Valuation and Compensation Implications of Private Transactions

2. Is the security identical to the subject security?  

Next, confirm that the transaction is in the same security. A company typically grants common stock to their employees, yet investors typically purchase preferred stock. Common stock lacks the liquidation preference and other key features of preferred stock. In that case, rather than simply equating preferred stock to the price of common stock directly, an approach that takes into account the differences between these stock types should be used, such as the option pricing method or applying discounts due to marketability . In this way, we can infer the value of the common stock based on preferred stock transactions. 

3. Is the transaction contemporaneous or recent?   

Often, we’re presented with transactions from more than a calendar year prior. In this case, we need to assess any changes we would expect to impact the price. Even a recent price may be outdated if significant news has been released since. 

If any of these tests fail, it’s not necessary to ignore a transaction, but it may make sense to place a lower weight on it or adjust for the differences in time or economic rights. 

Guidance in Chapter 9: Assessing Compensation 

Chapter 9 is about compensatory aspects of transactions and related disclosure requirements. 
 

If a security is purchased from an employee for more than it’s worth, the excess value is considered compensation. A good example of this is a tender offer, where the company sells shares to an outside investor at a price above what other investors would be willing to pay in a secondary market.³⁴  

When evaluating the transaction, it’s important to consider the intent . In some cases, the transaction is to provide liquidity, as in the selling of additional shares of the same security in a later round of financing. Others are more directly compensatory in nature, such as when the company or investor agree to compensate the grantees, knowingly paying more than the estimated value of the shares. 

There’s nothing actually new in the rules here. ASC 718 already requires the expense for compensatory purchases, and while they’re infrequent, we’re sometimes asked to assess the value and recognize their expense. A keen eye is needed to understand whether these transactions are compensatory or simply providing liquidity.  

Still, the new chapter provides additional specific examples and more concrete disclosure requirements, which should help deal with these transactions. 

Our Take 

Companies with buyback programs may already have been familiar with these processes, while those with more purchases on the secondary market may find them an interesting point to contend with.  

The characteristics of secondary transactions weren’t well codified under the existing guidance.  The addition of these two chapters will help to better align the AICPA guide with best practices. We believe the new guidance also provides a good framework as companies deal with more private company transactions both internally, and through private markets, where they may not see all of the details. 

The AICPA is looking to release a full exposure draft of the updated practice aid sometime in 2025. We’ll keep readers apprised of any new developments.