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Stock-based compensation issues in an IPO and SPAC, explained · PwC's accounting podcast

• 0:00
  SPEAKER_02: Welcome to PWC's Accounting Podcast Series.
• 0:03
  SPEAKER_02: I'm Heather Horn.
• 0:04
  SPEAKER_02: Thinking about an IPO or SPAC?
• 0:07
  SPEAKER_02: If so, stock compensation may be, or perhaps better said, should be, on your mind.
• 0:13
  SPEAKER_02: There are a lot of accounting considerations that get triggered as a company goes through the process of becoming public, one such consideration being stock comp.
• 0:21
  SPEAKER_02: To help us avoid some of the accounting headaches and to get ahead of the challenges, joining me today is PWC partner Jay Selber.
• 0:28
  SPEAKER_02: Jay is from our national office and is a regular podcast guest.
• 0:32
  SPEAKER_02: Jay will also be a guest on our upcoming webcast on May 19th around rebuilding revenue.
• 0:38
  SPEAKER_02: If you're interested in joining and earning CPE credit, register at viewpoint.pwc.com.
• 0:45
  SPEAKER_02: But back to today.
• 0:46
  SPEAKER_02: Is an IPO or SPAC in your future?
• 0:49
  SPEAKER_02: Or even if not, given the level of activity right now, it's definitely a timely topic to learn about.
• 0:57
  SPEAKER_02: So, Jay, thanks so much for joining me today.
• 1:00
  SPEAKER_02: Looking forward to hitting on a topic that's in the news a lot recently, which is the huge amount of IPO and SPAC activity.
• 1:08
  SPEAKER_02: Although I'm happy we're going to be focusing in on one particular area that I know from personal experience dating back many, many years, is very complicated or can be very complicated when you're dealing with going public, and that would be in the area of compensation.
• 1:23
  SPEAKER_02: So can you give us a quick overview of what you're thinking in this area?
• 1:29
  SPEAKER_00: Sure.
• 1:29
  SPEAKER_00: And certainly thanks for having me here today, Heather.
• 1:32
  SPEAKER_00: And you're right, we do see a lot of really interesting things in the stock compensation arena in an IPO.
• 1:38
  SPEAKER_00: Well, at least I think they're pretty interesting.
• 1:41
  SPEAKER_00: And uh some of them can take a fair bit of time to address.
• 1:44
  SPEAKER_00: And many of them are areas that we see the SEC issue comment letter questions about.
• 1:49
  SPEAKER_00: So it's good to get ahead of them early.
• 1:52
  SPEAKER_00: And I know you talked about both of them here.
• 1:54
  SPEAKER_00: Uh, while I'll probably generically refer to IPOs during the course of the podcast, pretty much all of these topics equally apply to SPAC mergers and their related filings too.
• 2:05
  SPEAKER_02: All right.
• 2:06
  SPEAKER_02: Well, Jay, I'm actually happy to hear you say you think it's interesting because if not, I'm not sure our audience would be that interested.
• 2:12
  SPEAKER_02: So it's a good, at least a good starting point.
• 2:15
  SPEAKER_02: So, with that, you know, as we talked in preparation for the podcast, and again, as I think about my own experience, it sounds like definitely some of the main themes we run into are valuation, recognition, and presentation.
• 2:28
  SPEAKER_02: So pretty much actually everything to do with the county.
• 2:31
  SPEAKER_02: Um, but why don't we jump into the first topic on valuation?
• 2:34
  SPEAKER_02: And in particular, let's talk here about cheap stock.
• 2:38
  SPEAKER_02: What is that?
• 2:38
  SPEAKER_00: Well, who doesn't love a sale, Heather?
• 2:40
  SPEAKER_00: Perfect.
• 2:41
  SPEAKER_00: And I think why while we all like to buy stock cheap and sell high, what this is getting at is the measurement of the fair value of stock-based awards, especially in the recent period leading up to the IPO.
• 2:56
  SPEAKER_00: And the question is around whether the fair value of the awards, which is driven in large part by the value of the underlying shares, is appropriate.
