for Series B Funded Companies

Probably you know that startups with more and more capital funding are obligated to account for stock option expenses. The companies that fall under Generally Accepted Accounting Principles (GAAP) must account for stock option expenses in the financial statements as per ASC 718. Well, stock options in privately held companies are generally issued to employees as a part of an equity compensation plan. In stock options, employees are granted shares at a predetermined price after a certain period. But, did you know that Series B funded companies must comply with ASC 718 to report stock option expenses? This article will comprehensively understand ASC 718 and its applicability to Series B funded companies.

ASC 718 for Series B Companies

After a company is funded under Series A or B, it may fall under GAAP and subsequently comply with ASC 718. So, what is Series B funding? Well, Series B funding is the second round of funding after a company has completed Series A funding. It is during Series B funding that a company has been evaluated and has proved the viability of its business model. While the average amount of funding in Series B usually ranges from $7 million to $10 million.

Thus, when a company secures Series B funding, these ventures are known as Series B funded companies. Stock options in this regard are usually issued to employees, advisors and consultants in order to attract, retain and even motivate them. Basically, employees have the option to buy shares of the company at a predetermined price after some fixed period of time under stock options. Therefore, ASC 718 is an accounting policy which has been created for the purpose of reporting and accounting for stock option expenses in these companies.

ASC 718 – how does it impact Series B funded companies?

Series B funded companies are generally small-sized companies. As a part of GAAP, these companies must comply with ASC 718. But, what are the implications of ASC 718 for Series B funded companies? How stock options expense for series B funded companies work? What ASC 718 for series B funded companies actually means? Well, stock options are considered as a non-cash expense, and thus according to ASC 718, stock option expense must be recorded in the income statement. At the same time, the impact of stock options expense for Series B companies should not always be understood from a narrow viewpoint.

In fact, complying with the ASC 718 to account for stock options is a win-win situation for the employees, the company as well as from the standpoint of investors. As such, the Financial Accounting Standards Board (FASB) issued the new accounting standards for stock-based compensation expense ASC 718, which became effective in 2009 with the purpose to provide consistent rules for the measurement and recognition of the compensation expense associated with stock-based compensation plans. Thus, in practical terms, ASC 718 enables companies to make greater informed decisions based on the materiality of stock options expense.

What is it used for?

Generally, ASC 718 is used to account for stock option expenses when a company falls under GAAP. These expenses are recorded in the financial statements as non-cash expenses due to the fact that in stock options, the transfer of equity is involved instead of cash. In this regard, ASC 718 works out as an accounting framework that enables companies to track their stock-based compensation expense in accordance with the general requirements of the Financial Accounting Standards Board (FASB). Below mentioned are the key components of ASC 718:

• Financial information must be documented and presented in accordance with ASC 718 so that the government can determine whether the business is following the rules and regulations governing stock-based compensation. As a result of this, the credibility and the market value of the company can be maintained.
• ASC 718 states that the expensing of stock options can be used as a way to protect the legal rights of both employers and employees. As such, stock option expense for series B funded companies under ASC 718 can help maintain the integrity of the stock options. ASC 718 shall set forth in reasonable detail the terms and conditions of the stock-based compensation for purposes of complying with applicable laws and regulations.
• Business valuation can be affected based on the stock option expenses recorded in financial statements. It is critical to have an accurate representation of the expenses in order to determine the fair value of the company. The stock options expense for series B funded companies under ASC 718 can assist in the accurate valuation of the company, and thus ASC 718 ensures that stock compensation expenses are reported consistently.

Accounting for stock option expensing for series B companies

Based on ASC 718, the stock option expense for series B funded companies should be accounted for in the financial statements as a non-cash expense. Usually, the stock option expense is classified in the same account as the other non-cash expenses under the income statement. While the calculation of the stock option expense for series B companies shall be made in accordance with the fair market value of the stock, the number of shares to be issued, and the vesting schedule. Hence, with the help of simple calculation, the amount of stock option expense can be determined and accounted for in the financial statements under ASC 718. Therefore, the below-mentioned calculation shows how the stock option expense is determined.

