CALL TO ACTION for NVCA Members
FASB Acts to Require Stock Option Expensing

Action Needed: NVCA members and their portfolio companies are strongly encouraged to write comment letters to FASB expressing opposition to their proposal to expense stock options and highlight its negative implications, especially regarding the reduced quality of the resulting financial statements and the internal and external costs of implementation.

Background:
On March 31st, FASB released their final Exposure Draft, the Share-Based Payment, and Amendment of FASB Statements No. 123 and 95. As anticipated, it will require that all share-based payments, including employee stock options, be treated as an expense on the income statement. While FASB has been signaling this move for over a year, we believe the details of the exposure draft clearly demonstrate that FASB has not adequately addressed the flaws in current valuation methodologies, despite over 10 years of consideration.

The FASB proposal is perhaps even worse than we anticipated in its treatment of nonpublic entities. The proposal generally calls for stock options to be expensed at grant date using either the Black-Scholes method or binomial methods, which are widely acknowledged to be problematic when applied to employee options. However, for nonpublic entities, FASB has specifically disallowed the current standard (known as minimum value) by which private companies could calculate an option value without the volatility input required for public companies. Now, FASB has determined that if a nonpublic entity decided it could not reasonably estimate the fair value of employee stock options (using Black-Scholes or binomial models), it choose to use a modified “intrinsic value” method. Doing so requires recalculation of the expense every reporting period creating variable accounting treatment as the stock options are marked-to-market.

NVCA’s View:
We believe the FASB proposal fails on multiple levels. From a purely accounting perspective, the valuation methods proscribed will not result in a better depiction of a company’s economic health or more transparent financial statements. On a macroeconomic level, we do not believe that FASB has given any consideration to the negative impact an expensing rule will have on the nation’s economy. Further, we believe that the cost of implementing these inaccurate valuation methods will be a much greater burden on startups and nonpublic entities. We believe FASB’s proposal if enacted as proposed will ultimately undermine stock options as a tool that has successfully aligned the interests of shareholders with employees and which has been critical in our ability to foster the companies that have driven the nation’s economic growth.

Action is Need Now!
Now is the time for our industry’s voice to be heard loud and clear. FASB has repeatedly stated in recent Congressional hearings that they do not believe stock options expensing will be a critical issue for small business. In fact, FASB claims that only 3% of all small businesses use stock options. Of course, what they have failed to mention is that within that 3% are the venture-backed companies that are responsible for creating 10 million jobs and over 11% of annual US GDP.

A strong showing of substantive public comment letters is needed to make FASB reexamine its proposal, particularly in the areas of valuation and the impact of expensing on smaller enterprises. Members of Congress are increasingly concerned about the potential negative impact that expensing as proposed by FASB will have on the nation’s economy, as well as the fact that FASB still has not developed an accurate valuation method that works across the broad spectrum of companies that utilize stock options. Congress will be closely watching the public record on the FASB proposal. We need to create a strong record of comment letters from our industry, especially the portfolio companies, which question the conclusions reached in the FASB Exposure Draft.

The public comment period ends on June 30, 2004. We urge every NVCA member to weigh-in at this critical juncture. Companies can email their comments to FASB at the following address: Director@fasb.org with reference to File Reference No. 1102-100. Please copy NVCA jcdowling@nvca.org on your email.

Proposal Details and Additional Resources:
The Exposure draft is divided into eight sections. The sections that are most relevant to non public entities are Appendix B and C. Appendix B contains implementation guidance, which illustrates the application of the proposed Statement; this guidance is an integral part of the proposed Statement. The Exposure draft can be found on the FASB website at http://www.fasb.org/draft/ed_intropg_share-based_payment.shtml

FASB is seeking comment on a wide variety of topics ranging from whether or not stock options should be expensed, to what is an appropriate measurement date, to comment on measuring volatility, among others. NVCA and AEEG members are encouraged to comment on more than one of the issues upon which FASB is seeking comment. NVCA’s outside counsel has prepared a document that outlines the FASB Exposure Draft and offers some key points on the issues. That document is attached (click here) for your consideration as you draft your individual comment letters. Copies of recent Congressional testimony and additional background and reference materials can be found on the NVCA website at www.nvca.org or on our coalition website at www.savestockoptions.org

Next Steps:
NVCA will be organizing an industry-wide conference call in the coming weeks to coordinate our letter writing campaign. Please plan to participate on this call so that we can ensure that our letters are substantive and that we comment on all the various topics for which FASB is seeking comment.

With an anticipated enactment date of January 2005 (for public companies and January 2006 for most private companies) it is critical that all possible pressure be put on FASB and that means writing strong, thoughtful letters that highlight the numerous problems with the proposal.

If you have questions or would like additional information, please contact Jennifer Connell Dowling.