• 3:05
  SPEAKER_00: And while that's always a challenging question for private companies, it's definitely accentuated as the company ramps up to an IPO and presumably is growing its value, and especially if the projected IPO price is significantly higher than the value that the company came up with to value awards that were issued in the recent past.
• 3:27
  SPEAKER_00: And so essentially the concern is that those valuations are too cheap in relation to the actual IPO price.
• 3:34
  SPEAKER_00: The valuations that a company may have historically done, even if very thoughtfully prepared at the time, are subjective, whereas the IPO price is objective.
• 3:44
  SPEAKER_00: So that can raise questions about how supportable those previous valuations are.
• 3:49
  SPEAKER_02: And Jay, maybe before we go on, is this just in relation to the final, you know, when they actually go public because the cause issues, or is this even in sort of the pre-public filings that are done leading up to the IPO?
• 4:04
  SPEAKER_00: Well, it includes both.
• 4:05
  SPEAKER_00: And even when you're doing that filing uh that's sort of in preparation for the offering, you you either already have an estimated IPO price or range of IPO prices, or maybe you have inclinations of it from the bankers at that point.
• 4:22
  SPEAKER_00: So it's relevant uh in any of the filings that are leading up to the IPO.
• 4:27
  SPEAKER_02: Okay, so then, Jay, if we see a big difference between the numbers originally used and then the valuations we're seeing in either the run-up to the IPO or the IPO itself, does the company actually have to go back and change its numbers used in previous financial statements?
• 4:43
  SPEAKER_00: Um not necessarily, Heather, but a company should revisit the valuations that they use for recent stock compensation grants in light of the IPO price, and see if the overall story makes sense.
• 4:57
  SPEAKER_00: For example, what has been the ramp up in the value over time, like what significant milestones have occurred at the company?
• 5:05
  SPEAKER_00: Have there been new product developments or customer sign, for example, or new executives that have been hired, key financings that have taken place, some hitting some key financial milestones like achieving profitability, things like that.
• 5:21
  SPEAKER_00: And do they align with the increase in value up to the projected IPO price?
• 5:28
  SPEAKER_00: And then also, if there have been any third-party equity financing transactions, like direct ones that the company has done, as well as any secondary transactions that current shareholders or employees might have done, how have those been factored into the valuation?
• 5:45
  SPEAKER_00: Even in this case, even looking at comparable public companies and how their stock price has fared over that time could be relevant too.
• 5:53
  SPEAKER_02: So then, Jay, maybe one question is in a way this come down to process.
• 5:58
  SPEAKER_02: And as long as you, you know, in the past had a good process and were appropriately considering developments at the company, that's going to be easier to support than maybe otherwise.
• 6:11
  SPEAKER_00: Certainly on the spectrum of things, yes.
• 6:13
  SPEAKER_00: It may not get you there in its entirety.
• 6:16
  SPEAKER_00: Sometimes just the numbers have changed too much.
• 6:19
  SPEAKER_00: And at the end of the day, you may not be able to kind of bridge that gap between what you used before and sort of what the final numbers are, anyways.
• 6:27
  SPEAKER_00: But you certainly, you know, could part of it is lining up against the timeline of the deal.
• 6:33
  SPEAKER_00: In other words, when did the company start talking to investment bankers?
• 6:37
  SPEAKER_00: And when did the bankers start talking about potential valuations and the IPO price that they might they think they could get?
• 6:45
  SPEAKER_00: Those are also important because it could be hard to justify valuing your common stock for compensation purposes at one price if the professional investment bankers are telling you the stock is worth significantly more.
• 6:57
  SPEAKER_02: Right.
• 6:58
  SPEAKER_02: I think these are good reminders for a lot of company, private companies trying to deal with their stock valuations.
• 7:04
  SPEAKER_02: So then, Jay, you mentioned there could be this gap that you can't really bridge.
• 7:08
  SPEAKER_02: So how do you think about that?