How do you calculate the stock option expense of a Series B company?

Stock option expense for Series B funded companies is calculated based on the fair value of the stock and the number of options granted, further categorized in a vesting schedule. Thus, the calculation of stock option expense shall look as follows.

To calculate the total stock compensation expenses, multiply the number of stock options granted by the fair market value (FMV) of the share on the grant date. To calculate the amount to record for each annual period, divide the total stock compensation expense amount by the number of vesting years. In order to practically demonstrate the calculation of stock option expense for series B funded companies, let us consider an example. Assuming that 20,000 shares are issued with a fair value of $24 per share and vesting in 3 years. In mathematical terms, the sum of the stock options expense shall be calculated as follows:

• 20,000 shares * $24 per share = $480,000
• $480,000/3 = $160,000

In the above situation, it is assumed that the grant of stock options leads to a total stock-based compensation expense of $160,000 annually, where the vesting period of 3 years is taken into account. Overall, this example demonstrates the calculation of the stock options expense for series B funded companies under ASC 718.

How to get started with ASC 718 compliance for your Series B company?

In order to fully implement ASC 718 compliance for your Series B funded company, you have to remain informed about the rules, guidelines and procedures. As a result, for effective implementation of the ASC 718 requirements, you must follow the below-mentioned steps:

• Calculate the fair value – To calculate the fair value of the stock options to be granted, you have to perform the required due diligence and gather accurate information about the share price using 409A valuation. So, 409A valuation is used to reasonably estimate the fair market value of the share in a private company. In this regard, 409A valuation is used to determine the strike price of the stock options.
• Allocate cost period-wise – Distribute cost over a period of time after measuring the fair market value of the share. To achieve this, you must know the duration of the stock option or the number of years over which the fair market value would be distributed. Calculating the useful life of a physically depreciable item, like a piece of equipment, is analogous to this concept.
• Determine cost regularly – When the depreciation amount is ascertained for each period or year, it must be entered in the financial statements (income statement and balance sheet) for that period. Delaying long-term expenditure, however, is dangerous, particularly if your business starts raising money through Series B capital. As a result, you must establish a regular procedure to monitor the fair value over time.
• Get help from professionals – When you are dealing with stock option expenses, a specialized third-party expert or a professional can help you to calculate the stock options expense accurately. Expert advisors like Eqvista can provide you with step-by-step methodologies, guidelines, and best practices to implement compliance. It is highly recommended to seek help from experts for the correct application of ASC 718 for your Series B funded company.
• Use automation – Implementing the procedures and policies of ASC 718 can be challenging and time-consuming. However, with advancements in technology, you can get help from automation software for effective implementation of ASC 718 compliance. Such software enables you to automate the processes of determining the fair value, calculating the stock options expense, and recording the same in financial statements.
• Plan strategically – To properly plan the implementation of ASC 718, it is advisable to establish a detailed plan of action that should be followed by the management team. It is highly recommended to develop a strategic plan, which includes all the essential elements related to rules and regulations, review of financial statements, and the selection of accounting methods.

Get your ASC 718 expense reporting from Eqvista!

You might have noticed that accounting for employee stock options under ASC 718 is quite complex, time-consuming and tedious. However, at the time time, it is essential to implement the compliance rules, guidelines and procedures. Why not let the experts take care of it? Instead of spending hours and days on calculations, Eqvista can help you out with the implementation of ASC 718 compliance in your Series B funded company. In this context, Eqvista offers a suite of a few modules, including 409A valuation, cap table management software for managing shareholders, and stock option expense reporting. With a complete solution provided at Eqvista, you will have a seamless implementation of ASC 718. If you want to learn more about Eqvista and the services offered, contact us.