Stock it to 'em

Entrepreneur, June, 2002 by Jennifer Pellet

Once upon a time, pre-IPO options were a good deal all the way around. But life-and accounting--is becoming more complicated these days. Take, for example, the practice of issuing pre-IPO options to suppliers and customers. Just last year, awarding favorably priced pre-IPO options--dubbed "cheap stock"--was a common practice for growing companies and an economical way for an early-stage company to reward its most loyal partners. But this year, thanks to the SEC, it may become an expensive proposition.

Why the change? "The SEC is saying companies that issue cheap stock need to take a charge on their income statements for the difference between the price at which the stock was issued and the IPO price," explains Peter Knutson, associate professor emeritus of accounting at The Wharton School of the University of Pennsylvania.

Companies, in turn, argue that the pre-IPO valuations are accurate because the liquidity that the P0 itself delivers is what makes the shares more valuable. In the heat of the debate, the SEC charged the American institute of Certified Public Accountants (AICPA) with developing a best practice resolution to the issue by year-end, says Knutson, who is serving on the AICPA's cheap stock task force. In the meantime, newly public companies should stock up on proof of value. "Until they come up with something, companies will be charged on their income statements unless they can provide satisfactory, documentable evidence that values used were justifiable," says Knutson. "The burden of proof is on the companies."