Historically under ASC 505-50, non-employee awards were valued on the date the equity award was earned (the vest date) while employee awards were valued on the date the equity award was granted (the grant date). Using mark-to-market accounting, the hope was to more accurately measure non-employee awards as the underlying value of the company’s stock fluctuates over time. This was later amended with ASU 2018-07 which have both non-employee and employee awards valued a single time on the grant date. The latest a company could adopt ASU 2018-07 was the company’s fiscal year after December 2019.
Let’s look at an example where the same award of 1,000 stock options is given to an employee and non-employee. Both vest 25% annually, have a strike price of $1.50, and expire in 10 years. Expense is recognized throughout the award's service period which generally begins on the grant date.
For the employee, the award is valued on the grant date using the Black Scholes option pricing model to estimate a $1.00 fair value per share.
The award consists of 1,000 stock options, with 250 options vesting annually.
All 1,000 stock options are valued at $1.00 per share for a total fair value of $1,000.
For the non-employee, the award is not valued on the grant date, but instead valued mark-to-market on the date each of the 250 tranches vest:
On 12/31/2020, the fair value estimate of the 250 options that vest on 12/31/2020 is $2.00 per share for a total fair value of $500.
Each of the remaining 250 vesting tranches are also measured on each of their respective vest dates to estimate a total fair value of $3,250:
With the strike price locked at $1.50/share, the stock option generally becomes more valuable over time as the underlying value of the company’s stock price increases.
In Carta’s reports, the ‘option values’ tab details how each stock option is valued. Employee awards will generally just have one valuation on the grant date. For non-employee awards valued mark-to-market, there will be multiple valuations if the award has multiple vest dates.
Note how employee award ES-1 has one single valuation on 1/1/2020 for $1.00 per share. Non-employee award ES-2, which is also granted on 1/1/2020, has a valuation on each of the four vest dates 12/31/2020, 12/31/2021, 12/31/2022, 12/31/2023.
Additionally, the term input for the Black Scholes model is different for non-employees. Employee awards use the expected term which is an average of the vesting term and the contractual term. Mark-to-market non-employee awards use the remaining contractual term. In the above example, upon the vesting date of the first 250 stock options on 12/31/2020, the stock option has a remaining contractual term of 9 years (12/31/2020 - 12/31/2030). When the second 250 stock options vest on 12/31/2021, there are 8 years remaining (12/31/2021 - 12/31/2030). And so on…
For non-employee stock options that have not yet vested, Carta will value the award as of the end of the reporting period as a temporary estimate to the fair value. This will later be adjusted with the actual fair value on the vest date or reversed if the shares are forfeited.