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Analysis of The New “Cheap Stock Guide” – Secondary Transactions

Valuation of Privately‐Held Company Securities as Compensation

 

Overview

On June 23, 2024, the Equity Securities Task Force (“Task Force”), established by the Financial Reporting Executive Committee (“FinREC”) of the AICPA, released a working draft of two revised chapters of the AICPA Valuation of Privately‐Held Company Equity Securities Issued as Compensation Guide (the “Guide”). The first chapter (Chapter 8) covers the Task Force’s revisions to the original 2013 “Cheap Stock Guide,” while the second chapter (Chapter 9) provides updates to ASC 718 for determining whether a secondary transaction is compensatory.

These revisions aim to clarify valuation principles under ASC 820 by providing a framework for calibrating to primary and secondary transactions, especially when valuing equity securities underlying stock‐based compensation. In Chapter 8, “Inferring Value From Transactions in a Private Company’s Securities,” the Task Force highlights key topics such as observable transaction prices, orderly versus non‐orderly transactions, and other considerations when relying on secondary market data. Chapter 9 goes on to address how repurchases or secondary transactions intersect with ASC 718’s guidance on compensation.

 

Key Updates in Chapter 8

What Has Changed

  • The revised draft offers new detail on how observable transaction prices can inform fair value under ASC 820, including steps to determine if a transaction is orderly.
  • Several important concepts are clarified, such as the unit of account, identifying the principal market, and understanding the roles of market participants.

Major Considerations

  1. Trading Volume & Market Participant Assumptions
    1. “In developing market participant assumptions, the framework requires consideration of all available transaction data, with greater emphasis placed on transactions with higher trading volume while still maintaining appropriate consideration of placing less weight on thinly‐traded securities in secondary markets.”
    2. The Task Force also stresses maximizing observable inputs and minimizing unobservable inputs wherever possible.
  2. Non‐Orderly Transactions
    1. “When evidence indicates a transaction is not orderly, practitioners should place little, if any, weight on the transaction price and rely more heavily on other valuation approaches.”
  3. Timing Adjustments
    1. Transactions that occur before or after the measurement date may require adjustments for any company‐specific or market‐related changes in value.
  4. Rights & Preferences
    1. Even if two securities look similar, differences in liquidation preferences, anti‐dilution provisions, or other features can significantly impact fair value.

Other Considerations & Adjustments

  • Primary vs. Secondary Transactions
    The Task Force notes that primary transactions (i.e., original issuances directly by the company) often require calibration to determine if their “entry price” aligns with a fair value “exit price.” Secondary transactions—purchases or sales of existing securities among investors—may likewise need adjustments if the volume is low or the transactions involve particular rights and preferences.
  • Types of Securities & Deals
    Various financing scenarios (e.g., preferred stock financings, simple or strategic preferred stock deals, tranche arrangements, acquisitions) may affect how practitioners weigh or adjust transaction data.

 

Implementation Guidance & Next Steps

Valuation specialists must apply significant judgment when determining appropriate approaches, methodologies, and weightings, particularly in cases where secondary transactions cannot be fully relied upon as fair value indications. In such situations, the Task Force recommends comparing secondary transaction data to the specialist’s estimated fair value to identify and explain the primary drivers behind any observed differences, while consistently adhering to the revised framework’s core tenets of maximizing observable inputs and minimizing reliance on unobservable inputs.”

When secondary trades do not occur in the principal (or most advantageous) market, the Task Force advises weighting those transactions alongside other valuation approaches (e.g., market, income, asset‐based methods) appropriate for each situation. Approaches and methods chosen must reflect each method’s strengths in estimating fair value, and practitioners should clearly document their reasoning.

If a secondary transaction cannot be fully relied upon to represent fair value, practitioners should reconcile it to their own fair value estimate and highlight the main drivers behind any observed differences. The Task Force had invited informal public feedback through September 20, 2024, and that comment period has now closed; final chapters are expected to be issued in 2025.

