Stock compensation awarded to executives and employees creates additional accounting complexity for pre-IPO companies and becomes an expanded audit focus by external auditors.
Rapidly growing companies with limited resources may find it challenging to build a more robust and efficient process since stock compensation accounting necessitates greater expertise and support often not found internally. To align to public company standards via a more mature stock compensation process, below are several key activities pre-IPO companies can initiate:
Implement Equity Plan Software
Equity management platforms, such as Morgan Stanley at Work’s Shareworks Platform, enable companies to efficiently manage their equity awards and cap table from early growth stage right through to operating as a public company. These tools can also:
- Improve data management (i.e., single source of truth for HR and finance).
- Create efficiencies through elimination of manual calculations.
- Simplify the application of withholding taxes.
- Add a layer of IT general controls to the process, effectively limiting access to sensitive compensation data.
- Provide additional efficiencies around stock compensation expense accounting when moving to a quarterly process as a public company.
Align 409a Valuations
Pre-IPO companies typically get 409a valuations prepared only in conjunction with fundraising activities (if any) and as part of year-end close. These valuations form the basis of the stock compensation expense recorded in the company’s Income Statement, but the timing of the valuation may not be aligned with the dates employees were granted awards.
The valuation of awards is a common area of comment by the SEC on S-1 registration filings, particularly when the grant-date fair value of the awards is significantly different from the target IPO price. To reduce the risk of an audit issue or an SEC comment on a future filing, prepare for more regular 409a valuations and align them with their standard grant dates of awards to employees.
Establish Internal Controls
Stock compensation expense may be a common source of misstatement for private companies, especially where a manual process is the only means for calculating the annual or quarterly expense. To mitigate the risk of misstatement:
- Develop a process flowchart.
- Perform a control gap assessment with a view to implementing additional process controls to reduce the possibility of an error.
- Introduce software and automation to improve process controls and limit access to data.
Review and Standardize a Complex Awards Process
To facilitate a more efficient audit, identify material and complex transactions throughout the year and proactively address technical accounting on a real-time basis. This is also applicable to complex equity awards, such as performance-based awards, which are commonly awarded to company executives and management.
The accounting for these awards may require a different expense recognition pattern to standard awards and may require quarterly monitoring. For any new types of awards issued to employees, companies should consider creating an accounting policy related to these award types in line with ASC 718 and establish a process for reviewing the accounting for such awards in future periods.
The above activities can be a significant challenge due to time and resource constraints, but the value and demand in taking action is necessary for public-company readiness.
To mature your stock compensation process and minimize the risk of audit issues or SEC comments, contact CrossCountry Consulting.