The law is perfectly clear: The stock options' strike price can be determined at fair market value by taking into account the valuation of the company and the difference in rights between the various classes of shares within the capitalisation table.

The tax authorities confirmed this principle on 28 March 2024, at the same time putting an end to the practice of lump-sum discounts on the stock options' strike price.

There are three essential steps:
The first is to determine the market value either of a share class – for example the price per preferred share issued during the last fundraising – or of the company.

The second step consists in comptuing the value of each share class till the price per ordinary share considering the preferred returns that should apply between preferred shares which benefit from a liquidation preference (priority payment rank in the event of exit up to a multiple of their investment).

The third step consists in calculating a discount for lack of marketability to be applied on those ordinary shares. Such a discount makes it possible to adjust the value of an ordinary share with regard to the non-liquid, minority nature of the beneficiaries of these options, on whom the transferability of their shares can be more controlled.

Three methods are commonly accepted to calculate an ordinary share price in case of preferred returns, : the Options Pricing method which is the most commonly used method, the PWERM method or the weighted probability expected return method, which allows the use of several exit scenarios, and the current value method which consists of considering the current valuation of the company as the exit valuation regardless of the maturity of the security.

The Options Pricing method is almost systematically used for companies, which plan to exit in more than three years and, which may experience a relatively significant variation in their valuation. This method thus makes it possible, with regard to the maturity horizon, the risk-free rate, and the volatility of the industry, to estimate a potential variation in value over the horizon using the Black & Scholes formula. We use the call option formula to distribute the price per share by share class based on the preferred return rules.

The discount for lack of marketability is determined by also applying the Black & Scholes (put protective approach) in order to measure the difference in value between an illiquid security and the same security that we have made liquid thanks to a put (option to sell). It is this difference in value that allows us to measure the discount for lack of marketability.

Unlike the United States and the United Kingdom, companies are not required to carry out a proper valuation. Companies will nevertheless have to justify the strike price of the stock options to avoid any tax and social consequences.

If freedom of proof is total, the administration considers that a valuation report will be accepted in the event of an audit.

Many of our clients have attributed stock options at with no discount or at a flat discount rate of 20% compared to the last fundraising round for many years. Switching to the fair market value has the effect of making previous plans obsolete or discriminatory between employees to whom the company has allocated overvalued stock options and new employees.

The problem is and the law is clear: We cannot change the strike price for outdated plans. Only one solution exists and that is to cancel and replace previous stock options plans. In this case, companies will be able to grant new stock options at today's fair market value while preserving the vesting period initially established.

In other words, employees will have a lower fair market value price, and will always have the same number of vested options.

Appraiser is not a regulated profession. You should therefore be vigilant about the expertise of the service providers you choose. It is key to ensure that they have true expertise in the valuation of stock options' strike price and that they fully understand the tax risk issues.

Sovalue is a company specialized in valuation of tock options' strike price. Our team has trained to meet the requirements of American regulations in order to be able to produce 409a reports for our clients. We have a multidisciplinary team of appraisers, investment advisors, lawyers, and tax specialists specialised in venture capital. This team allows us to provide the state of art of valuation practices and a great customer experience.