FASB Action Slams Growth-Oriented Small Businesses
Proposal to Mandate Expensing of Employee Stock Options Will Impede Entrepreneurship and Innovation in America

March 31, 2004 - Arlington, VA – After months of urging from America’s small business community to reconsider its quest to mandate the expensing of employee stock options, the Financial Accounting Standards Board (FASB) today dismissed all concerns and issued a proposal that will require stock option expensing for all companies. This proposal will result in less accurate financial statements, impede comparability and penalize rank-and-file workers. Most importantly, the proposal will seriously harm private, emerging growth companies that are highly dependent on employee stock options to recruit and retain employees as the mandatory expensing of employee stock options carries a cost that is too large for the majority of small businesses to bear.

“The FASB’s proposal reflects a blatant disregard for the challenges that small businesses will face in attempts to comply with this proposed standard,” said Mark Heesen, President of the National Venture Capital Association. “Every step the FASB has taken, from selecting discredited valuation standards to ignoring pleas for field testing, to rushing to push the standard through at any cost, is indicative of an organization that chooses not to listen. Our economy is going to pay a considerable price.”

Stock options have played an integral role in fostering entrepreneurship in America, setting the country apart from developed nations. Start-up companies are dependent on employee stock options because in their early stage of development they do not have the financial resources to offer competitive compensation packages. Stock options offer the potential to be rewarded for hard work and risk taking. By requiring the expensing of options, FASB is asking small companies to choose between attracting talent or showing positive net income – both of which are key drivers in the ultimate success of the organization.

FASB has also chosen to disregard the widespread agreement that there is no reliable or accurate way to value employee stock options. Rather than derive a new acceptable valuation model, as was requested by many constituents, the FASB proposal calls for companies to choose one of two existing valuation models – Black Scholes or the Binomial Method. Both valuation models were designed to value freely tradeable options, which employee stock options are not. Black-Scholes has been thoroughly discredited; the binomial method requires a complex array of assumptions and inputs but results in similarly inaccurate figures as Black Scholes.

While determining a value for employee stock options for any company is challenging, attempting to derive a value for employee stock options for a private, emerging growth company is nearly impossible. In most cases there are no benchmarks, no underlying stock performance history, and no budget to hire financial experts to develop models to obtain an accurate value. Currently, private companies have the option to choose the minimum value method when expensing, which helps companies that have no stock trading history. However, FASB has stated that they will no longer allow that option going forward under the new proposed rules. Instead FASB wants private companies to use costly and complex variable accounting, disguised as intrinsic value. Consequently, any option expense number derived will be done at a high cost and will be guaranteed to be inaccurate. Nevertheless, such companies must strive to be GAAP compliant as their aspirations are to become public companies and are encouraged to operate as such from inception.

“Expensing stock options will increase the time horizon for venture-backed companies’ reliance on expensive risk capital because it will take them longer to look profitable under these one size fits all rules,” explained Heesen. “Many will struggle with the possibility of altering the incentive plans that have helped them grow in the name of preserving their income statement. Either choice is a losing proposition for a start-up and a blow to innovation.”