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Start-Up Accounting - Employee Equity Compensation

I joined a startup with a great concept.  We've got eight people (and a landlord) accepting equity as compensation ... now I've got to put this on the balance sheet.

We have everyone on a "four month project" and have told them we will issue warrants at the end of the period, equal to the dollar value of the salary they negotiated for the period.  We are using the $4M Pre-money valuation that we are using with Angel Investors. 

Finally, we're using Quickbooks - and the business goes live in about a week.  

I'd love any thoughts ... point me to any blogs or sources of information. I'm an security analyst by background, and this is my first time inside a startup.  

Elizabeth 

Answers

Topic Expert
Brenda Morris
Title: Board of Directors, Audit Committee Chai..
Company: Boot Barn
(Board of Directors, Audit Committee Chair, Boot Barn) |

Hi Elizabeth:
Would love to help, what are the specific questions you 'd like some thoughts on?

1. How to book the transaction?
2. Blogs on start-ups or stock options or other?

Look forward to learning more about what sounds like a cool opportunity!

James Patlyek
Title: Managing Director
Company: Patlyek Consulting
(Managing Director, Patlyek Consulting) |

Elizabeth, basically the J/E is debit compensation for the salary and credit additional pid in capital. Then take the dollar compensation for everyone and divide by the warrant issue price to get the number of warrants.

Bryan Frey
Title: VP Finance/Corp Controller
Company:
(VP Finance/Corp Controller, ) |

Something to keep in mind, it caught my eye in your post, is that you are effectively pricing your shares even though it's not clear that you have a firm pre-$ valuation from angels. I may be reading this wrong, and if so my apologies, but it sounds like you have a pre-$ valuation in mind that you have been pitching but not consummated. Share prices for private company equity are typically based on a 409a valuation done either internally based on a fairly rigorous valuation process, or it is, far more frequently, done by an unaffiliated third-party valuation firm.

Search Proformative for "409a" and you will find tons of info on the process and what it means. However, when you give shares as compensation and the share values can be directly linked to a consistent $/share, you are effectively pricing the shares in a market you have created. That is, in an arm's length negotiation, these multiple folks have agreed to take, pulling a fake number here, say $.10/share. Thus, for every dollar of compensation they forego you are paying them 10 shares. You have just priced your stock at $.10/share.

I note this b/c the value of stock in an early stage company is a very important thing, and by pegging that value via these deals with employees or consultants you may be doing something you don't intend to do. I would simply suggest you read up on this a bit and make sure you are doing this advisedly. If you have more questions, just ask them on Proformative.

Topic Expert
Joan Varrone
Title: CFO
Company: Cloud Cruiser
LinkedIn Profile
(CFO, Cloud Cruiser) |

I agree with Bryan regarding the valuation amount..it should have back up with an external valuation. Also remember that your angel investors will be getting preferred shares and I assume that these warrants are warrants on common stock. You will also have a potential compensation expense going forward for these warrants as you would for stock options under 123R.

Best

Joan

Bryan Frey
Title: VP Finance/Corp Controller
Company:
(VP Finance/Corp Controller, ) |

Can't believe I neglected to mention the preferred vs. common issue. Thanks, Joan! And for the readers out there, preferred will virtually always have more value than common b/c, well, preferred shares have preferences (such as on liquidation, but there are many other items of preference) which lead preferred shares to have very different value than common shares. Something to keep in mind when using investor stock valuations as a proxy for common stock value. This is very dangerous.

Peter Skalla
Title: CFO
Company: CFOwise
LinkedIn Profile
(CFO, CFOwise) |

Elizabeth, it sounds like you are creating significant and unnecessary tax liabilities for the founders. Here's the way this is normally done . . .

After incorporating the company, sell stock to all the founders at a zero or near-zero pre-money valuation. The company's an empty shell at this point, so it's worth only what the founders put in. Say, a tenth of a cent ($0.001) per share. BUT, sell the stock under a restricted stock purchase agreement that gives the company the right to repurchase the stock at the original issuance price if the employment (or contractor) relationship is terminated for any reason. Typically that repurchase right expires (and from the founders perspective, the stock "vests") over a 3-5 year period. Nothing vests for 364 days, then 20% vests at the 1 year mark (with 5 year vesting), then 1/48th vests each month for the following 4 years.

The REALLY IMPORTANT thing is to file an 83(b) election with the IRS within 30 days of the purchase stating each has purchased the stock at fair market value.

Now no one owes taxes on a grant, no one owes taxes as the stock vests (thanks to the 83(b)), and if anyone leaves or otherwise doesn't work out (i.e. they're fired), the remaining founder team isn't diluted by dead weight. And you have a founding team that is highly incentivized to build the company.

This is a pretty tried and true formula for technology startups. There are always nuances so find an attorney who spends at least 50% of his life working with startups and venture deals and he'll walk you through it all. Here's a post to get you started: http://walkercorporatelaw.com/startup-issues/founder-vesting-five-tips-for-entrepreneurs/

Good luck with the startup!

Elizabeth Pearce
Title: CFO
Company: Green Jane Inc
LinkedIn Profile
(CFO, Green Jane Inc) |

Wow! Thank you. We're clear on what we want to do ... just need to make it happen.

I'm delighted that I joined Proformative.

Topic Expert
Dana Price
Title: Vice President, M&A
Company: McGraw Hill Education
(Vice President, M&A, McGraw Hill Education) |

Elizabeth, if you are looking for more information around who gets equity/how much, you might want to look at Fred Wilson's blog www.avc.com, specifically his April 19 post with video on a seminar he taught.

Chris Shumate
Title: Accounting Manager
Company: Dominion Development Group, LLC
LinkedIn Profile
(Accounting Manager, Dominion Development Group, LLC) |

Elizabeth - I just read an interesting article by Theran Welsh regarding phatom stock plans that may help also. It is rather lengthy and in a print-only publication. The contact email, however, is welshtatsva [dot] com. Article is "Gains from Phantom Stock Plans"

James Quinlan
Title: Partner
Company: Corporate Finance Group, inc.
(Partner, Corporate Finance Group, inc.) |

Elizabeth,

You will need to to take compensation expense for the warrants issued. This most likely will be debiting expense and crediting additional paid in capital. However in some cases the warrants would be liability classified if there is a cash settlement or repurchase option.

You will need to value the warrants using an option pricing model like the Black-Sholes model or binomial model. To tdo this you will need to get a valuation for hte underlying shares of common stock.

E-mail me if you want to discuss the accounting further.

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