• 7:10
  SPEAKER_00: Well, ultimately, when you look at all of it, if the previous valuations can't be justified in light of all of these facts and circumstances, including the projected IPO price, which is objective information, you know, they may need to be updated and additional compensation costs might need to be recorded for those awards.
• 7:31
  SPEAKER_02: So, Jay, if we're thinking about SEC comment letters in the IPO process, I am assuming this is an area that we see a lot of questions.
• 7:39
  SPEAKER_00: It definitely is.
• 7:40
  SPEAKER_00: We do see a lot of comment letters on this topic, uh, often asking for a lot of detail about past awards and how the company has determined its valuation of those awards.
• 7:52
  SPEAKER_00: Sometimes we see companies try to preempt this by sending in a supplemental cheap stock letter to the SEC as part of the filing process, uh, where they might lay out the key factors that the company considered and essentially trying to tell that story that I mentioned earlier.
• 8:09
  SPEAKER_00: And that can be an effective way to try to manage this issue.
• 8:13
  SPEAKER_02: I don't want to make you draw a conclusion here, but do you often see changes coming out of this process, or is it often more of a back and forth just making sure you can explain what you did?
• 8:23
  SPEAKER_02: And again, the documentation is going to be very important.
• 8:26
  SPEAKER_02: Or if it's too hard to answer, you can say that too.
• 8:30
  SPEAKER_00: I think that's a very facts and circumstances type of situation, Heather.
• 8:34
  SPEAKER_00: So it's probably dangerous to try to generalize to that question.
• 8:38
  SPEAKER_02: Great answer, Jay.
• 8:39
  SPEAKER_02: All right.
• 8:40
  SPEAKER_02: But fair to say that documentation is key here.
• 8:43
  SPEAKER_02: So all right.
• 8:44
  SPEAKER_02: So then, Jay, why don't we shift into this area of recognition?
• 8:47
  SPEAKER_02: And again, one thing I know that's always important and can be confusing in the accounting for stock comp arrangements is vesting.
• 8:55
  SPEAKER_02: And frequently, vesting will be contingent or triggered by an IPO or maybe some other change of control.
• 9:02
  SPEAKER_02: So, how does that interact with the accounting, particularly at the offering, the point of time of the offering?
• 9:08
  SPEAKER_00: Right.
• 9:09
  SPEAKER_00: So we do see lots of awards that vest over time, and that's called a service condition, as well as ones that vest upon achieving a defined milestone or metric, like an IPO or revenue target or something else, and that's called a performance condition.
• 9:26
  SPEAKER_00: Uh, we do also see ones that are could be tied into hitting a stock price target, which is called a market condition, but we'll we'll save that for another podcast.
• 9:33
  SPEAKER_00: Generally, equity awards that have service and or performance conditions, they're measured at the grant date, uh effectively assuming they will vest, it's not baked into the value.
• 9:45
  SPEAKER_00: But that value is only recognized if it's probable that they will actually vest.
• 9:51
  SPEAKER_00: So if the award requires an IPO or other liquidity event to become vested or become exercisable, then perhaps no expense was recognized historically because that liquidity event performance condition was not considered probable.
• 10:10
  SPEAKER_00: But once the IPO occurs, then expense would need to be recognized to catch up for any amounts that now are already either earned or probable of becoming earned in the future just through continued service.
• 10:26
  SPEAKER_00: And this is where things can get tricky because a lot of times these awards actually have two triggers.
• 10:31
  SPEAKER_00: The employee has to work for a certain period of time, and there has to be an IPO or change of control.
• 10:37
  SPEAKER_00: And many times that service component is defined in pieces or tranches, such as 25% of the award would vest each year or beat the service condition each year for four years.
• 10:52
  SPEAKER_00: And that's often referred to as graded vesting.
• 10:55
  SPEAKER_00: And there's a particular nuance in the stock compensation guidance that says if you issue awards with graded vesting and just service conditions, just time-based conditions, then the company has a policy choice to recognize or attribute that expense either on a straight line basis over the overall vesting period of the award, the four years in that early example, or on an accelerated or graded or tranche by tranche method that effectively recognizes all of those tranches simultaneously over their respective periods.
