Emerging Growth Companies — Interpolation Considerations for Valuing Share-Based Compensation

Special Series for Start-Up Companies — Part 1

ASC 718 requires the use of a fair-value-based measurement method for share-based payment arrangements. In the absence of an observable market price, an entity will generally use a valuation technique such as the Black-Scholes-Merton model to estimate the fair-value-based measure. While ASC 718 does not require the use of a particular model, it does require, at a minimum, that the selected valuation model incorporate certain inputs. One input that may be subject to significant management judgment is the fair value of the underlying shares as of the grant date.

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For tax purposes, entities will often hire a specialist to perform independent valuations to assist in determining the value of the underlying shares. (Such valuations are often referred to as “Section 409A valuations” since they are subject to the requirements of that Internal Revenue Code section.) Early-stage companies often obtain the independent valuations only once per year. However, as illustrated in Figure 1, the dates of the valuations do not always coincide with the grant date for a share-based payment award. As a result, management will need to assess the current fair value of the underlying shares as of the grant date.

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FRA 17-3 | March 17, 2017

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