The market for private company equity securities, often referred to as the "secondary market," continues to expand. Sales of employee shares to a third party in a secondary market transaction can introduce unique accounting challenges.
A purchase by a third party of shares from an employee, at fair value, is typically a transaction among shareholders, with no accounting recognition by the company. However, if the transaction price paid by the third party exceeds the fair value of the shares, the company will need to evaluate whether there is a compensatory element to the arrangement. In particular, if the company is involved in facilitating the transaction, it is likely that compensation expense will arise. Consideration of the extent of the company's involvement should include whether the company helped to arrange the transaction and whether it was concurrent with (or a condition for) a sale of other financial instruments by the company to the third party.
It is also important to understand the relationship between the company and the third party in the transaction. If the third party has a pre-existing economic interest in the company, the third party is presumed to be acting on behalf of the company as described in SC 1.4.
In such a situation, unless the payment is clearly for another purpose, the excess of the purchase price over the fair value of the shares would be considered compensation for employee services. In that case, the company would reflect the transaction as a contribution of the excess purchase price from the economic interest holder and payment of compensation to the employee.
Secondary market transactions often have other complexities. For example, a history of repurchasing unexercised options or "immature" shares (shares in which the employee has not yet vested or has vested but which have been held for less than six months) could create a presumption that the company intends to settle future awards in cash, which would require liability classification for those awards.