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  • Writer's pictureMarcus P. Miller, CFP®

Are you a tech employee? Here's what you need to know about stock-based compensation

Stock-based compensation is a form of compensation given to employees in the form of company stock or stock options. Companies use this as a way to reward and attract talented employees.

How does stock-based compensation work?

Employees are typically given either company stock or options to purchase the company’s stock at a predetermined price. If the employee chooses to accept stock as compensation, they will own shares in the company and benefit from any appreciation in the stock price. If they choose to accept options, they will have the right (but not the obligation) to purchase a specified number of shares of the company’s stock at a predetermined price. If the stock price rises above the option's strike price, then the employee can benefit from the difference.

How stocks are valued and their performance monitored

The company stock or options are typically valued based on the company’s current stock price. For non-publicly traded companies, this is done through a process called a 409A valuation. In this process, an independent third party assesses the company’s value and determines the fair market value of the company’s stock. The 409A valuation is used to ensure that all employee stock compensation is granted at a fair price. A liquidity event may also be used to provide a market-based valuation of the company’s stock; this is when the company is acquired, merges with another company, goes public, or has some other type of transaction that allows founders and early investors in the company to cash out their ownership shares.

409A Valuation

A 409a valuation is an appraisal of a company’s common stock that takes into account current market trends and conditions. It is used to determine the fair market value of the stock, which is important for privately-held companies that need to provide evidence that their stock price is accurate. The 409a valuation also helps ensure there are no tax implications related to overstating the value of a company's stocks, protecting employees from unfair taxation.

Why are 409a valuations important?

Companies use 409a valuations to comply with Internal Revenue Services (IRS) regulations and demonstrate compliance in regards to setting the right price for their common stocks. Without these valuations, companies could potentially take advantage of loopholes and commit fraud. 409a valuations help ensure that companies are not overstating their stock prices and that employees are paying the correct amount of taxes on stock options they receive.

What does a 409a valuation include?

A 409a valuation is an appraisal process that takes into account current market trends and conditions related to