So it’s that time of the year again when you are required to expense your company’s stock options under ASC 718.
Maybe this year you’re doing your first audit and need to expense your options for the first time.
Or perhaps you’ve been expensing your stock options through an outsourced firm but you’re ready to bring it in-house and automate it through software.
Well, that’s great because I’m going to walk you step-by-step through the process of expensing your stock options the easy way. Specifically with Capshare’s software.
Don’t worry if you’ve never used Capshare before. The principles and broad strokes we go through are universal. That being said you’ll probably find that using Capshare will be significantly easier than any other option available to private companies.
We’ll use specific examples and by the time we’re done, you’ll know exactly how to generate stock options expense reports under ASC 718.
It may go without saying, but you’re going to need up-to-date information on equity grants, which means you’re probably going to need an up-to-date cap table.
If you already have your cap table managed on Capshare then great, you’re all set.
But what if you have an up-to-date cap table, but it’s not on Capshare? For example, maybe it’s in excel.
There are a lot of reasons why Capshare is a much better way to manage your cap table than excel (or any other platform for that matter).
But if migrating your cap table over to Capshare doesn’t sound like your idea of a fun afternoon then fear not.
Our support team can migrate your entire cap table for you for $100 (only for new customers).
Ok now that we have that out of the way, let’s start expensing stock options!
A Peak at Your Cap Table Before Beginning the Expense
One of the most important inputs into the calculation of your stock option expense will be your option grants.
Below is a screenshot of what you’d find in your option grant sheet in Capshare.
The option expense will heavily rely on information like the grant date, strike price, vesting plan, option type, etc.
As long as your cap table is current, you can jump right into creating the expense.
If you’re trying to figure out how much you can expense for the year, you’ll probably want to run a report for the full calendar year.
We’ll assume that we’re running a report for 2016.
So we’re going to run our report from 12/31/2015 through 12/31/2016.
Corporate Tax Rate
A Corporate Tax rate will allow Capshare to also calculate a deferred tax asset if it’s necessary.
A best estimate here is fine, and won’t affect the core calculations.
You can tighten that up later on if you determine this calculation is important for your organization.
For this example, we’ll just assume that our corporate tax rate is 35%.
Expense Allocation Method
If you’re in the U.S., the straight-line allocation expense method is what you’ll be using 99.99% of the time.
So that’s what we use here too.
Selecting the Grants to Include in the Report
Next, you’ll want to choose the grants that you want to be included in the report.
For this example, we’re just going to include option grants but you could certainly run a report for a specific equity plan, or just your dev team, etc.
Valuations of Common Stock
You’re also going to need your company’s historical 409A values.
Be sure to add the common share value and valuation date for each of your company’s past valuations.
On to the next step!
Auditors prefer that you calculate volatility by using public companies that are comparable to yours.
Public companies can be looked up and added by their ticker symbols. Capshare pulls the information directly from Capital IQ.
The public comps that you add will be used to calculate your own company’s volatility and play a major role in the overall expense. So it’s worth spending time to list a good collection of viable comparable companies.
If you’ve had a 409A valuation, then you should use the same tickers that were used as public comps in your 409A valuation.
Otherwise, your auditors are going to ask why you used two different comp sets…
…And you probably won’t have a great answer…
And your auditors aren’t going to like that.
So just stick with the same public comp set as your 409A valuation.
The forfeiture rate is applied to account for the portion of employee grants that won’t make it past their cliff as a result of quitting, being fired, etc.
Unlike volatility, forfeiture rates make a very small impact on the end result of your option expense.
There was a change in ASC 718 starting in 2017 that permits for 0% forfeiture rate across the board.
Even though forfeiture rates don’t impact your overall expense much, it’s a good idea to use a 0% forfeiture rate now that it’s allowed.
It’s easier, it’s faster to audit and there are fewer questions.
Calculate the Expense
That’s all you have to do.
Now that we have all our inputs, it’s time to calculate the expense.
Capshare uses the Black-Scholes model to run the calculations on each option that you chose to include in the report.
This would be quite complex to do manually, but fortunately, we get to use software to do it.
If you’re curious to learn more about the nitty-gritty and theory that goes into option expensing, we’ve written a guide on it.
But now is the fun part.
After a few minutes of hardcore number crunching, Capshare will spit out a nice shiny, audit-ready report.
If you ever get audited, you’re going to want a report that “shows your work”. Capshare does a good job of making it very clear how every detail was used to generate the final expense. You can also export the whole thing into Excel if you’d like.
Fair Value Calculation
There are a few aspects to a stock expense report.
The most important tab of the report is the Fair Value Calculation tab.
This part of the report shows the 5 inputs into the Black Scholes calculation and the “fair value” that is output for each stock option.
Underlying and Exercise/Purchase Price
The “Underlying” column shows the underlying value of common stock and the “Exercise/Purchase Price” is the strike price.
The “Term” represents how long we think the option grant will be outstanding from when it was issued to when it either cancels or exercises.
If you want to better understand how the term is calculated you can read up on it in more detail here.
The Risk-Free Rate is the interest rate at which you can lend money, with an almost perfect certainty that it will be repaid. Hence why it’s “risk-free”.
The rate that we’re going to use as an input is the risk-free rate as of the date of the grant. This figure is pulled automatically from the US Treasury’s database for you.
And the volatility is based on the public comps we provided earlier.
The transaction details tab shows you what things looked like at the beginning of the period all the way through the end.
For example at the beginning of the period, we can see that Kenny McNight’s OP-26 grant had 15,000 shares outstanding in which 3,125 were unvested.
Then under “Unvested Transactions” we can follow any transactions that happened during the period.
So for Kenny, those 3,125 shares vested and he exercised 14,062 shares during the period.
Under the “End Balances” section that leaves us with an ending balance of 938 shares, each of which is vested. There are no unvested shares left.
So this is an easy way for us to see every transaction with a fine level of detail across hundreds of grants.
The transaction details above then feed into the expense breakdown for each option. This tab of the report is like a receipt for each and every expense item.
Going back to Kenny McNight’s OP-26 grant, we can see that at the start of the period, 12,185 shares were ready to be expensed. At the end of the period, all 15,000 were ready to be expensed.
In the Expense Calculation section, Capshare pulls the information together for the expense calculation. I’ve outlined the calculations that are happening in each column below:
- Fair Value: Here we’re just repeating the Fair Value that was calculated back on the ‘Fair Value Calculation Tab’
- Forfeiture Rate: If a forfeiture rate was entered, it would show up here.
- End Gross Cumulative Expense: This will include the ‘End Shares to Expense’ multiplied by the Fair Value listed two tabs back. This represents the total expense we would expect to have booked for this grant from the start of time, until the end of our report period.
- End Net Cumulative Expense: For shares still in a cliff, the forfeiture rate needs to be applied, we didn’t have a forfeiture rate, so this will be the same as the last column.
- Begin Net Cumulative Expense: This uses the same calculations as the last couple columns, but as of the start of our report period.
- Current Period Expense: We then take the End Net Cumulative Expense, minus the Begin Net Cumulative Expense, to determine the expense we would expect to see for this period.
The overall expense to be booked is just the total from that Current Period Expense column.
If you think you might be ready to use Capshare to generate audit-ready ASC 718 reports let us know.
We can show you exactly how to set everything up so that you are able to generate audit-ready reports in minutes rather than weeks.