8. Hey, this price is too low!

The inherent volatility in stock option valuation.

We issued a dual-purpose valuation report recently to a management team that we really like to work with, and got back a bit of a surprise. “Hey,” they said, “this option price is lower than the last report you issued. We’ve made progress – what gives?” Actually, this shouldn’t be a very surprising response at all. But being buried in our own little world of valuation (it’s really all we do, besides drink strong coffee and occasionally sleep), we were caught off guard.

So, friends outside the dark realm of valuation, take this in stride: there are only a few things you need to focus on with respect to these valuations.

First, the facts:

1. We are providing these valuation reports for regulatory compliance.


2. Our valuations must abide by certain strict requirements in order to comply.


3. Valuations introduce volatility, capturing micro- and macro factors that influence the end result. The more valuation points that a company has, the more volatility is measured and displayed.

Now, focus on these three simple things:

1. For compliance with IRC 409A, you can set your option price at any point equal to or above the Fair Market Value of the stock options. Thus, if you are issuing stock options at $0.08 and we tell you the FMV is $0.02, you are well in the clear to continue issuing options at $0.08.


2. The lower the FMV in the current report, the more room you have for the volatility meter to spike at your next valuation date and still keep your options priced where they are. So if we later issue a new report that puts your FMV at $0.08, you’re still in the clear with an $0.08 option strike price. In other words, we may measure the volatility of your common stock but your option strike prices may be insulated from such swings all the same.


3. The lower the Fair Value of these selfsame options, the lower will be your FAS 123(R) expense. Huzzah. It may be immaterial anyway, at any rate, let’s all keep in mind that this is a non-cash expense.

Keeping this in mind, I understand the compulsion to use our shiny and weighty valuation reports as a metric for the company’s progress. However, given the standards of value for which we are conducting this exercise, I would urge you to exercise extreme caution when doing so. Rather, keep your head down, focus on the real stuff. You’ll find out what your company’s really worth at exit. Until then, everything is just theory.