mployee stock options have grown to a significant portion of family wealth.  This has been caused, in part, by incredible advances in the stock markets, NASDAQ up 85.5% and Dow Jones Industrials up 25.2%.

As a consequence of this increase in the value of options, many executives have been gifting options to their children as a means of estate planning and asset protection.

In order to make a gift of stock options, fair market value must be established.   The most popular method of pricing options is the Black Sholes Options Pricing Model.  This model must be used with caution since it is structured to value options in the public market place where continued employment is not a component.

 Options have two components of value, namely the intrinsic value (excess of market price over strike or exercise price) and time value.  The time value reflects the pivotal position of the holder who can benefit as the security price advances with little downside risk.

The appraiser must temper the Black Sholes results with certain factors:

·         Probability of employee staying with company

·         Insider trading restrictions, if applicable

·         Impact on market of significant blocks of stock

·        Probability of employee death

EMPLOYEE DAMAGES

For tax purposes, awards received by employees from employers for lost wages can be either taxable or nontaxable depending upon circumstances.  In general, awards related to physical injuries are not taxable and awards received for other reasons are taxable, such as lost wages resulting from age discrimination.

The objective of damage awards is to provide a fund which when invested at moderate returns will reimburse the employee for lost wages over the time period of lost wages.  The basic axiom is that if the award is taxable, damages should be based on pretax earnings; whereas if the award is not taxable, the damages should be based on post-tax earnings.  That difference can easily be 30% or more.  However, the earnings on the non-taxable award would normally be taxable which requires an adjustment increasing the award.

A simple method for the valuator to deal with this problem is to compute the present value of the non-taxable award, using tax-exempt municipal bond rates.

Case Wizard

Family Court: We were recently involved in testifying in a marital dissolution action whereby we were appointed by the court to independently determine the value of the husband’s sizable construction contracting business.  After being cross-examined in depth by both attorneys, the judge found the value to be what was presented by Synergy.

About the Firm

Wally King and Ken Pia attended a course in Chicago on preparing a defensible business valuation. Ken attended the Advanced Business Valuation Annual Meeting in New Orleans.

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