If you hand out stock options to employees, a controversial ruling from the Financial Accounting Standards Board might give you pause. The decision, issued late last year by the oversight agency, based in Norwalk, Conn., directs both public and private companies to list outstanding options as an expense item on their books rather than tacking them on to their financial statements as a footnote. The new guidelines are set to take effect in June for public companies and in December for private firms.
Although most people perceive this to be a public-company issue, private companies are just as likely to face repercussions, says Bob Marshall, a former Silicon Valley entrepreneur turned venture capitalist, and an FASB critic. About 5% of public companies, including Microsoft and Coca-Cola, already expense options. But expensing options is almost unheard of among private firms, even though, according to Marshall, options are "the mother's milk for Silicon Valley and tech companies around the country."
Expensing options will have at least two significant effects on private companies. First, it will reduce a firm's reported profits overnight and could inevitably push some businesses from the black into the red, says Joseph Rich, a compensation expert with Pearl Meyers & Partners of Marlborough, Mass. This could, in theory, scare off potential investors. Second, because a privately held company's stock is not openly traded, an accountant determines an option's real-world value, using mathematical pricing models like Black-Scholes or an index of similar publicly traded companies. But that will drive up a company's accounting costs at a time when that line item is already swelling, thanks to Sarbanes-Oxley regulations.
There is a silver lining. Rich believes that large corporations may respond to the new rules by "cutting way back on" their use of options. If that is the case, small companies may enjoy a recruiting advantage if they are willing to dangle equity in front of talented execs.