What are my options if there is a decrease in fair market value (FMV)?
Why is my FMV lower than the prior 409A Valuation?
What is a down round?
A down round occurs when a new financing round is priced lower than the most recent prior round (i.e., the share price decreases). Down rounds typically result in a decrease in the 409A fair market value.
There are many reasons why FMV might decrease over time. Some common reasons include:
Change in valuation methodology
Company performance
General market and economic conditions
Raising a down round of financing
Changes in cap structure
If you have received a 409A valuation with a lower FMV, the following list outlines possible courses of action to take regarding options that are currently outstanding or expected to be issued.
Option A: Issue options at the lower strike price supported by the current valuation (i.e. the Benchmarking Analysis)
Generally speaking, issuing options at the lower strike price is more advantageous for employees, given that it allows them to buy into the Subject Company with less cash. A lower strike price (i.e., fair market value of common stock) may also reduce the tax liability for employees exercising options, given that it may reduce the spread between the strike price of the option that is being exercised and the fair market value of common stock at that time.
Option B: Maintain the strike price of the prior valuation (e.g. a higher strike price)
The fair market value in a 409A valuation can be thought of as a ‘floor,’ and the Company can issue options with a strike price at or above the fair market value and remain in Safe Harbor until the current valuation expires. This may be the simplest approach if the current fair market value is lower than previous strike prices by a ‘small’ margin.
Option C: Reprice options that are ‘underwater’
Stock option repricing involves canceling employee stock options that are ‘underwater’ (i.e. the strike price is higher than the current market price) and reissuing new stock options that are priced ‘at-the-money’ (i.e. at the current market price). Please note that the grant date would be updated to on or after the Valuation Date of the 409A valuation that supports the current market price. Generally speaking, vesting for the new stock options would be maintained; however, this is at the discretion of Management. It is important to note that there are potential tax considerations with this approach. Please consult with appropriate legal and / or tax advisors before repricing options.
Review the following Carta Support Articles if management is interested in completing a stock option repricing:
Option D: Issue new stock options that are priced ‘at-the-money’ without canceling the stock options that are ‘underwater’
As an alternative to a formal stock option repricing, Management may consider issuing new stock options that are priced ‘at-the-money’ to employees that had received stock options that are ‘underwater’ without canceling the stock options that are ‘underwater’. The difficulty of this approach would be determining exactly how many additional options should be granted. In addition, if the Subject Company does have an eventual successful exit, then the employee may have both the original and new grants, which could lead to greater-than-anticipated dilution.