Evidentiary requirement and 409A valuation

Several clients ask us questions about what types of information is collected and why. You see, 409A valuations have got more to do with substantiation and evidence and less to do with valuation techniques and number crunching. One of the things we have noticed, especially, in valuation work from overseas is use of data sources, enumeration and explanation of data, and calculation methods that dont quite fit in with US Tax Court lingo or evidentiary standards. We collect information that is more appropriate to pass the evidentiary standards set out in usual IRS court cases and US GAAP standards. This also makes the audit work a breeze as most information they are looking for is set in in the manual. While working with one client, they mentioned that a company in India charges less for valuations and then when we inquired as to what they normally ask and process, the client mentioned that they use a single approach to arrive at results for all firms. Use of a single approach goes against the well established US evidentiary standard that all available approaches have to be weighed, before one or more approaches can be discarded. This "discarding" process has to be shown through calculations and comments. Cutting work short and then paying less for that defeats the evidentiary standards set out in the US. While the cost, income and market approaches are the usual methods to evaluate a firm or its assets' valuation, use of these methods have to be relevant and appropriate to how the "most advantageous transactions" market currently uses them. The valuations have to be created to reflect as if the buy or sale transaction occurred in the most advantageous market. Another thing to note that is the fact that, in the US we have something called "investment value", that widely differs from fair market value. Investment value cannot be used for 409A valuations. In reviewing valuations from overseas, we find that specific notations to which valuations are "investment" and which are "fair market", are totally missing. We are not sure how these valuations even pass US audit requirements as many of the valuations are shallow and will not stand scrutiny here, should the IRS were to scrutinize them in  the future. While many of these foreign firms are presenting a quick, short valuation report, companies beware that they may not meet US evidentiary standards. We do understand the analytical strengths and cost advantages associated with doing overseas work. But cutting prices and sacrificing evidentiary standards is something we cannot advocate to any of our clients.

Too small to cope with 409A regulations? Try Restricted Stock!

One of the things about 409A regulations is that it imposes a valuation requirement on you, which could be expensive depending on the service provider. Not every service provider operates efficiently and only a few like us are able to provide the highest quality at affordable rates. It took a lot of trial and error work, technology utilization and template work to get to this business proposition. If you are a very small founder and your head swims over how to create paperwork for 409A compliance, I recommend you use restricted stock for your employees. Restricted stock is outside 409A requirements and you dont have to get a valuation done to determine the fair market value of the underlying stock at the time of the grant. While restricted stock units are attractive, if you include clauses such as the right to call back the stock, then the position maybe treated akin to an option and may end up falling under 409A. So, make sure you issue a plain vanilla restricted stock. You also attract taxes only when you actually book a capital gain on the stock rather than a possible tax payment right at the time of grant as in an option. There are advantages to issuing an option such as the inexpensive costs that companies have to bear and significant upside, should the stock price go up. But if the stock price went down, you may not have any stock at all, unlike in a restricted stock scenario where your stock is worth something unless it goes to zero. This means that it is important to issue stock options at very early stages of a company's development but the hitch is that it requires significantly more paperwork than restricted stock. Hybrid solutions are possible. Please contact us to learn more.