Susan Garvin, CEP, Stock & Option Solutions, Inc.

Henley Hom, Stock & Option Solutions, Inc.

The Top 10 Administrative Issues for Equity

Compensation for Privately Held Companies

1

Disclaimer

• The following discussion and examples do not necessarily represent the official views of Stock & Option Solutions, Inc., with respect to any of the issues addressed. Moreover, this presentation and the views expressed by the individual presenters should not be relied on as legal, accounting, auditing, or tax advice. The outcome of any individual situation depends on the specific facts and circumstances in which the issue arises and on the interpretation of the relevant literature in effect at the time.

• Anyone viewing this presentation should not act upon this information without seeking professional counsel and/or input from their advisors.

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What is Stock Plan Administration?

• A stock Administrator has multifaceted responsibilities and generally includes:

– Record keeping of Equity Plans

– Participant Communications

– Accounting for Stock based Compensation

– Capitalization table management

– Payroll reporting related to Equity Transactions

• Stock can report to multiple departments functionally:

– Accounting/Finance/Payroll

– Human Resources

– Legal

– Treasury/Shared Services

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Administration issue #1

Define Roles and Responsibilities

• Establish and maintain process flow of

information

– Participant data, Grants, and transactions.

– Provide reporting of activity on demand

• Ensure communication materials are distributed

– Board Minutes for grants and warrants

– Exercise and year-end tax statements

• Capitalization Table

• Accounting and payroll reporting

4

Additional Responsibilities

• Early Exercise, 83(b) elections, Stock transfers

• Analysis for corporate transactions or financing

round.

• Dividend payouts or Tender of shares

• Year-End reporting (Sec. 6039)

• Data audits and reconciliation between periods.

• Understanding Option pricing model inputs,

expense accruals, and Journal entries.

• Rule 701 if applicable

5

Administration issue #2

Know your Plans and Grant agreements

• Does your plan allow what you’re granting?– Various types to equity Vehicles

– Terms and features of each plan

• Is your plan expiring soon?– Shares available

• Terms of your plan– Accelerations

– Change in control

– Termination clauses

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Administration issue #3

Have a process set for granting Options and awards• Document BOD approval or executive approval

• 409(A) valuation for ISO’s– IRC §409A says that for an illiquid stock of a start-up corporation (less than 10

years) a valuation would be presumed reasonable if it is evidenced by a written report, performed by a person with significant knowledge and experience or training in performing similar valuations

• Recording of grants– Sources and uses of documents

• Creation of grant list and process to record/communicate

• Where grants originate– Offer letters

– Engagement letters

– Board meeting discussions

– Annual grants, ongoing awards

– Performance Plans

– Consulting and other service agreements

– Etc., etc., etc.

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Administration issue #4

Implement a record-keeping system

• Possible Solutions

– MS Excel or MS Access

– Off the shelf software

– Outsource/Third Party

• Systemized way of recording all equity compensation plan

information

– Plans and terms

– Grants

– Exercises

– Cancellations

• Educate and understand the system/process

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Administration issue #5

Define who’s responsible for Capitalization table

management• Issuance of stock

• Tracking and management of stock

• Communication between all parties

• Shareholder lists

• Early exercise feature

• Data from Acquired companies

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Administration issue #6

Define process flow and responsibility of Stock

based compensation

• Measurement Date

– Timely communication to employees

• Vesting Schedule = Service Period

• Grants to non-employees

• Purpose: Establish a basis to measure compensation expense for the

company

• FAS 123(R) – ASC Topic 718

– Estimate and recognize a compensation expense using the “fair value”

method

– Option Pricing Model (Black-Scholes or Binomial)

• Option Price, Expected Life, Current Price, Expected Volatility, Expected

Dividends, Risk Free Interest Rate

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Options Valuation

• Estimating Volatility

– Historical volatility and implied volatility are not

available.