• 11:33
  SPEAKER_00: But if the award has graded vesting and either a performance or a market condition, the accelerated approach has to be used.
• 11:41
  SPEAKER_00: You don't get a choice.
• 11:42
  SPEAKER_00: And so here, because the IPO event is considered a performance condition, the attribution of the expense has to be on that accelerated method.
• 11:52
  SPEAKER_00: It can't be a straight line approach.
• 11:54
  SPEAKER_00: And that results in a more front-loaded amount of expense being recognized at the time of the IPO.
• 12:00
  SPEAKER_00: And it's also a little more complex to track everything going forward.
• 12:04
  SPEAKER_02: Yes.
• 12:04
  SPEAKER_02: So, Jay, when you were talking, I literally had a flashback to sitting in a client's file room, which is where our audit room was, literally in their file room, looking at vesting schedules and how complicated they were.
• 12:17
  SPEAKER_02: So I can personally attest, very complicated, something very important to get right.
• 12:22
  SPEAKER_02: One question though, and I think this is obvious, but just want to make sure.
• 12:26
  SPEAKER_02: So let's say you're in the quarter prior to the planned IPO.
• 12:30
  SPEAKER_02: You know, you're doing those financials probably for your S1 filing or whatever filing.
• 12:35
  SPEAKER_02: Do you anticipate the IPO or it's in the period that the IPO occurs that you would recognize the vesting, et cetera?
• 12:42
  SPEAKER_00: Well, here I would say the general practice or view, Heather, is that IPOs are not considered probable effectively until they occur.
• 12:55
  SPEAKER_00: There's just too many external contingencies associated with it.
• 13:00
  SPEAKER_00: It's not defined anywhere in the literature that way.
• 13:04
  SPEAKER_00: The guidance just says evaluate if it's probable of happening or not.
• 13:07
  SPEAKER_00: But the generally accepted practice is not to consider them probable until they actually happen.
• 13:12
  SPEAKER_00: And so in that period leading up to it, so the actual filing that you make for the IPO, you probably don't have the expense yet.
• 13:21
  SPEAKER_00: But you probably should be disclosing that it's coming because it's uh it's about to happen.
• 13:25
  SPEAKER_00: And it'd be you wouldn't want people to uh to be surprised by it in the first quarter after the IPO.
• 13:30
  SPEAKER_02: All right, very helpful.
• 13:31
  SPEAKER_02: So then, Jay, I know going back to the vesting, that was dealing more with the recognition and timing of stock comp expense for awards that had already been issued, so that was sort of pre-existed.
• 13:43
  SPEAKER_02: But I know a lot of newly public companies also like to put in place employee stock purchase plans.
• 13:49
  SPEAKER_02: And those also have very complex measurement issues.
• 13:52
  SPEAKER_02: So maybe start by explaining what we mean when we say employee stock purchase plan, like what's in the scope of that, and then I'll have more questions.
• 14:01
  SPEAKER_00: I'm sure you will.
• 14:03
  SPEAKER_00: Uh well, employee stock purchase plans, which are often abbreviated as ESPPs, they typically give employees the right to have money withheld from their paycheck over a defined period of time, and usually that's six months, although it could be longer in some cases.
• 14:24
  SPEAKER_00: And then that money at the end of that period is used to purchase stock at a discount.
• 14:30
  SPEAKER_00: And usually what we see is that it's based upon the price, a price, it's 85% of the lesser of the stock price at the beginning or the end of the period.
• 14:43
  SPEAKER_00: So it's designed to provide a discount and it gives you a little bit of protection as well.
• 14:47
  SPEAKER_00: Kind of the stock price goes up, you get to continue to buy at the lower price.
• 14:51
  SPEAKER_00: But if the stock price goes down, you can you can buy at a cheaper price.
• 14:54
  SPEAKER_00: So you're gonna make money one way or the other.
