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6.2 Measurement of awards issued by nonpublic companies
Publication date: 29 Feb 2024
us Stock-based compensation guide
The selection of the appropriate measurement method depends on the classification of the award. Figure SC 6-1 summarizes alternative measurement methods by nonpublic companies for equity and liability awards.
Figure SC 6-1
Measurement methods (nonpublic companies only)
Measurement methods (nonpublic companies only)
Equity-classified awards |
Liability-classified awards |
Value according to the following hierarchy:
|
Accounting policy election:
* Nonpublic companies may elect to use the calculated value method to measure liability-classified awards if the calculated value method is used to measure equity-classified awards.
|
New guidance
In October 2021, the FASB issued ASU 2021-07, Compensation—Stock Compensation (Topic 718) Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards (a consensus of the Private Company Council), which provides a practical expedient for nonpublic entities that may be used in determining the current underlying share price input of equity-classified share-based awards issued to both employees and nonemployees (in lieu of a specific estimate of fair value in accordance with ASC 820). ASU 2021-07 describes the practical expedient as “reasonable application of a reasonable valuation method” and notes that a valuation performed in accordance with the regulations of the US Department of the Treasury related to Section 409A of the US Internal Revenue Code is an example of a reasonable valuation method.
The expedient can be elected for equity-classified share-based awards in the scope of ASC 718 but is not available for liability-classified awards. If elected, the expedient is applied on a measurement-date-by-measurement-date basis and must be applied to all awards that have the same underlying share and same measurement date. The practical expedient is effective prospectively for all qualifying awards granted or modified during fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early application, including application in an interim period, is permitted for financial statements that have not yet been issued or made available for issuance as of October 25, 2021.
Although ASU 2021-07 is designed to provide a practical expedient, a reporting entity’s obligation to develop the underlying estimates and assumptions necessary to perform a valuation in accordance with Treasury Regulations is no different than a valuation performed pursuant to the fair value guidance in ASC 820. ASU 2021-07 requires that if an alternative valuation is used, it must be updated for any information that may materially affect the value of the entity since the last valuation, and the valuation must be performed within 12 months of the relevant measurement date.
6.2.1 Measurement of equity awards by nonpublic companies
Consistent with public companies, the fair value method for awards classified as equity, if practicable to apply for a nonpublic company, is preferable. The AICPA Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, provides both valuation and disclosure best practices related to the issuance of privately-held-company equity securities as compensation, including awards that are within the scope of ASC 718.
In some cases, nonpublic companies may find it difficult to use the fair value method because of the difficulty of estimating volatility for use in an option pricing model. Generally, nonpublic companies can look at volatility of similar ("peer group") public companies to help determine a volatility assumption. See SC 9.4.1.2 for a more detailed discussion on how to select an appropriate peer group.
In addition, a nonpublic company that conducts private transactions using its stock or issues new equity or convertible debt instruments may consider its shares' historical volatility when estimating expected volatility.
For the sake of convenience, throughout this guide, the term fair value is intended to be the equivalent of fair value-based method as used in ASC 718.
6.2.1.1 Use of calculated value method by nonpublic companies
If sufficient information is not available to estimate expected volatility, nonpublic companies may use the calculated value method. The calculated value method requires the use of an option pricing model that substitutes the historical volatility of an appropriate industry/sector index for the expected volatility assumption. A company should first consider other methods, such as applying the fair value method using peer group volatility, before utilizing the calculated value approach. We believe most companies should be able to identify a peer group to estimate expected volatility.
To apply the calculated value method, companies should select an appropriate industry/sector index (e.g., from the Dow Jones index series), taking into account the nonpublic company's size. Likewise, if a nonpublic company participates in two different industries that have experienced different volatilities, it would need to decide how to average those volatilities for purposes of determining its own volatility assumption.
Once an appropriate index has been identified, a nonpublic company should use the volatility that corresponds to the option's expected term. For example, if the expected term of the nonpublic company's option is five years, it should use the five-year volatility of the appropriate index.
