Brad's Books and Organizations

Books

Books

Organizations

Organizations

Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

« swipe left for tags/categories

swipe right to go back »

409A – Oh How I Love Thy Wiliness

Comments (6)

Now that one of our favorite IRS regs – Mr. 409a – has been around for a while, it’s still causing plenty of confusion, wasted time, energy, and money.  The final regulations – issued in April – are to become effective on January 1, 2008.  However, one 9/10/07, the IRS announced that they were extended the compliance deadline a year – it’s now 12/31/08 instead of 12/31/07.  Thanks Uncle Sam – that’s nice.

The whole thing is still stupid for small companies where there should be some sort of exemption.  Since this doesn’t seem like it’ll happen, it’d be nice if the IRS and the Financial Accounting Standards Board could get together and let the accountants be able to either accept the 409A valuation as part of FAS 123 or – even better – let the FAS 123 valuation be used for the 409A valuation.

Yeah – that would be too easy, logical, and would make the auditors job more straightforward, which would mean less work and billings for them. 

Since you are going to get charged for it anyway, I suggest you send your auditors a copy of your 409A valuation report whenever you get them (many of our companies get them quarterly – once you get a rhythm established, it seems to be the least expensive and lowest risk approach to this absurdity.)  By sending the 409A valuation report to your auditor whenever you get them, you can at least ask the question "do you support this valuation" on a regular basis.  Most auditors won’t give you a straight answer, but at least they can’t say "hey – you never showed us the 409A valuations" during your annual audit when their FAS 123 valuations are coming out significantly different than your 409A valuations.

  • Anon

    Brad, thanks for your continued efforts to help start-ups navigate the ridiculous 409A rules. My company (a start-up) selected one of the big 3 firms to do our first audit, and at the outset of the relationship we told the auditors that we intended to use our 409A valuation for 123R purposes. We offered them an opportunity to review our 409A valuation reports in advance, ask us (and our valuation consultant) questions, etc. Our auditors took a thoughtful and reasonable approach to this matter, and after getting comfortable with our consultant's valuation methodology they agreed to accept our 409A valuation as an input to all of our 123R calculations. We completed our audit with a clean opinion and during the process no issues were raised by the manager, partner or concurring partner regarding 409A/123R common stock valuation.

    Until the IRS and FASB figure out that they need to coordinate their rules (don't hold your breath), this issue should be manageable for most start-ups using your suggested approach.

  • Bo Brustkern

    Brad,

    Great points you raise here, and I agree this is a real pain for early stage companies. As you know, I am part of a boutique valuation services firm that serves venture backed clients on both coasts. We've seen a fair slice of the market and been through our share of SAS 73 reviews. With that in mind, I'd make two points to complement your post.

    1) CFOs of private companies (big and small) should cause their valuation providers to speak with their auditors prior to engagement. Not prior to starting the work, mind you, but prior to even hiring the valuation shop — prior to signing the engagement letter. The fact is that valuation providers will be held to the Fair Value standard, and it's a bony one. If your auditors and valuation providers do not see eye-to-eye on certain practices — the most obvious being which allocation methodology will be used (i.e., the Option Pricing Method), then you should go find another provider.

    2) We have heard from a very knowledgeable source within the IRS, in a face-to-face conversation, that the IRS does not (yet) have an answer to the question of how to reconcile Fair Market Value (409A) with Fair Value (123R). This person went on to say that they are “leveraging the financial reporting community” particularly with reference to allocation methodologies (again, the Option Pricing Method). It is only a guess on my part (speaking personally here, and throughout this comment), but that sounds a lot to me like convergence.

    Good news, bad news for our clients. The good news is that so-called “dual purpose” reports will withstand the scrutiny of both tax and GAAP enforcers. The bad news is that the valuation exercise for all companies — big and small — became irreversibly more challenging in 2007 due to the advent of Fair Value accounting via SFAS 157.

    At risk of appearing self-promoting, I would point your readers to the following brief articles that attempt to further explain the issues from our perspective:

    “Dual Purpose is de rigueur” http://www.arcstonepartners.com/valuationArticles

    “This just about sums it up”
    http://www.arcstonepartners.com/valuationArticles

    “Valuation Updates: when and how”
    http://www.arcstonepartners.com/valuationArticles

  • Ronald Lewis

    All of the confusion and pain can end once the IRS is abolished (same for the Federal Reserve). Most government programs and agencies are worthless.

  • http://www.vcexperts.com Mike

    This is why Brad should seriously inform his readers about the K.I.T. database by VC Experts. If PWC and E&Y are agreeing with what we have done, then something is right!

  • http://www.vcexperts.com Mike

    This is why Brad should seriously inform his readers about the K.I.T. database by VC Experts. If PWC and E&Y are agreeing with what we have done, then something is right!

  • http://www.pedatacenter.com Michael

    This is why Brad should introduce K.I.T. found at http://www.pedatacenter.com which will enable professionals and entrepreneurs alike to get valuation comparables without some of the headaches incurred by going to 3rd party providers. If PWC and E&Y say it's an invaluable resource, then we obviously did something right.

  • http://www.pedatacenter.com Michael

    This is why Brad should introduce K.I.T. found at http://www.pedatacenter.com which will enable professionals and entrepreneurs alike to get valuation comparables without some of the headaches incurred by going to 3rd party providers. If PWC and E&Y say it's an invaluable resource, then we obviously did something right.