• 14:56
  SPEAKER_00: And these plans fall under certain special tax law provisions, and those are designed to basically keep these out of ordinary taxable income for the employee for tax purposes, but they are still considered compensatory for accounting purposes because the company is transferring value here.
• 15:16
  SPEAKER_00: And usually what we see is that in an IPO, the ESPP would usually be launched or made available to employees to elect to participate shortly after the IPO is complete.
• 15:30
  SPEAKER_02: I see.
• 15:31
  SPEAKER_02: So then what are the key accounting issues in an IPO?
• 15:34
  SPEAKER_00: So while the overall accounting for ESPPs in general is kind of complicated, especially how to value that arrangement, because you get a discount, and there's that downside protection that comes out of the lesser of pricing.
• 15:48
  SPEAKER_00: So that's not easy in and of itself.
• 15:51
  SPEAKER_00: But the particular issue I wanted to bring up here in an IPO situation is that we don't think the grant date of the award for accounting purposes for an ESPP can take place before when people actually sign up and decide what they're going to have withheld, because that's how the mutual understanding of the key terms and conditions of the award, which is the accounting definition of a grant date or part of the definition of that, uh, that that's how that's when it would get established in an ESPP.
• 16:26
  SPEAKER_00: And the grant date's important because that's when the value of the award is calculated.
• 16:31
  SPEAKER_00: So if a company allows people to join the ESPP after the IPO occurs, or for a window of time afterwards, but uses the IPO price as that beginning price, and that means that employees would benefit from any run-up in the price from that sort of initial IPO price that the stock was sold to underwriters for by the time they actually sign up, then the expense for accounting purposes would end up being bigger.
• 17:02
  SPEAKER_02: Sounds like another place where disclosure could be very important.
• 17:06
  SPEAKER_00: Right, definitely.
• 17:07
  SPEAKER_00: And yeah, we find that it catches people by surprise.
• 17:11
  SPEAKER_00: Oftentimes we understand that for legal reasons, a company may not be able to set it up before the IPO.
• 17:18
  SPEAKER_00: And this isn't generally an issue for an ongoing public company because the way an ongoing company would do it is they would give people the window of time to sign up in advance of when the next six-month period is going to start.
• 17:32
  SPEAKER_00: So everything is kind of locked and loaded at that starting date.
• 17:36
  SPEAKER_00: What's unusual here is it doesn't get locked and loaded until a little bit afterwards.
• 17:40
  SPEAKER_00: And sometimes we find it catches people by surprise that they have to go back and measure the expense using a different amount than they maybe had thought they would use.
• 17:50
  SPEAKER_02: Oh, got it.
• 17:51
  SPEAKER_02: That's actually a very helpful context, Jay, to do that comparison there.
• 17:55
  SPEAKER_02: So then let's shift gears a little bit.
• 17:57
  SPEAKER_02: And obviously, companies going through an IPO process will also have to deal with lots of things that come along with being a public company, especially the reporting requirements for SEC filings.
• 18:09
  SPEAKER_02: And so if we think about stock comp, what are some of the things the companies going through an IPO should keep in mind that are unique to SEC filers?
• 18:18
  SPEAKER_00: Well, maybe I'll start with one that's probably a little bit more obvious, and that's earnings per share.
• 18:23
  SPEAKER_00: EPS is only required for companies with public equity or those who are filing with a regulator to sell public equity.
• 18:33
  SPEAKER_00: So most companies in an IPO probably haven't calculated or presented EPS in the past while they were private, but they need to include EPS for all the periods in the financial statements that when they uh send in their filing to the SEC.
• 18:48
  SPEAKER_00: And I guess what I would say here is don't underestimate the time it takes to do EPS computations for all those historical periods, especially if there's earnings in any of those periods and you have to include potentially dilutive securities.
• 19:05
  SPEAKER_00: Uh and stock because stock-based awards are one of those instruments that get included, along with things like convertible debt or convertible preferred stock or other kinds of financial instruments that could result in shares getting issued down the road, uh, because stock awards are included for EPS, because they could result in shares as well.
