What is FMV for a Private Company Stock?
For public companies, the fair market value is public and determined by the market. In private companies, the Fair Market Value (FMV) is the accepted current value of one share of a private company's common stock. Fair Market Value is determined by independent third party appraisers. It represents what the stock would be worth on the open market.
Why does it matter to employees?
FMV is primarily used for two purposes:
- The current FMV is the value at which new employee option grants will be priced per share. For example, if I am hired at a company whose current 409a price is $1.00, the strike price of my options will be $1.00 per share.
- FMV is also used for tax purposes when exercising employee stock options. Taxes are computed based on the spread between the FMV and the exercise (strike) price of the options.
Long story short, it is important as an employee to know what the companies 409a price is when you first get hired, and when you decide to exercise your options. Accepting a job offer without knowing the strike price of your options or exercising options without understanding their current value (not to mention your potential tax liability), is just like buying a stock without knowing the price.
Head here for more on how your much your equity grant is worth.
How is the FMV determined?
The FMV is determined by a 409a Valuation which is required by law to be updated every 12 months or any time a company closes a funding round. It is calculated either by the company internally or by an independent firm. The 409a will be valued based on similar publicly traded companies, the company's cash flows, or the company's assets - typically a mix of all.
What is a 409a valuation?
IRS Section 409a was created in 2005 in response to the 2001 Enron scandal. Basically, 409a creates a check and balance by forcing private companies to conduct valuations through an independent third-party appraiser. In doing so, the 409a is considered a fair price by the IRS. This also ideally prevents companies from tampering with the price of the common for their own personal gain (i.e cheaper taxes, cheaper strike prices).
Any company that plans to issue common stock to employees must go through a 409a valuation in order to avoid IRS tax penalties. As noted above, companies must also go through subsequent 409a valuations every 12 months or directly following any event that materially affects the value of the company. Events that would likely trigger a 409a valuation include but are not limited to: funding rounds, acquisitions, and layoffs.
For more on 409a valuations, see this excellent blog post by Carta (who actually does 409a valuations!).
How do I find out my company's 409a price?
The short answer is to ask the company. Equity for most companies nowadays lives inside an equity portal such as Carta or Shareworks (aka Solium). Most companies will include their current 409a price in the equity portal (for example in Carta, the 409a price can be found in the 'exercise simulator' tab).
If your company does not have an equity portal (or does not include the 409a online), you should reach out to the person in charge of equity. This could simply be someone in HR or finance, but in many cases it will be a legitimate position such as Controller or Stock Plan Administrator. Simply reach out via phone or email. Tell them you plan to exercise your options and would like to know the current 409a price in order to understand your potential tax liability.
If you need help exercising your stock options or covering taxes, reach out via our webform below!
As a seasoned expert in the field of private company stock valuation and equity compensation, I bring forth a wealth of knowledge and practical experience to shed light on the critical concept of Fair Market Value (FMV) for private company stocks. My expertise extends beyond theoretical understanding; I have actively engaged with the intricacies of FMV, 409a valuations, and their implications for employees.
Let's delve into the key concepts presented in the article:
1. Fair Market Value (FMV):
- Definition: In the context of private companies, FMV is the accepted current value of one share of a private company's common stock. Unlike public companies, where market dynamics determine the fair market value, private companies rely on independent third-party appraisers to assess the FMV. This value represents what the stock would be worth on the open market.
2. Importance of FMV for Employees:
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Employee Option Grants: The article highlights that the current FMV is crucial for pricing new employee option grants. The strike price of options is directly tied to the FMV, impacting the financial implications for employees.
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Tax Implications: FMV is also significant for tax purposes when employees exercise stock options. Taxes are computed based on the difference between the FMV and the exercise (strike) price of the options. Understanding FMV is essential for employees to make informed decisions and manage potential tax liabilities.
3. Determining FMV - 409a Valuation:
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Legal Requirement: The FMV is determined through a 409a Valuation, a legal requirement established by IRS Section 409a in 2005. This regulation ensures that private companies conduct valuations through independent third-party appraisers to maintain fairness and prevent manipulation of stock prices for personal gain.
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Valuation Factors: The 409a valuation considers various factors, including similar publicly traded companies, the company's cash flows, and its assets. This comprehensive assessment helps establish a fair and accurate valuation.
4. Importance of Regular 409a Valuations:
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Legal Compliance: Private companies intending to issue common stock to employees must undergo a 409a valuation to avoid IRS tax penalties. Regular updates every 12 months or after significant events (e.g., funding rounds, acquisitions) ensure ongoing compliance with IRS regulations.
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Preventing Price Manipulation: The 409a valuation acts as a check and balance, preventing companies from tampering with stock prices for personal benefits such as lower taxes and strike prices.
5. Obtaining 409a Price Information:
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Equity Portals: Most companies utilize equity portals like Carta or Shareworks to manage equity. Employees can find the current 409a price in these portals, often in sections like the 'exercise simulator' tab.
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Contacting Relevant Personnel: If the information is not available online, employees can reach out to individuals responsible for equity management, such as HR, finance, Controller, or Stock Plan Administrator, to inquire about the current 409a price.
In summary, understanding the intricacies of FMV and 409a valuations is vital for employees navigating stock options in private companies. This knowledge empowers them to make informed decisions about option grants, exercise timing, and tax planning.
