This just makes me want to crawl under my desk and cry for a while.  Can you imagine how much it would hurt if you threw that at a lawyer or an accountant and actually hit them with it?

Skadden Partner Completes 409A Handbook: “

Sneak Preview Here

Regina Olshan

Erica Schohn

Flashback: Regina Organizes Push for 409A Extension“

(Via 409A Dismay.)

Holy Absurdity Batman, someone actually writes a dedicated 409A site called 409A Dismay.  For the latest and greatest 409A silliness, you are one click away from a subscription.

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.

Jason and I have written extensively about 409A – a new tax regulation for pricing stock options in private companies that both of us think is fundamentally absurd.  For the past 24 months we’ve been dealing with draft regulations which have made the problem of figuring out how to deal with pricing stock options in private companies both ambiguous, time consuming, and unnecessarily expensive (at least if you want to conform to the draft rules.)

The final regs have been released and Jason has sacrificed his brain by reading through him.  His comments are over at AsktheVC.

On Wednesday, the IRS announced what it called “relief” extending the “transition period” of compliance with 409A through January 1, 2008 (unless you are a public company and you are involved in a back dating scandal, then you are still hosed.)

What the IRS really means (as translated by my trusty sidekick Jason) is “We still can’t figure out how to implement this puppy, so we are telling y’all to keep complying the best you can (in good faith) and we’ll get back with you fine folks once we figure out what we meant in the first place.”

Bottom Line:  Act as if 409A is alive and well.  Refer to our prior posts if you are curious about our take on it.  We continue to hope that someone important in Washington DC will wake up one day and realize how completely absurd 409A and kill it.  Oh well – it’s good to have fantasies.

While I was on vacation, I got an email from someone much more “in the know” than I am that it is highly unlikely that the final 409A regulations will be finalized in time for them to be effective by 1/1/07.  Daniel Hogans – attorney-advisor in the Treasury Office of Tax Policy – stated during a speech at the American Law Institute-American Bar Association’s meeting last week that the proposed regulations’ effective date of Jan. 1, 2007, is “increasingly unworkable at this point.” People can “reasonably expect to see additional guidance” on the effective date issue.  Hogans said he did not expect structural changes in the final regulations, but there will be changes in the details.

Just when you thought you’d never hear from me and Jason on 409A again, we received the following missive from a lawyer friend of ours:

(The) IRS is now saying that drafting final regs is too hard and that they won’t be out until late summer/early fall.  That translates into September/October in my head. Apparently they’re having issues with putting together startup valuation rules.

Well, at least we don’t feel so stupid now thinking that complying with 409A is an almost impossible task.  As previously stated in our 409A series, the idea of coming up with any “real” private company valuation is, at best, a shot in the dark.  Nice to see the IRS struggling with a monster of its own making. 

We can’t wait to see what guidance they come out with.

Jason sent me a quote that was on the first slide of a 409A presentation from one of the major law firms we work with.

“409A is the tax law that ate the world.  Every day we discover another 12 issues.”
—– Senior US Treasury Department Tax Official, March 13, 2006

Maybe Jack Bauer will start paying attention to 409A in tonight’s episode of 24.

I guess it is only fair that while Jason and I rip on the IRS, accountants, and lawyers regarding 409A, we make take a few shots at the VC community.  VC’s are perhaps the most uninformed population with respect to the 409A guidelines. In general, it’s been very disappointing to here other VCs speak about the regulations and make grotesque over-generalizations regarding their applicability. At this point, I can’t remember how many “this isn’t right” emails that I’ve had to send. At least I have a blog that I can send them to (of course – not for “official advice”), as opposed to having to type the same email 100 times.

Following is an example that came up last week that made my head spin.  One of our companies – a relatively young one that has only had one round of financing - is in the middle of raising a new financing.  They are doing well, have a competitive financing situation going on, and I expect they will have multiple options to choose from.   The company is well informed about 409A, has done all the things you’d expect them to, and are planning to have an outside audit done by the end of April.  The financing is expected to close by the end of March – they are holding off on the 409A audit to wait for the financing to be completed.  They have decided to hold off granting any new options until after the financing and have accepted that the option price will be driven by the 409A audit based on the new preferred stock price associated with the financing.

One of the VCs they are talking to has asserted that they cannot close a financing without an outside audit. The assertion from the VC is that “it’s too risky and creates too much liability for the new investor.”  Huh?  In addition to being a completely illogical statement, it’s clear the VC simply doesn’t understand 409A since holding off on the financing will likely drive the value of the common stock down (since the company is running out of money) while doing the financing will drive the value of the common stock up (since it’ll be well-financed at a higher per share price then before.)  Which is a more conservative position to take?  Actually, it doesn’t really matter – since it’s an early stage companies we are likely talking about pennies a share in any scenario.

Add one “point” to the “noise” column under 409A. It blows my mind that major business decisions (e.g. the financing of an early stage company) are being driven by the IRS guidelines. Shame on you IRS, but more shame on the VCs who remain ignorant about the real facts.

I just received a memo from a name-brand Silicon Valley law firm in response to a board discussion that I was part of about 409A (the company granted some options today, obligatory 409A discussion ensued.)  While I’m sure the law firm in question was trying to be helpful, the first paragraph of the memo says “But section 409A does not apply to Incentive stock options, or “ISOs”.  Grrr.

While this may be factually correct, it’s a logically false statement.  The memo goes on to correct this notion on the bottom of the second page, ending with “Therefore, it will be advisable in the future to use care when valuing Common Stock, regardless of whether the options being granted are ISOs or NSOs.”  Ok – thanks – but most entrepreneurs aren’t going to read past the first page!

I sent my lawyer friend the following note:

I’d like to suggest that the statement that 409A does not apply to ISO’s is misleading. While you clarify the dynamic later in the memo, a number of people (including lawyers, VCs, and entrepreneurs) have insisted that 409A doesn’t apply to ISO’s, so you don’t have to do anything to comply with 409A except grant ISOs. Obviously the conclusion being drawn by some is completely false and the concept is self-referential – if an ISO is granted below FMV, it no longer qualifies to be an ISO, becomes a NSO granted below market, and is subject to 409A. I don’t know if you have any influence on the way this memo is written / presented, but I’m personally tired of explaining to people that – in fact – ISOs are part of the discussion given that to be an ISO, they have to be granted at FMV, the determination of which is linked directly to 409A. Of course – I’m not a lawyer – so while I can’t include IRS Circular 230 in my emails about this, this is just my opinion and shouldn’t be relied on for anything by anyone.