The NASPP Blog

Defining Fair Market Value

There isn’t a U.S. rule or regulation that gives a specific definition for the fair market value, either for creating an option exercise price or for calculating income on transactions, even though fair market value (FMV) is a fundamental measure for all awards. Section 409A regulations require that a consistent and reasonable valuation method be applied to stock grants. For private companies, coming up with a reasonable method for valuing company stock is complex, but for public companies it is generally accepted that the FMV for stock plans is based off the open market trading value of the stock.

Not so Definite

All stock plans should define the fair market value, but should also give the Plan Administrator the authority to determine FMV as needed. This is particularly crucial for companies whose stock becomes very thinly traded, but can also be an important piece of flexibility for other stock transactions.

The grant date fair value should, if at all possible, follow the plan definition. For transactions, however, there may be a need to have more than one definition for FMV. Most of applicable tax code (e.g., Section 409A, 422, or 83) focuses on the method used for determining grant date fair value. Section 409A is the most specific, permitting the use of an average sale price provided that the period used does not exceed (and is both set and irrevocable) 30 days prior to the grant date. However, 409A does permit the company to use more than one FMV, provided each application of FMV is consistent.

There may be situations where ESPP purchase or restricted stock vesting event dates fall on a non-market day and the plan defines FMV based on current day trading values. Alternatively, many companies prefer to define the FMV for transactions with a sale (e.g., broker assisted cashless exercise or immediate sale on vesting of restricted stock) as the sale price. There are also situations where the company has a unique need that justifies defining the transaction date fair value as something other than the plan definition. All of these are reasons why a company may choose to use more than one definition for fair market value.

Make it Official

Even if your company doesn’t plan on ever diverging from the plan definition of fair market value, you should still consider the possibility of a non-market day transaction and create an official definition of FMV for that circumstance. If you are currently using or considering using an different FMV definition than the one in the plan, assuming you have confirmed that the plan gives the plan administrator that authority, best practice would be to have that policy made official. In addition, even if you have created an official policy or procedure, the best way to show that the company is being reasonable and consistent with its definition of FMV is to have the Board or the Board’s designated compensation committee ratify the policy in a resolution.

What Other Companies Are Doing

Curious about how other companies define FMV? In the NASPP’s 2010 Domestic Stock Plan Design Survey, 78% of respondents use grant date closing price for option grants, but only 60% use closing price as the FMV for exercises. In addition, 80% use the actual sale price for broker-assisted cashless exercises.

-Rachel