– Options for non-public companies

• Comparable publicly held company

• Estimating Expected Term

– Company history if available

– SAB 107/110 (“the staff will accept the following "simplified"

method for "plain vanilla" options consistent with those in the fact set

above: expected term = ((vesting term + original contractual term) / 2” )

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Administration issue #7

Rule 701 Compliance

• Expressly designed to exempt sale of stock to employees (and consultants, directors, etc.) in compensatory context

• 90 days after a company goes public, shares held by non-affiliates are freely tradable

• Rule 701 Limitations

• During one-year period, cannot sell more than the greater of:

• $1 million dollars worth of stock

• 15% of the company’s outstanding stock

• Stock worth more than 15% of the company’s assets

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Administration issue #7

Rule 701 Disclosure Requirements• Trigger: When aggregate exercise price of all options granted

in a 12-month period will exceed $5M (excluding grants to officers, Accredited investors, and grants outside the U.S.)

• Requirement: Must provide all Rule 701 optionees, a reasonable time before they exercise, a disclosure package consisting of:

– Financial statements:• Two years of P&L and one balance sheet

• GAAP-compliant (unaudited OK if no audit)

• No more than 180 days old

– Risk Factors

– Summary of material terms of plan

• Consequences: Failure to comply will lose the Rule 701 exemption from SEC registration for all option grants in the period, and could result in rescission rights and an SEC enforcement action.

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Rule 701 Compliance

• Administrative Procedures

– When granting options or issuing stock

• Verify that Rule 701 limits won’t be exceeded

– Audit at least once a year

– Non-compliance

• Can interfere with an IPO

• May have to rely on another exemption, imposing significant

resale restrictions on employees

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Administration issue #8

Employee communications

• Written material should be succinct and easy-to-read

– Define terms if necessary

– Use multiple documents instead of one large

document

– Don’t go overboard, communicate the essentials only

• FAQ (Frequently Asked Questions)

• Avoid giving tax advice

• Examples! Illustrations!

• All written documents and presentation materials should

be reviewed by legal counsel

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Employee Communication

• How?

– In-person

– Online

– Recorded online

– Video

• What?

– Limit the communication to information employees need to know

• Don’t discuss different programs at the same time

• Discuss tax treatment specific to employees

• Make sure the presentation is timely

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Administration issue #9

Periodic audits and reconciliations

• Validate who has access and authority to make or request

changes to the database.

• Monthly reconciliation with Capitalization Table

� General Ledger of detailed transactions

� Periodic reconciliation of Shares

• Audit Exercises and releases to payroll’s W-2 income to

ensure data flows are properly working.

• Validate outstanding shares with “Active” and

“Terminated” employees.

• Roll forwards and activity tie out by period.

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More Helpful Tips On Reconciliations

• Types

– Period to period, quarter-to-quarter, year-to-year

– Stock Plans to HR

– Stock Plans to Payroll

• Methods

– Spreadsheet functions (vlookup)

– Access database

• Best Practices (seem obvious, but…):

– SAVE soft / e-copy of EACH report at period close

– SAVE back up copy of database at period close

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Administration issue #10

Advance issues

• Financing Round

• Dividend payments

• Blue Sky Laws

• ESPP Plan

• Tender Offers

• Merger or Acquisitions

• Secondary markets

• Preparing for IPO

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Preparing for IPO

• Assisting Employees in Stock Sales

– Information meetings without tax advice

– Onsite financial advisors for employees

– Resale and contractual limitation

• Evaluating staff expertise

– Expertise required in Accounting, Tax, Securities Law

and Administrative Issues

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Contact Information

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Susan Garvin, CEP

Equity Compensation Consultant

910 Campisi Way, Ste 2E

Campbell, CA 95008 USA

Bus: (408) 979-8700

E-mail: Sgarvin@sos-team.com

Henley Hom

Principal

910 Campisi Way, Ste 2E

Campbell, CA 95008 USA

Bus: (408) 979-8700

E-mail: hhom@sos-team.com

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