ASC 718 – Stock Option Expense for Series C Funded Companies

Accounting Standards Codification Topic 718 or ASC 718 is a standard that was established by the Financial Accounting Standards Board (FASB) in 2009 with the intent to provide an accounting framework for stock option expenses. In privately held companies, stock options are offered to employees as a form of stock-based compensation. Likewise, ASC 718 is the standard that defines the accounting and reporting of stock options by privately held companies. While Series C funded companies usually fall under Generally Accepted Accounting Principles (GAAP), and hence ASC 718 is applicable. In this article, we will briefly discuss the various aspects of ASC 718 and how Series C funded companies must adhere to it.

ASC 718 for Series C Companies

Before we dive deeper into the details of ASC 718, it is important to learn about “stock-based compensation or stock options”, which is the primary component of ASC 718, and look at the structure of Series C funded companies. Stock options provide opportunity for employees to buy shares of the company they work for at a predetermined price called the exercise or strike price after a certain period of time. Therefore, stock options are the means by which a private company can reward its employees for their contribution.

Now, you might wonder what is Series C funded? Well, a Series C round of funding is the third round of financing, and it is the most common in startups. Usually, in a Series C round, the business has typically shown solid growth and development, as well as established revenue streams. Generally, the Series C round is in the range of $40 million to $50 million. So, the companies that have raised Series C funding are synonymous with the term Series C funded companies.

In this regard, when Series C funded companies grant stock options, the expense must be recorded in the financial statements as per ASC 718. But, what is the implication of ASC 718? what are the uses of ASC 718? and how to calculate and report the expense of stock options? The following section provides a detailed explanation.

How does ASC 718 impact Series C Funded Companies?

Similar to all other companies, Series C funded companies must maintain the financial statements that comply with GAAP and the FASB, one of which includes the use of ASC 718. Stock options expense for series C funded companies is reported as non-cash expense under the income statement. In essence, ASC 718 for series C funded companies is the standard that describes the accounting principles for the expenses of stock options. The impact of ASC 718 for Series C funded companies depends on various factors such as the structure of the equity compensation plan, the number of options granted, the vesting schedule, and other related attributes.

Basically, the purpose of ASC 718 is to ensure that non-cash expense is reflected in the income statement in a manner that is transparent and consistent. In layman’s terms, ASC 718 requires a company to record all expenses that have been incurred as a result of granting stock options to employees. Thus, the implication of ASC 718 may vary based on several factors, however, it is essential to note that abiding by ASC 718 is a must.

Purpose of ASC 718 for Series C Funded Companies

The primary purpose of ASC 718 is to ensure uniformity and consistency in the accounting of the expenses incurred by granting employees stock options. In this regard, ASC 718 is a comprehensive standard that defines the accounting treatment of stock option expense and that should be followed by Series C funded companies. Here are a few examples of the uses of ASC 718:

• Ensure compliance with relevant laws and regulations – In order to protect the legal interests of the company and its employees, it is essential that the accounting of stock-based compensation is carried out in a standardized, uniform and consistent manner under ASC 718. The reporting must outline the terms and conditions of stock-based compensation in a reasonable amount of detail.
• Accurate business valuation – Based on the stock option expenses reported in financial statements, the business valuation may have different results. For the purpose of calculating the fair value of the business, an accurate representation of the stock option expense is essential. As a result, ASC 718 is a valuable standard that helps to report stock compensation expenses consistently by requiring series C funded companies to classify stock compensation expenses in a consistent manner.
• Maintain business’s credibility – In order for the government to assess whether the company is adhering with the laws governing stock-based compensation, financial information must be documented and presented in compliance with ASC 718. This enables the company to keep its reputation as well as build credibility in the eyes of potential investors. Therefore, the elected stock option plan must meet all the standards under ASC 718.

Accounting for stock option expensing for series C companies

There are certain terms that must be defined in order to understand the exact classification of stock option expenses. Under stock options, employees have the right to acquire a particular number of shares of the company they work for, at a certain price, after certain vesting periods. The price at which the employee can exercise or purchase their stock option is called the strike price, which is based on the fair market value of the share at the time of grant.

While the vesting schedule refers to the length of time before the employee can exercise their options. According to the number of shares granted, the fair market value of share, and the vesting schedule, stock option expenses can be determined. Thus, once the expense is calculated, accounting for stock option expenses under ASC 718 is carried out. As the employee accrues service time up until the vesting date, this expense is recorded as a non-cash expense on the income statement.

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

Now that you know the concept of ASC 718 for Series C funded companies, you might be think how to calculate the stock option expense? For calculating stock option expense, you need to follow these simple steps.

• Step 1: Determine the number of shares that are granted
• Step 2: Calculate the fair market value of the shares at the grant date
• Step 3: Determine the vesting schedule in years

Once, you have all the above-mentioned information, you need to multiply the number of stock options granted by the fair market value of the shares. Then, the result is divided by the number of years of the vesting schedule. The outcome will be the stock option expense for a Series C funded company. Let’s take an example and see how to calculate the stock option expense of a hypothetical company that grants all its employees 5,000 shares at a fair market value of $12 per share with 4 year vesting schedule.

• 5,000*12 = $60,000
• 60,000/4 = 15,000

Hence, the stock option expense is $15,000.

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

In order to ensure that your company is following the standard of accounting for stock options under ASC 718, the following tips are important:

• Calculate the fair value – The first step is to determine the fair value of the shares at the time of grant. In order to do so, you must carry out the necessary due diligence and collect reliable data about the share price using 409A valuation. Well, 409A valuation is a way to measure the fair market value of shares in private companies. Thus, the strike price of the stock options is determined using 409A valuation.
• Allocate cost period-wise – After determining the fair market value of the share, distribute the cost over time. You must be aware of the stock option’s length or the number of years over which the fair market value would be dispersed in order to accomplish this. As a matter of fact, this concept is similar to depreciation in the sense that the cost is spread over a period of time.
• Determine cost regularly – It is essential to constantly allocate the expense to the period in which it occurs. In order to accomplish this, the depreciation amount must be recorded in the financial accounts, including the income statement and balance sheet for each period. Deferring long-term spending might not be favorable, though, especially if the company begins by raising money through Series c funding.
• Get experts help – The process of complying with ASC 718 involves calculating the fair value of the share and identifying the vesting schedule. Thus, in order to streamline the process of implementing ASC 718, a professional like Eqvista can help you. It is because Eqvista comes with a modern and user-friendly framework that simplifies the process.
• Use automation – Just like any other accounting trends, ASC 718 compliance is subject to change at all times. In order to make sure your business practices are in compliance with ASC 718, you can opt for automation tools. As a result, you would be able to make the calculations in an objective and precise way.
• Plan strategically – Since ASC 718 compliance is not a one-time process, you need to plan the implementation of this concept before you even start. You must be aware of the strategies that can help your company adopt ASC 718 easily, and thus, improve the level of accuracy in your financial reports.

Have your ASC 718 expense reporting prepared by Eqvista!

While it may be challenging to implement an accounting standard like ASC 718, however, it does not mean that you should fail to adhere to the standard in the first place. In order to help with ASC 718, Eqvista offers a cost-effective solution. We strive to make business accounting standards simpler, more efficient and more accurate. From 409A valuation to ASC 718 compliance, Eqvista makes sure that your company is in compliance with all the accounting standards. Get in touch with our team to know more!