• 19:25
  SPEAKER_00: And what's challenging with these is a couple of things.
• 19:28
  SPEAKER_00: One is they they often be calculated individually, theoretically.
• 19:32
  SPEAKER_00: Every single instrument has to be looked at on its own.
• 19:35
  SPEAKER_00: And that's because they often have different exercise prices, they have different grant dates, they have different amounts of compensation, which is sort of considered the non-cash proceeds for the stock that employees are paying.
• 19:48
  SPEAKER_00: And they have to be weighted only for the periods of time that they're upstanding.
• 19:52
  SPEAKER_00: So, in essence, you have to look at all of them individually or reasonable groupings.
• 19:56
  SPEAKER_00: You can't just lump them all together into one calculation and do it in the aggregate.
• 20:01
  SPEAKER_00: Then to do the calculation, uh, it's done using what's referred to in the guidance as the treasury stock method.
• 20:08
  SPEAKER_00: And I won't get into all the details of that here because there's an awful lot that goes into it.
• 20:12
  SPEAKER_00: Uh, but one of the things it does require is having an average stock price for each period that you're doing the calculation.
• 20:20
  SPEAKER_00: So the obvious question is how do you do that if you weren't public and you don't have a quoted price to look to, to average out?
• 20:27
  SPEAKER_00: So the answer that we usually see is that companies have to estimate that, just like lots of other things.
• 20:33
  SPEAKER_00: And hope, you know, ideally you're going to do that consistent with other stock valuations that you might have done.
• 20:40
  SPEAKER_00: If you've been granting awards over time, you've had to value the stock at different points of time in order to come up with the values of the awards.
• 20:47
  SPEAKER_00: So you'd leverage that and whatever else you have in order to come up with reasonable estimates of the fair value of stock.
• 20:54
  SPEAKER_00: So you can kind of come up with that average stock price for the for the different periods.
• 20:59
  SPEAKER_02: So, Jay, while you were just talking, I had another flashback to that file room, but I also have a question for you.
• 21:05
  SPEAKER_02: So you're talking here about estimating prices in the past, and it seems like where we started was talking about the value of your stock at various points in time.
• 21:16
  SPEAKER_02: So are those two numbers going to line up, or how does that work together?
• 21:20
  SPEAKER_00: No, I think that's a fair observation.
• 21:22
  SPEAKER_00: I mean, the idea is that they should, that the first topic we talked about on cheap stock was about coming up with fair values that everyone can get comfortable with at different points in time.
• 21:32
  SPEAKER_00: And once you have that information, you certainly should leverage that to come up with sort of an average stock price here.
• 21:39
  SPEAKER_00: The challenge that sometimes happens is that while there are some companies that grant options all the time, so they have lots of data points to work with from that first step in the valuation process, uh, some companies don't.
• 21:52
  SPEAKER_00: Maybe you only grant options once a year, or you've only done it every other year or so.
• 21:56
  SPEAKER_00: So now you have you might have data at those points in time.
• 22:00
  SPEAKER_00: But the trick is how do I come up with a reasonable determination of an average price for periods in between those?
• 22:07
  SPEAKER_00: So you have to sort of extrapolate or triangulate uh sort of in the middle in order to come up with a reasonable, reasonable average price along the way.
• 22:15
  SPEAKER_02: All right.
• 22:15
  SPEAKER_02: But sounds like it'll be important to make sure the numbers line up and there's some consistency there.
• 22:21
  SPEAKER_02: So uh that's helpful.
• 22:23
  SPEAKER_02: And then Jay, I know this is very complicated.
• 22:25
  SPEAKER_02: So what other challenges on this would you highlight?
• 22:28
  SPEAKER_00: Well, maybe, maybe two others I I would pick on here.
• 22:32
  SPEAKER_00: One is if the stock awards have either performance or market conditions in them, like a revenue target or an EBITDA target or that IPO target that we we talked about, um, those can be challenging because in that case, you have sort of a two-step process you have to do.
