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409A; Need for annual update

If there has been no change in the business is an annual update necessary


Topic Expert
Keith Perry
Title: Director of Global Accounting
Company: Agrinos, Inc.
(Director of Global Accounting, Agrinos, Inc.) |


My understanding is that this is an unqualified "yes". The issue is the safe-harbor guidelines need to be adhered to. This means the earlier of annual *or* material event. Remember that part of the 409a review is going to look at external factors (comparables, the market, etc), and those do change independent of your business.

However, you don't need one (to the best of my knowledge) if you aren't issuing any options, as there is nothing to protect with the safe harbor.



David Belgum
Title: CFO
Company: LeoNovus, Inc.
(CFO, LeoNovus, Inc.) |

Keith is correct in his response. If a company does not have a 409A appraisal of their stock, and if the IRS believes the option price of stock is less than its fair market value, the tax payer (option-holder who excised the shares) has the burden to prove otherwise. Board of directors should be concerned about subjecting employees and service providers with significant penalties and interest.

Topic Expert
Stephen Roulac
Title: CEO
Company: Roulac Global LLC
(CEO, Roulac Global LLC) |

Updates are needed on schedule for multiple reasons:
1 Compliance optics: if not legally required, still there are impressions conveyed by what is said and not said
2 Stakeholder, current and prospective, connection: more communication is better than less
3 Better to initiate, even if perceive not needed, than later have to justify why not provided
4 Though there may be perception of 'no change in the business,' this thinking is at least suspect, if not flawed. Is every customer relationship identical? every competitor the same? market position unchanged? Are the capital market conditions identical?
Rather than treating with benign neglect, better to provide valuation/status update, even though overall valuation conclusion may be same.

Topic Expert
Simon Westbrook
Title: CFO
Company: Aargo Inc.
( CFO, Aargo Inc.) |

Stephen's reasons are all great and nobody can argue against them as being desirable, other than on the basis of cost in relation to risk. If significant option grants are made to Directors and officers, I believe this may be far more likely to trigger a challenge than small grants made to regular employees.

There are a number of 409A valuation sources out there I have seen priced from $1,000 to $10,000, with no clear evidence that the price is directly proportional to quality. When the risk is low, cheaper 409A valuations are easier to make!

By the way, I recently came a cross a Stock Option Agreement in which the section alerting the employee to his 409A problems and responsibilities were made very very clear. I would have expected prospective grantees to have been so scared by the risk and penalty potential that they may even question accepting the options.

Apart from the impact of the general economic situation and reduced liquidity potential, do we have any evidence that suggests stock options are being used less and less as a form of compensation due to the risks and costs of Option plans under 409A?

Topic Expert
Keith Perry
Title: Director of Global Accounting
Company: Agrinos, Inc.
(Director of Global Accounting, Agrinos, Inc.) |

Simon; not that I have seen. 123(r) yes, for profitable companies especially, but not 409A. In a start-up scenario, you might personally feel that taking a 30% salary hit in exchange for options is a good deal. In such an event, the company takes a 123(r) hit, but from a cash standpoint the single employee taking significantly less salary more than makes up for the cost of the appraisal.

Note further, if the 123(r) valuation is even close to being accurate, then it is a wash where you've traded cash comp for stock comp and landed at a similar expense figure (while preserving all-important cash).

A more mature company may (and, to the extent I've seen, many have) decide that the employees do not consider options to be comp, so for them it is not a wash, and they eliminate the extra expense by eliminating the options.

Final point on this diatribe: I'm officially a 123(r) convert. I did think it was a silly idea previously, but the change in behavior I've seen is pretty telling. I now don't think that people really understood that shareholders were, in essence paying out of their own pockets for all those options. That they are less-often paying by granting options in a post 123(r) doesn't say much for the idea that markets are efficient, but does say, to me, that 123(r) was the right call.


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