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Comment by scurvy | Hacker News Reader

Actually, it depends. In Uber's case yes it would be the 409A as there is no secondary market. If there were a secondary market, it would be the last sales price from the day you exercised, not 409A value.

The IRS guidelines say the spread between grant price and fair market valuation. If there's a secondary market, that's your fair market, not 409A (which is a joke anyway).

Also, most companies use the last public valuation as a basis for 409A valuation rather than hiring someone to do it in a separate process. The investors buying shares are the experts here. Of course there are considerations for preferred vs common stock and things like warrants, but they start at the top line number from the last round.

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No, that's incorrect (speaking as a founder who's raised $35mm and sold shares on the private market). Private financings will trigger a new 409a valuation but won't influence it. 409A valuations are typically based on Black Scholes and have no connection to private funding valuations. Secondary sales only affect fair market if there's a functioning secondary market, and AFAIK there are no private startups with a FUNCTIONING secondary market.

You can do 409A however you want which is why I said it was a joke. I've worked in 2 places that based it off of last round after accounting for full dilution. You can use black Scholes, last round, or your finger in the air it doesn't matter. If it had to be accurate they wouldn't allow Black Scholes which has been all but disproven.

Also there are lots of secondary markets for private companies right now. What makes you think otherwise?

Okay thanks for confirming you don't know what you're talking about. Black scholes is options valuation and never used in 409A valuation. You can't just make stuff up, you have to justify it to your auditors.

Options valuation is derived from your 409A valuation...and heyjon used Black Scholes to derive present option value. The two are related. Black Scholes is considered to be massively flawed by the larger public options market, but it's still used a lot in the private equity options side. Hence, why I said that it really could be whatever you wanted. If there were a legit requirement that it be an accurate valuation, you could never get away with Black Scholes. It's common knowledge that it's seriously flawed.

As for 409A valuation, I've never heard of an auditor seriously examining it or questioning its validity. It's mostly the "valuation expert" says, "What value do you want for 409A?" You tell them, they ask to see the books, and then say "OK I can sign off on that."

Black Scholes is used to value options, eg to set the strike price on options. So, it is used for this purpose by companies who need to set option strikes at fmv. I have no idea why he says it's been repudiated. As far as I know, it is still used in public market option pricing. Most people buying or selling options are not pricing them, but accepting the market makers price. How would you have any clue how they're coming to that value?

I previously wrote software at a major market maker. I can't say (NDA) what they use, but most professionals consider Black Scholes to be mickey mouse. If you're using it in the public market, you're not going to fare well on American style options.

As for real world proof of Black Scholes being garbage, it doesn't get any better than Long Term Capital Management.

Black-Scholes (and the Merton version) are useful as simple estimates of option prices. Of course it's not going to be accurate (it assumes a lognormal distribution for volatility, JFC) - but the model is public and easy to calculate, providing a stable basis for these kinds of prices.

Edit: people buying/selling options are of course performing their own pricing operations. They don't care how the market price is determined, since they believe their model is the best and gives more accurate prices than anyone else.

Edit 2: furthermore, to properly price startup options, you need to account for their 'random-expiration' nature: we have no idea when Uber will IPO. this makes it difficult to use traditional option pricing models which have fixed maturities (you can take integrals over the model's results at each possible maturity). additionally, choosing a discount rate is hard when realizing that most employees are not well-diversified, unlike the investors/funds that the traditional models are written for

There's not much difference between an American style public equity option and private equity option. Both can be exercised at any time. Perhaps you're thinking of European style options, that can only be exercised on a fixed date (expiry).

While neither are great, binomial is better for American style options than BS.

American options still have fixed expiration dates, and cannot be exercised after that. While that's closer to a startup's option structure, it still doesn't account for the uncertainty in when or if the startup will go public. Additionally, you never exercise dividend-less American options early, and startups generally don't offer dividends.

I guess you could choose an arbitrarily distant expiration date, but my bigger point was that while BS is clearly not going to give perfect results, the results are reasonable enough and transparent enough to justify their use for tax purposes in lieu of actual market prices.

I don't know. I read When Genius Failed. I'm quite sure it had little to do with Black Scholes. It was primarily an issue of trading illiquid positions that weren't hedged as well as they thought.

> Black scholes is options valuation and never used in 409A valuation

'never' is wrong, depending on your meaning. It's definitely used in many 409A valuations. Typically a 409A will use a couple different approaches to come up with the initial valuation -- it will look at the discounted cash flow, the value of assets and liabilities, and generally will look at 'guideline companies' and their public valuations or cash value upon sale. Once one or more (often times all) of these methods are used for the initial valuation, the value is fed into a Black-Scholes model. That price (after applying discounts for non-marketability) is used as the fair market value for the common stock.

This is wrong information. 409A valuations are generally based on revenue models, profit models (not applicable for most startups) or comparatives. It's not done based on funding rounds because there's a lot of goodwill based in that.

Most companies push the 409A valuations as low as possible precisely because of income tax ramifications on exercise.

It depends on what the actual market value of your stock is upon exercise, not just 409A. Sure, it might be the 409A value, or it could be the last sales price on something like SecondMarket. If there's a secondary private market, that will trump whatever your company says the 409A value was.

If your company says the 409A is $1.50/share but people are selling on secondary markets for $4/share, you must use $4/share when computing your exercise benefit.

If there's no secondary market, it's the last 409A value.

This is an interesting conversation. I wish someone with readily verifiable credentials could weigh in. I'm not saying the parent, or GP do not have the credentials, just that they've not been established. I'd love to hear from an accountant or tax attorney on the topic.

From what I can tell, taxes will be based on the values in Form 3921 (for ISOs and ESPPs), which is delivered by the employer.[0]

Here's a sample 3921.[1] The FMV is delivered in Box 4. My question is where does that value come from? Is it the last 409A valuation, or is it required to use sale data from secondary markets?

I've received several of these forms over the years, and the FMV has always been the value from the last 409A. I have no idea if there was a secondary market for the shares.

[0] https://www.irs.gov/taxtopics/tc427.html

[1] https://www.irs.gov/pub/irs-pdf/f3921.pdf

If you get a 3921, use what's there; the burden of accuracy is on the company.

I worked at a place that didn't issue 3921's (in the .com go round). I had a hell of a time reaching someone still at the company who could give me that information almost a year later (and after several rounds of devastating layoffs). I really don't know what she based the figure on.

It's not a matter of if. Companies are required to issue a 3921 these days.[0] That was not the case in the dot-com days. I don't even know if Form 3921 existed then.

[0] http://www.startuplawblog.com/2011/01/05/companies-remember-...

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