• 22:50
  SPEAKER_00: You you first have to assess whether those contingent conditions are being met based on the facts that exist at the end of each reporting period.
• 23:02
  SPEAKER_00: And then if they are, then you would put them through the treasury stock method calculations that I was alluding to before.
• 23:09
  SPEAKER_00: But if they're not, then you wouldn't do that, and they just wouldn't be factored into EPS that period.
• 23:16
  SPEAKER_00: What's tricky here is that this is different than what you do for compensation purposes.
• 23:21
  SPEAKER_00: For compensation purposes, we were talking about you assess what's probable and you recognize expense based on what's probable.
• 23:26
  SPEAKER_00: But for EPS purposes, probability isn't a factor.
• 23:30
  SPEAKER_00: It's all a function of is it or isn't it happening based on the numbers as of the end of the period?
• 23:37
  SPEAKER_00: So it just means there's another set of numbers to run, and there's some sort of disconnect between what you're doing for accounting purposes for compensation and what you're doing for EPS purposes.
• 23:47
  SPEAKER_00: And you know, there's a lot of, I'll call it devils in the details kind of things to work through in that contingent share guidance that I won't get into here, but but it can be pretty complicated.
• 23:57
  SPEAKER_00: Uh, one, and I'll say very different nuance that we run into as well is that some stock awards entitle their holders to get paid dividends if the company declares dividends on common stock, even though they're not a common stock holder, the option or the restricted stock award might give them the right to get dividends too.
• 24:17
  SPEAKER_00: And in some cases, those may make the stock awards what gets referred to as a participating security, which is a whole nother ball of wax, but that requires allocation of the EPS numerator as well to those other instruments.
• 24:32
  SPEAKER_00: So that also affects EPS in a different way, but it affects EPS as well.
• 24:36
  SPEAKER_00: So there really is a lot to think through here and in these stock comp and EPS topics.
• 24:41
  SPEAKER_00: And I generally find that none of it is easy.
• 24:44
  SPEAKER_00: Uh, we have a long chapter in our financial statement presentation guide about calculating EPS that listeners can take a look at.
• 24:52
  SPEAKER_02: Yeah, you preempted my question there because I do think there's a lot more to it.
• 24:57
  SPEAKER_02: It's a helpful overview, though.
• 24:58
  SPEAKER_02: So then, Jay, let me ask you another question.
• 25:00
  SPEAKER_02: I know another thing we see that also directly impacts the face of the financial statements and that may be new for companies about to become public, is this notion of mezzanine equity.
• 25:13
  SPEAKER_02: And this is something that some listeners may not even be familiar with.
• 25:17
  SPEAKER_02: So perhaps you can first explain what we mean when we say mezzanine equity, and then what types of things go in there.
• 25:25
  SPEAKER_00: Right.
• 25:25
  SPEAKER_00: So the SEC rules require presenting any type of equity arrangement that could potentially result in the company needing to pay cash to the holders of that equity to redeem it.
• 25:42
  SPEAKER_00: And regardless of how remote that possibility is, just the bare existence that the company could be forced to pay it, uh, the SEC says you have to record that in what's described as mezzanine equity, meaning it's presented separately between liabilities and regular or more permanent equity.
• 26:01
  SPEAKER_00: And the SEC is pretty explicit that they cannot be included together with regular stockholders' equity when you present the balance sheet and the roll forward of equity in the financial statements.
• 26:12
  SPEAKER_00: And it's meant to highlight for readers the potential cash obligations of the company, even if they're not considered actual debt or liabilities under GAAP.
• 26:22
  SPEAKER_00: And while people may be more used to hearing this being applied to preferred stock arrangements that might have redemption features, it does also apply to stock awards if they have similar features.
• 26:36
  SPEAKER_00: For example, uh some have put features, some stock awards have put arrangements that maybe didn't cause liability classification under the stock compensation guidance.
• 26:47
  SPEAKER_00: Um, you know, maybe because it couldn't be triggered for at least six months after when the stock was issued, which is sort of the defining line in the stock compensation guidance for one stock is considered mature.
