Equity Value + Employee stock options and share dilution
so when you try to get the equity value of a company and adjust the market cap for in the money options, warrants etc., is there a requirement for the company to buy back those shares at the market price? or does the company usually do this anyway, even though it's not required?
and also when you calculate enterprise value, why do you separate the equity value from preferred stock? shouldn't equity value = the market cap adjusted for options + preferred shares ? preferred shares are equity, too, right? (or is this separation just a convention?)
1). No, no obligation for the company to buy back shares using the options proceeds. However, in banking, we almost always use the Treasury Stock method to calculate diluted shares outstanding, and this method does assume that the company uses the options proceeds to buy back shares in order to "minimize" dilution (that's why when using the treasuty method you notice that 1 option causes a fractional dilution, and not 1 per 1).
2). We separate the Equity Value from Preferred Stock because Equity Value in this case refers to the portion of value attributable to common stockholders ONLY, hence it does not include preferreds.
3). Well, in terms of Preferred Stock being equity or not, it is debatable. That's why a couple of people refer to Preferreds as hybrid instruments (can be both debt and equity). It really depends on the terms attached to those preferred to determine its classification (for example, Redeemable Preference Shares are genereally considered Debt for some Analysts; Cumulative Preferred Shares are also considered debt in most cases and banks cannot count them as Tier 1 capital, etc). So, it really depends. However, I always prefer to have a separate line in my models for preferred shares when calculating from Enterprise Value to Equity Value for example, (I say that because some people put the preferreds straight inside their Net Debt figure in the model for purposes of calculating TEV).
Hope this helps.
thanks so much! that was really clear!
Technical question: equity value and stock options (Originally Posted: 10/11/2015)
Financial gurus, I've been having trouble figuring this out and would appreciate some guidance. So say a company issues stock based compensation. What happens to the balance sheet when the company grants the shares? And what happens to the balance sheet when the employee exercise the shares? What line items change??
Tyty
SBC is a non-cash expense and gets added back to CFO. I can't remember how options are accounted for on BS.
When the company grants the shares at exercise, APIC goes up by the exercise price x share count and share count goes up. Cash also goes up by the same amount. Usually shares are sold in the open market by option owner for the profit if ITM.
You should think about it from the company perspective as if it is raising money at a predefined price.
Options are recorded as expense over the life of the vesting schedule. Expense is determined based on fair-value at time of grant. So debit comp, credit APIC as the options vest.
When the options exercise the co receives cash in the amount of strike * shares, reduces APIC by the cumulative expense (amount of equity contributed in the form of labor) and increases the common account by the value of equity distributed to option holder.
So an example:
Suppose an employer grants Bob 100 options with exercise of $50/share - then suppose that at the time of grant these options are determined to be worth $10/share (based on Black-S or whatever). These options vest over 5 years. So each year employer expenses 100/5*10 = $200 of SBC and adds to the equity acccount (APIC) an amount of $200.
Then suppose in year 5 all of Bob's options have vested and employers stock price trades at $60/share. Bob exercises his 100 options, paying $50/share for 100 shares of common equity at $60/share. Employer receives cash for this purchase of $5000, reduces the APIC account by the $1000, and increases the common equity account by $6000 (via issuance of 100 shares at $60/share).
Entries for annual expense:
Dr. SBC $200 Cr. APIC $200
Entries for exercise:
Dr. Cash $5000 Dr. APIC $1000 Cr. Common Equity $6000
Extremely clear and helpful, thx rionexpa!!!
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