 

Decision Tree

 

1) A primary transaction is defined in Chapter 8 as “[a] transaction involving the original issuance of an equity interest in or debt instrument of a privately-held company directly by the company to an investor, other than in a public offering. Note that primary transactions may involve existing investors, new investors, or both.”
2) A secondary transaction is defined in Chapter 8 as “[a]ny purchase or sale, other than the original issuance, of an equity interest in or debt instrument of a privately-held company. Such transactions may be completed either in a private transaction
between two or more parties, or through a secondary exchange. A secondary transaction differs from a public market transaction in that the securities transacted are not public; therefore, generally the buyers in these transactions are accredited investors, and the issuers of the securities are not subject to public company reporting requirements. For the purposes of this guide, a purchase of an equity interest or debt instrument by the company (or its related parties or other economic interest holders) from employees are also considered to be within the scope of secondary transactions.”

Summary of Working Draft Topics

Below is a snapshot of how Chapter 8 organizes its key areas. Full details can be found in paragraphs 8.01–8.66 of the working draft:

  • Unit of Account (8.13–8.15): Identifies which security (or award) is being measured.
  • Primary Transactions (8.29): Treat “entry price” versus “exit price.”
  • Secondary Transactions (8.01): Factors for assessing reliability and weighting of observed prices.
  • Principal or Most Advantageous Market (8.04–8.05, 8.16–8.24, 8.29): Guidance on determining if a transaction truly reflects the principal market.
  • Orderly Transactions (8.33): Clarifies that an orderly transaction isn’t forced or distressed.
  • Market Participants (8.34–8.37): Details assumptions about independent, knowledgeable parties.
  • Calibration to Entry or Observable Prices (8.25–8.28): While introduced in the draft, the Task Force suggests further consideration is needed if calibration is used.
  • Transaction Price Weighting (8.41–8.55): Advises how to allocate weight to various transaction data.
  • Types of Transactions & Securities (8.55–8.66): Explores common secondary scenarios and their influence on calibrating fair value.

 

Chapter 9: Selected Accounting & Disclosure Matters

This proposed update refines how secondary market transactions or repurchases fit into ASC 718, Compensation—Stock Compensation. Key takeaways include:

  • Repurchase Above Fair Value: If an entity (or a related party) repurchases securities from employees or service providers at more than fair value, the excess must be recognized as compensation cost under ASC 718.
  • Broad Application: Even if the company is not the direct purchaser, transactions by related parties or economic interest holders may still fall within ASC 718’s scope.
  • Holistic Assessment: Entities are advised to consider the overall benefit derived from the purchase and their role in facilitating the transaction when deciding whether a compensatory element
  • Illustrative Example: The draft includes a new example outlining disclosure considerations and financial reporting impacts for companies—particularly those that may soon become SEC registrants.

 

About CFGI and How We Can Help

CFGI, a portfolio company of The Carlyle Group and CVC Capital Partners, is the largest indepedent accounting advisory firm. We support the Office of the CFO by delivering people, processes, and technology solutions to solve operational finance and technical accounting challenges.

CFGI Valuation Services provides a national, full‐service approach to valuing businesses, intangible assets, real estate, and more. Our comprehensive valuation solutions—designed for mergers and acquisitions, financial reporting, and tax compliance—anticipate the requirements of auditors, capital markets, the SEC, and tax authorities.

We also specialize in 409A valuations that can be used for ASC 718, offering clients the advantage of interdisciplinary teams that include both accounting advisory professionals and qualified valuation specialists. Given the evolving landscape of secondary transactions and the new updates to the “Cheap Stock Guide,” CFGI is here to help you navigate the complexities of these rules and their implications for financial reporting or valuations.

 

 

Authors:

 

Brian Reichert, Managing Director

AJ McFarland, Manager

Malick Shahab, Partner

Brian Powell, Partner

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