  • Michael

    This is why Brad should introduce K.I.T. found at http://www.pedatacenter.com which will enable professionals and entrepreneurs alike to get valuation comparables without some of the headaches incurred by going to 3rd party providers. If PWC and E&Y say it's an invaluable resource, then we obviously did something right.

  • http://www.erain.com Mike Soucie

    Brad, you're right on with your 409A analysis. I can't tell you how frustrated and pissed off this regulation has made me.

    For Electric Rain, its been nothing but a huge and costly headache. We're now in a grid lock with our auditor because they dispute the fmv of grants made months before a related party stock sale that exceeded the fmv stated on the grant (which came from a third party valuation just 6 months earlier). The auditors believe the grants fmv should have gradually increased to be more inline with the related party transactional price. This is so crazy. How was I supposed to know what the related party transaction price was going to be before it was negotiated, let alone expected to pay for interim valuation reports throughout the year? Now, nobody knows what to do and they won't release our audit. I also have outstanding employee grants I need to make, but don't have a fmv price until this is resolved. For the future, we're seriously considering a fixed annual review date for all our employees to occur just after we receive our yearly valuation report just so this crap doesn't happen again. It’s really nuts.

    This regulation is absolutely ridicules, and especially for a small company that has so little time and resources. It's a HUGE and costly distraction as legal is now getting involved and I just got their first invoice. I'm pissed. I really can't believe there isn't a provision for smaller companies. The IRS and FAS board really need to get a clue, not all businesses are Enron!

  • Anon

    Brad, thanks for your continued efforts to help start-ups navigate the ridiculous 409A rules. My company (a start-up) selected one of the big 3 firms to do our first audit, and at the outset of the relationship we told the auditors that we intended to use our 409A valuation for 123R purposes. We offered them an opportunity to review our 409A valuation reports in advance, ask us (and our valuation consultant) questions, etc. Our auditors took a thoughtful and reasonable approach to this matter, and after getting comfortable with our consultant's valuation methodology they agreed to accept our 409A valuation as an input to all of our 123R calculations. We completed our audit with a clean opinion and during the process no issues were raised by the manager, partner or concurring partner regarding 409A/123R common stock valuation.

    Until the IRS and FASB figure out that they need to coordinate their rules (don't hold your breath), this issue should be manageable for most start-ups using your suggested approach.

  • http://intensedebate.com/people/bo_brustker4303 bo_brustker4303

    Brad,

    Great points you raise here, and I agree this is a real pain for early stage companies. As you know, I am part of a boutique valuation services firm that serves venture backed clients on both coasts. We've seen a fair slice of the market and been through our share of SAS 73 reviews. With that in mind, I'd make two points to complement your post.

    1) CFOs of private companies (big and small) should cause their valuation providers to speak with their auditors prior to engagement. Not prior to starting the work, mind you, but prior to even hiring the valuation shop — prior to signing the engagement letter. The fact is that valuation providers will be held to the Fair Value standard, and it's a bony one. If your auditors and valuation providers do not see eye-to-eye on certain practices — the most obvious being which allocation methodology will be used (i.e., the Option Pricing Method), then you should go find another provider.

    2) We have heard from a very knowledgeable source within the IRS, in a face-to-face conversation, that the IRS does not (yet) have an answer to the question of how to reconcile Fair Market Value (409A) with Fair Value (123R). This person went on to say that they are "leveraging the financial reporting community" particularly with reference to allocation methodologies (again, the Option Pricing Method). It is only a guess on my part (speaking personally here, and throughout this comment), but that sounds a lot to me like convergence.

    Good news, bad news for our clients. The good news is that so-called “dual purpose” reports will withstand the scrutiny of both tax and GAAP enforcers. The bad news is that the valuation exercise for all companies — big and small — became irreversibly more challenging in 2007 due to the advent of Fair Value accounting via SFAS 157.

    At risk of appearing self-promoting, I would point your readers to the following brief articles that attempt to further explain the issues from our perspective:

    “Dual Purpose is de rigueur” http://www.arcstonepartners.com/valuationArticles

    “This just about sums it up”
    http://www.arcstonepartners.com/valuationArticles

    “Valuation Updates: when and how”
    http://www.arcstonepartners.com/valuationArticles

  • http://intensedebate.com/people/ronald_lewi4305 ronald_lewi4305

    All of the confusion and pain can end once the IRS is abolished (same for the Federal Reserve). Most government programs and agencies are worthless.

  • Mike Soucie

    Brad, you're right on with your 409A analysis. I can't tell you how frustrated and pissed off this regulation has made me.

    For Electric Rain, its been nothing but a huge and costly headache. We're now in a grid lock with our auditor because they dispute the fmv of grants made months before a related party stock sale that exceeded the fmv stated on the grant (which came from a third party valuation just 6 months earlier). The auditors believe the grants fmv should have gradually increased to be more inline with the related party transactional price. This is so crazy. How was I supposed to know what the related party transaction price was going to be before it was negotiated, let alone expected to pay for interim valuation reports throughout the year? Now, nobody knows what to do and they won't release our audit. I also have outstanding employee grants I need to make, but don't have a fmv price until this is resolved. For the future, we're seriously considering a fixed annual review date for all our employees to occur just after we receive our yearly valuation report just so this crap doesn't happen again. It’s really nuts.

    This regulation is absolutely ridicules, and especially for a small company that has so little time and resources. It's a HUGE and costly distraction as legal is now getting involved and I just got their first invoice. I'm pissed. I really can't believe there isn't a provision for smaller companies. The IRS and FAS board really need to get a clue, not all businesses are Enron!

Build something great with me