Drawing Parallels and Lessons in Valuation from the U.S. to France

In a strategic move to preempt financial irregularities and enhance valuation transparency, Sovalue is leading the charge of American valuation techniques into Europe, with a specific focus on the French tech ecosystem. This initiative is propelled by the recognition that France is currently positioned similarly to where the United States stood prior to the infamous Enron scandal—a pivotal moment that reshaped U.S. financial regulations and valuation practices. By drawing on lessons from the U.S. experience, Sovalue, in collaboration with the Direction de la Législation Fiscale (BOFIP), aims to proactively address potential valuation discrepancies and avoid a crisis of confidence in the market. This forward-looking approach seeks not only to align French valuation methodologies with proven American standards but also to set a new benchmark for transparency and reliability in stock option valuation, thereby steering the French market towards a more stable and trustworthy financial future.

Learning from the Past

BSPCE strike price valuation was not of anyone’s concern in the French Tech ecosystem from the introduction of the mechanism until the drop of tech valuation in 2023, when everyone realized that their overvalued stock options were worth nothing anymore.

Indeed, the 2023 financial crisis created a tremendous shot in the arm in France, as the Enron case did in the U.S. 22 years ago.

The U.S. and the French markets have similar characteristics and it is interesting to use the U.S. market history and how it remodeled itself with such a change in the stock option valuation methods. This will be insightful for the French market for predicting trends and perfecting valuation methodologies.

In the U.S., prior to 2007, no stock options valuation reporting rules were compulsory for companies to grant such options. So what happened?

In the years leading up to Enron bankruptcy in 2001, Enron executives committed a number of misdeeds. Among them, those who were granted large stock options awards accelerated the vesting of their options and then exercised and sold stock when the company’s shares were trading at all-time highs, all the while knowing they were overstating the value of the business to drive up the company’s valuation. As the fraud came to light, it exposed loopholes in such compensation plans that until then had largely been ignored by Congress. The Enron stock option fraud was not covered by existing insider trading laws, so as a response, Internal Revenue Section 409A was passed as part of the 2004 American Jobs Creation Act.

In a nutshell, stock options can benefit from tax incentives mechanisms if they give employees stock options that have a strike price exactly equal to the fair market value (FMV) of the common stock at the time of the grant.

For publicly-traded companies, where the fair market value is the current stock price, this is easy. But it’s not straightforward for privately-held companies, such as startups.

As a concession, provisions were created so that privately-held companies could determine the FMV of their common shares in a way that would be accepted as valid by the IRS—what is known as “safe harbor.” However, the new standards of proof were a radical change from how privately-held companies had previously determined the FMV of their common stock.

Whereas in the past, a company would decide on its own (with advice from the Board and outside counsel) what they felt was an appropriate price, they would now have to provide substantial supporting evidence, i.e. a 409A valuation report.

The Future of BSPCE Valuations in France

We clearly see the similarities between the U.S. and the French markets. In France, prior to 2023, companies decided on their own (with advice from the Board and outside counsel) what they felt was an appropriate price. This was also the case in the U.S. prior to 2007, this situation looked “standard” for anyone (investors, lawyers, entrepreneurs), using rule of thumb to discount stock options strike price.

Similarly to the U.S., we had to wait for a shock wave of realization in France, to acknowledge that this rule of thumb applied to determine any BSPCE strike price had literally no economic justification. 2023 was, and 2024 will be, pivotal years for French Tech, as many voices have raised to denounce the abnormal practice, including Sovalue.

The French Tax code gives the possibility to discount the BSPCE strike price compared to the last issue price under certain conditions. However, some lawyers had a very conservative interpretation of the article 163 bis G of the same code, so that very few companies, combined with a lack of education on this matter, were inclined to take the risk of a fair market value in estimating BSPCE’s strike price. However, in fall 2023, the government confirmed that the application of discount for the determination of the fair market value of BSPCE’s strike was more widely accepted, as it was already applied in the U.S.

Since these announcements, the Direction de la Législation Fiscale has made clear moves to clarify the interpretation of the law in order to introduce the need to have fair market value on the BSPCE’s strike price using financial objective methods such as the option pricing. These consecrations should be live Q1 2024 in France in the BOFIP.

Sovalue's venture to learn from the past, specifically the regulatory responses to the Enron scandal and the establishment of more stringent stock option valuation methods in the U.S., we hope France will stay ahead of any similar financial crises in Europe. This approach is timely and crucial, especially in light of the recent tech valuation downturn in 2023 that exposed the vulnerabilities within the French Tech ecosystem. The collaborative efforts between Sovalue and the BOFIP to refine and implement these valuation techniques mark a significant step towards international financial alignment and stability. Through adopting proven valuation methodologies and fostering an environment of regulatory clarity and transparency, the French market is poised not just to recover but to thrive, underlining the importance of global cooperation in navigating the complexities of modern financial landscapes.

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