6.2.1.2 Use of intrinsic value method by nonpublic companies
As discussed in SC 2.2.3, in some rare circumstances, it might not be possible to reasonably estimate the fair value or the calculated value of equity-classified awards on the grant date because of the complexity of the award's terms. In these limited situations, a nonpublic company should use the intrinsic value to measure the value of the award. The company should then remeasure the intrinsic value each reporting period until the award is exercised, settled, or expires, even if the company might be able to reasonably estimate the fair value at a later date. Thus, the final measurement of compensation cost would be the award's intrinsic value on the settlement date.
Applying the intrinsic value method to stock-based compensation awards classified as equity is expected to be as rare for nonpublic companies as it is for public companies. A nonpublic company is unlikely to issue awards with terms so complex and unique that it would be unable to reasonably determine the awards' fair value or calculated value.
6.2.1.3 Consistency of measurement method by nonpublic companies
A company should apply the same measurement method for all similar awards, and, for awards that require periodic remeasurement, over the entire life of each of those awards. If a nonpublic company used the intrinsic value method for an award and subsequently believes that fair value or calculated value can be estimated for its new awards, it may use either of those methods, as appropriate, for the new awards even though it will continue using the intrinsic value method for the old awards. If a nonpublic entity has previously measured its equity-classified awards at fair value, generally the company would be unable to justify the use of the intrinsic value or calculated value method for similar awards in the future as fair value would need to be deemed impracticable. The decision on which measurement method to use should be based on a company's specific facts and circumstances.
6.2.2 Measurement of liability awards by nonpublic companies
The alternative measurement methods available to a nonpublic company for measuring its liability-classified awards depend on the method the company uses to measure its equity-classified awards. A nonpublic company that uses fair value to measure its equity-classified awards should adopt an accounting policy to measure all of its liability-classified awards using fair value or intrinsic value. A nonpublic company that uses a calculated value to measure its equity-classified awards would have an accounting policy choice to measure all of its liability-classified awards using the calculated value method or the intrinsic value method. Under each of the measurement alternatives for liability-classified awards, the company will remeasure the award on each reporting date using the same method until the award is settled.
If a nonpublic entity has a policy to measure its liability-classified awards at fair value, generally the company would be unable to change its policy to use the intrinsic value method, as that change would likely not be viewed as preferable.
6.2.3 Simplified method for estimating expected term by nonpublics
As discussed in SC 9.3.1, SAB Topic 14 (Section D.2, Question 6) provides a simplified method for estimating expected term that is not based on a company's historical exercise data for awards that qualify as "plain-vanilla" options. It is acceptable for a nonpublic company to use the simplified method for stock options if they meet the criteria in SAB Topic 14. It may require judgment to determine whether the criteria are met to apply the simplified method. For example, we believe an equity-classified option with a repurchase feature that is designed to provide liquidity (e.g., a fair value repurchase feature) could still be considered "plain vanilla." However, other repurchase features could preclude a company from concluding that an option meets the criteria (e.g., certain book value repurchase features).
6.2.4 Practical expedient-estimating expected term by nonpublics
Nonpublic companies may employ a practical expedient for estimating the expected term of stock-based compensation awards that would not meet the criteria to apply the simplified method in SAB Topic 14 (see SC 6.2.3), such as awards with repurchase features and awards with performance conditions. However, the practical expedient can only be elected if the award meets specified criteria, which include being granted at the money and not having a market-based vesting condition. The practical expedient varies based on the vesting conditions, as summarized in Figure SC 6-2.
Figure SC 6-2
Practical expedient for estimating expected term of nonpublic company stock options
Practical expedient for estimating expected term of nonpublic company stock options
Type of vesting provision |
Probability of performance condition being met at measurement date |
Practical expedient for expected term |
Service condition only (implicit or explicit) |
N/A |
Midpoint between the end of the requisite service period and the contractual term of award |
Service and performance conditions |
Probable |
Midpoint between the end of the requisite service period and the contractual term of award |
Not probable |
If service period is implicit: contractual term If service period is explicit: midpoint between the end of the requisite service period and the contractual term of award |
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