Funds completes reissuance of tax-qualified stock options

In a move that might be followed by other startups, Funds, operator of the fixed income asset management service “Funds”, announces that as of December 2023, the reissuance of tax-qualified stock options has been completed based on the notice of interpretation of laws and regulations regarding tax-qualified stock options released in July 2023.

**Changes in Interpretation of Laws and Regulations**

Until now, there have been no clear rules on the design of tax-qualified stock options, especially on stock price calculation. As a result, practices have tended to be highly individualized, such as referencing the valuation price of the most recent fundraising round for unlisted companies, or applying discounts based on differences in asset distribution between preferred and common shares.

Against this backdrop, the National Tax Agency released a new notice last July which stipulates methods for calculating the “price per share at the time of concluding the contract for stock acquisition rights” related to exercise price requirements. According to this notice, stock options issued by unlisted companies like Funds for shares without a market price will be deemed to meet the exercise price requirements if the “exercise price” is set at or above the share price calculated by the prescribed methods.

**Background for Reissuing Tax-Qualified Stock Options**

Funds’ mission is “to find answers that don’t yet exist for future anxieties.” Funds has pioneered numerous “firsts” in financial undertakings and product development. Once again, Funds felt their raison d’être was to serve as a first penguin in addressing the anxiety surrounding stock options, an incentive unique to startups. Funds hopes that by publicly sharing this example, they can help alleviate concerns for startups in general.

Additionally, according to a Nikkei article based on its 2023 “Next Unicorn Survey,” average salaries at promising startups exceed those at listed companies. This indicates startups’ compensation is improving.

Against this backdrop, by redesigning stock options based on the notice, those joining startups in later phases, so-called “middle/late stage” employees, can now obtain more attractive incentive compensation. This is expected to further accelerate the inflow of excellent talent to startups.

**Key Points in Reissuing Tax-Qualified Stock Options at Our Company**

Funds has offered tax-qualified stock options in the past. However, based on the revised legal interpretation in the notice, Funds has recalculated share prices using the net asset value method under the special provision to enable setting lower exercise prices compared to before.

On the other hand, when the exercise price is set based on the share price calculated by the special provision method, if the share price calculated for accounting purposes exceeds the exercise price, the difference must be recorded as stock-based compensation expense. For Funds, a third-party valuation firm performs the accounting share price calculation, determining preferred and common share prices separately, and Funds records the difference as stock-based compensation expense.

In recording stock-based compensation expense, rules specified in the “Accounting Standard for Stock Options” and “Guidance on Accounting Standard for Stock Options” must be followed. Specifically, the accounting treatment is determined based on factors like vesting conditions, probability of exercise, service requirements, handling when the holder leaves the company, etc. Depending on the design, expenses may be recorded ratably over the requisite service period or in full on the grant date. Consultation with the auditing firm is also necessary to align on the specific company conditions.

In practice, similar effects can be achieved not only through reissuance but also by modifying the contract terms. However, reissuance resets the starting date for the exercise period, one of the requirements for tax-qualified status, to the latest grant date. Therefore, for companies with long operating histories, it can secondarily restore the tax benefits period for employees.

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