• 26:59
  SPEAKER_00: Uh, but it does still give the holders the right to potentially get cash from the company down the road.
• 27:06
  SPEAKER_02: All right.
• 27:06
  SPEAKER_02: So, Jay, I think that's helpful to highlight because actually I hadn't focused on that before.
• 27:11
  SPEAKER_02: But then what are the issues that listeners should be thinking about?
• 27:15
  SPEAKER_00: There are some kind of particular points of the SEC guidance that tells you how to do the calculations for different types of stock awards that would need to go into the mezzanine.
• 27:28
  SPEAKER_00: And those calculations factor in the vesting provisions and they factor in the option exercise prices.
• 27:34
  SPEAKER_00: So there's kind of particular rules around it that affects how much gets presented in the mezzanine each period, how it gets accreted, if there's any impact on the EPS calculations and all that.
• 27:46
  SPEAKER_00: And like a lot of things that I brought up today, I won't go through all the details here because they're kind of lengthy, but listeners can take a look at the guidance.
• 27:54
  SPEAKER_00: We we have it in section 3.3.10 of our stock compensation guide has a lot of those specifics.
• 28:02
  SPEAKER_00: I'll just say that it can be a lot of work to calculate the amounts for all the periods presented in the IPO for all the awards that all have these different kinds of investing cycles and things like that.
• 28:13
  SPEAKER_02: Yeah, I think if there's a theme for your comments, it's that this is a lot of work.
• 28:17
  SPEAKER_02: And I would say an unstated theme is maybe if I was an engagement team helping a client, I'd want to have you on speed dial.
• 28:23
  SPEAKER_02: So, Jay, thank you.
• 28:25
  SPEAKER_02: I know you mentioned a few sources of help, but where else would you suggest people go if they have questions on these topics?
• 28:32
  SPEAKER_00: Right.
• 28:32
  SPEAKER_00: So I've I've mentioned the stock compensation guide, and there's a few different parts of it that would uh address many of these topics, like the performance vesting and the graded vesting attribution and things like that.
• 28:45
  SPEAKER_00: Uh, our financing guide also has a discussion about mezzanine equity in it.
• 28:53
  SPEAKER_00: And our deals practice, our our um accounting advisory practice, has also published a document about cheap stock considerations as sort of part of their observations from the frontlines series.
• 29:07
  SPEAKER_00: So that would also be available on um on our website for people to look at as well that has some good information in there about it.
• 29:14
  SPEAKER_02: Great.
• 29:14
  SPEAKER_02: We'll include links to all those in the show notes.
• 29:16
  SPEAKER_02: All right.
• 29:17
  SPEAKER_02: Well, Jay, thanks for joining me as always.
• 29:19
  SPEAKER_02: Wrap up with a final question and finally spring and finally getting some nice sunshine as we even look ahead to summer.
• 29:26
  SPEAKER_02: So just curious what you are enjoying most about the change in seasons and like I said, weather getting a little nicer.
• 29:34
  SPEAKER_00: Well, I am definitely enjoying being able to look out my window here and see lots of uh flowers on the trees and leaves on the trees.
• 29:44
  SPEAKER_00: Uh, it's always a nice, a nice time of year.
• 29:46
  SPEAKER_00: It would be nice if we could warm up a little bit more consistently, but it is nice to be able to uh not be looking at bare limbs on all the trees that I have around my house here.
• 29:55
  SPEAKER_02: Yeah, I think this is probably one of the most beautiful times of year in New Jersey, New York, that whole area.
• 30:00
  SPEAKER_02: So, all right.
• 30:01
  SPEAKER_02: Well, Jay, once again, thanks for joining me.
• 30:03
  SPEAKER_02: Really appreciate all the insights.
• 30:05
  SPEAKER_00: You're welcome.
• 30:06
  SPEAKER_00: Thanks for having me.
• 30:10
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• 30:14
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• 30:19
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• 30:43
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  SPEAKER_02: For PWC, I'm Heather Horn.
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