Equity Compensation Values and Valuation

Private Company Liquidity: Fueling American Entrepreneurship
Introduction
Next Exit 100 Miles?
Troubled Angels
How Does It Work?
Company Valuations Through Time
Value Is Allocated According to the Capital Structure
Exit... Stage Left
Other Exits Not Available
The Role of Private Company Liquidity in the US Economy
Conclusion

SEC Simplified Method Transition Considerations
Introduction
How to Transition Away from the SEC Simplified Method
Summary Academic Research Results
Closing Comments

Forfeiture Rates
Introduction
Background
Annualized Forfeiture Rate vs. Flat Rates
Estimation Process
Static vs. Dynamic Application of Forfeiture Rates
Rate Too High
Rate Too Low
ASC Topic 718-10-35-8
Forfeiture Rates and Monthly Vesting
Different Forfeiture Rates
Conclusions

From "Forfeiture Rates"

Generally speaking, two different types of forfeiture rates can be estimated and applied to the accrual of share-based compensation expense:

• A flat rate or
• An annualized rate

A flat rate is simply that - calculating the likelihood that the grant will forfeit over the entire service period and reducing the accrual of expense by that percentage. If at grant the company determines that the forfeiture rate for the three-year vesting/service period is 15% the company will accrue just 85% of the expense over that service period, truing up when the shares vest. The benefit of this approach is that it's somewhat simpler to understand and audit. The limitation of this approach is that a single flat rate can be applied only to grants having the same service period. For grants with different service periods, the same flat rate cannot generally be applied since the longer the service period the more likely termination prior to vesting will occur (i.e., forfeiture). Therefore the company must determine at the time of grant a different forfeiture rate for each grant or group of grants with a different service period. For example, a group of grants with a three-year cliff vest service period should have a different forfeiture rate than a grant with a four-year cliff vest service period and so on.

An annualized rate is the average percent of forfeitures over a year-long period. When an annualized rate is applied to the accrual of expense, it is applied differently based on the vesting period. For example, if the annualized forfeiture rate is 5%, when this rate is applied to a grant or group of grants vesting over one year, the expense is reduced by the 5% amount. 95% of the expense is accrued. However, now consider a grant vesting over two years - if 5% of the awards will be forfeited in one year, then over a two-year vest period, some amount greater than 5% is likely to be forfeited. How is the 5% applied in order to reflect this fact?