Accurate stock based compensation expense (SBC) is a growing part of headcount expenses upon which all business leaders — FP&A and various functional — critically plan their operating roadmaps during their annual planning cycle.
Realtime, data-based headcount forecasting is a big part of why I joined Precanto, an AI/ML headcount forecasting platform. In this series, we at Precanto are examining some of the key data that powers headcount forecasting, such as payroll taxes and SBC, and how the intricacies of this data can contribute to missed forecasts and poor financial planning.
Beyond paper tallies, SBC impacts hiring, retention, and overall business growth, but presents serious challenges for finance leaders forecasting the costs and assessing the impacts of SBC on the business. Getting it wrong can hurt companies competitively. But getting it right is hard.
What is stock based compensation?
SBC, sometimes known as equity or share-based compensation, is a practice in which companies reward employees with shares of ownership in the business, usually in the form of options or restricted stock units. SBC is typically offered in addition to salary and/or bonuses.
SBC offers companies a few advantages. If employees have a stock-based stake in the company, the thinking goes, they are more invested in the firm’s success.
Another is cash management. Paying employees in the form of stock offers payment tomorrow for work done today. For highly competitive industries, like the technology sector, SBC offers a way to sweeten the offer package for new hires without negatively impacting corporate cash flow.
This can cut expenses for the company in the short-term and be exceptionally profitable for the employee in the long-term. Consider the Google in-house masseuse hired in 1999, who cashed out her options five years later to retire in comfort and start her own charitable fund. If the company does poorly, however, this isn’t the case, so the employee takes on some risk – especially if they’ve exercised their options from their own pocket.
How stock based compensation creates forecasting obstacles?
It is no mystery that employment performance has been glued as a metric to company and stock price growth, and SBC has been a major vehicle of incentive. The average SBC for the industry rose from 4% of 2012 revenue to 11% of 2020 revenue and around 23% of 2021 revenue, according to Barron’s. This resulted in over $270 billion in SBC in calendar year 2022, notes Morgan Stanley.
While the macroeconomic slowdown of 2023 has stalled stock growth, the strategy to leverage non-cash incentives and the anticipated industry rebound has continued to make SBC a staple of attracting top talent, most prominently in the technology sector.
Hiring the best talent has become the make-or-break for most companies, ensuring SBC will not go away. In fact, in a world of creative financing solutions, from options (ISOs, non-quals) to RSUs to PSUs and so forth, SBC will only become increasingly voluminous, complex and possibly ad hoc for key talent.
That means finance and accounting teams will be left with not only valuing and booking today’s expenses, but predicting and budgeting for tomorrow and beyond. They’ll need to track the re-valuation of equity grants on a periodic basis, and evaluate the resulting payroll expense, payroll tax, and overall compensation impact while building out multiple year outlays.
Nailing down SBC precisely is extremely challenging, given the breadth of issues that impact the expense outcome, and multitude of scenarios and valuation assumptions that can be modeled. Best practice, from a finance standpoint, calls for creating low, mid, and high scenarios in order to understand the potential risk for SBCs – resulting in three very heavy spreadsheets.
There are so many variables that impact SBC:
- Stock price
- 409A valuation
- Term
- Volatility
- Attrition
- Assumed rate
- Risk-free rate
- Yield
- Possible dividends
All of these require fine-tuning and debate – but decision-making deadlines for hiring won’t wait for all these iterations to settle on a single, most likely scenario.
Precanto: Stock based compensation forecasting for modern enterprises
Precanto transforms how companies manage their financials and make headcount spend decisions by applying automation and AI/ML with built-in finance context. SBC modeling remains a key component of that context.
The goal is to shift finance teams away from laboriously time-consuming assessment models, which demand custom formulas, sprawling manually updated spreadsheets, and data processing prone to human error. Instead, Precanto replaces that with user-friendly dashboards that shift models in moments and are based on data cleansed of inaccuracies.
This allows companies to create faster, more accurate SBC forecasting that helps leaders drive better decision-making about any tech company’s largest expenditure.
While finance leaders strive to understand the payroll impact of late-breaking compensation grants, and project future existing and planned equity compensation, Precanto can help manage these headcount related matters, freeing executives to focus on scaling headcount, and optimizing recruiting.
Learn more about Precanto. Book a demo today.
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