Valuation of non-public stock

[Guest JM123]

Draft ISO/NSO plan provides that value will be determined by the company using reasonable application of a reasonable method, etc. Service provider is expressing concern that owner of closely-held can manipulate its payout by simply withdrawing equity (or other ways that negatively impact a valuation formula that is used (EBITDA x multiplier less liability).

To address this concern, service provider suggests adding back dollar amount of equity withdrawn during 12 month period preceding the exercise.

Any problems?

[Guest basilb]

Draft ISO/NSO plan provides that value will be determined by the company using reasonable application of a reasonable method, etc. Service provider is expressing concern that owner of closely-held can manipulate its payout by simply withdrawing equity (or other ways that negatively impact a valuation formula that is used (EBITDA x multiplier less liability).

To address this concern, service provider suggests adding back dollar amount of equity withdrawn during 12 month period preceding the exercise.

Any problems?

I'm no FMV expert, but it seems to me that it would not be ok to have valuation based on anything other than actual FMV at the time of determination. Maybe having a built-in valuation formula could help address his/her concerns?

[Guest JM123]

I'm no FMV expert, but it seems to me that it would not be ok to have valuation based on anything other than actual FMV at the time of determination. Maybe having a built-in valuation formula could help address his/her concerns?

How about a built-in formula that states that FMV on grant is auto automatically recalculated to reflect a significant distribution made to shareholders within x years of the grant. Problem is that if the recomputed FMV is lower than the actual date of grant value, it would be viewed as a non-exempt discounted option.

If it is instead treated as a modification/grant of a new option, then so long as not discounted at time of deemed new grant, it would continue to avoid 409A.

However, this approach could economically disadvantage the optionee if the value increases prior to the deemed new grant. For example, if original value = $5/share, which appreciates to $7 in year two. But if in year 1 company incurs debt to distribute cash to shareholder, which under new formula results in value of $6 and a new grant with $6 strike price.

This would appear to qualify for exemption from 409A, but how can we compensate for the $1/share loss in economic value to the optionee? Should that amount be built into the employment agreement, or can it be treated as a SAR somehow?

Any thoughts greatly appreciated.