All pre-IPO and public companies must have their financial processes and statements audited by an independent auditor to ensure they comply with Generally Accepted Accounting Principles (GAAP) and other regulations, including the Sarbanes-Oxley Act.
As a part of this process, the auditor will examine your stock compensation plan. It is critical that your equity plan is ready to withstand the scrutiny and important that you take the proper steps to prepare for the examination. By doing some anticipatory work, you’ll be well prepared for the audit rather than relying on the auditor to surface any issues that you’ll then have to fix - risking a delay to your IPO or other undesirable consequences.
Here are four things you can do now to avoid a problematic audit:
Locate all your grant agreements and ensure the physical, signed agreements match with what’s in your spreadsheets or stock plan management system. If your agreements are paper documents, it’s a good idea to scan and store them electronically in a single, secure place for the auditor to access.
Document your accounting policy choices and be ready to explain clearly why you’ve made the decisions you have. Your auditor will want to understand how you’ve valued the stock that you’ve offered to employees, and will want to be sure that if you have offered discounted stock, that it’s handled in compliance with IRC rules (Rule 409A) for deferred compensation.
Ensure you have appropriate controls in place and that you can demonstrate them to the auditor. Section 404 of the Sarbanes-Oxley Act of 2002 makes senior executives personally liable for any failure of governance that leads to inaccurate or misleading financial disclosures. Make sure your equity compensation calculations and processes are fully documented and auditable at every step.
Know the tax implications of your stock plan for when the company becomes profitable. The tax rules surrounding different types of stock can be very complex, and there’s often a temptation not to think about them until the company IPOs or becomes profitable. That can have unexpected and painful results, even damaging the stock’s performance. Look to your expert advisors for advice on how best to account for your stock compensation plan and make best use of tax rules applying to it.
Taking the time to perform these four steps in advance of your company’s audit will put you in the right position to pass. Preparing for an audit is just one of the critical ways to prepare your equity plan for an IPO. Be sure to download Future-Proof Your Equity Compensation Plan for a full list of 5 critical steps that will ensure your share-based compensation plan is ready for the next step.