Meaning
Ownership shares issued to service providers carry purchase prices or tax valuations equal to the current appraisal value of corporate stock at the time of grant. Issuing fair market value equity grants avoids immediate tax liability on unearned income while establishing baseline cost bases for recipients. The framework applies to incentive stock options and restricted stock units, ceasing when shares are issued at a discount to current appraisal values.
Valuation Method
Independent 409A valuations determine current share pricing using market comparisons, discounted cash flows, and net asset calculations. Issuing stock options below current valuation triggers severe tax penalties under federal tax regulations. Regular annual revaluation updates keep option exercise prices compliant with tax laws.
Tax Treatment
Option grants priced at current value allow recipients to defer income tax recognition until option exercise or share sale. Recipient tax obligations arise upon exercise for non-qualified stock options based on the spread between strike price and current valuation. Holding underlying shares after exercise for required statutory periods transitions future appreciation into long-term capital gains tax categories.
Cap Table Impact
Share issuance dilutes existing equity holders while aligning recipient financial incentives with equity appreciation. Board approval dates must match valuation effective dates to maintain legal tax safe harbors. High share valuations increase option exercise costs for employees.
