Everyone knows issuing stock options and warrants is a great way to compensate employees and contractors for a job well done. These methods of compensation have been embraced by the startup community as a way to reward others without using up their much-needed cash.
Issuing options and warrants to customers is a less common practice but can be a great mechanism to establish and solidify a trusting relationship with your valued customers. Options and warrants issued to customers have many benefits, including replacing a cash rebate, serving as a form of collateral or guarantee of performance and aligning the interest of your company with the interests of your customers. Talk about a win-win.
If you issue these share-based payments to your customers, Accounting Standards Update (ASU) 2019-8 will have an impact on your financials.
Here are the key provisions of the accounting standards update that you need to know about:
- Options and warrants are measured at fair value on the date they are granted
- The fair value of options and warrant is recognized as a reduction to revenues over the life of the customer relationship
- The ASU is effective for fiscal years beginning after December 31, 2020
What does this mean for you?
This ASU aligns much of the share-based payment guidance with the new revenue recognition standards. Options and warrants issued to customers will now be evaluated as part of the transaction price of a customer contract. The timing of your revenue recognition will impact the recognition of these share-based payments. As revenues are recognized, the value of the options and warrants will be recognized as a reduction to revenues.
Some things to consider:
- Make sure that you are granting options and warrants in a manner that does not create any tax issues for you or your customers
- Evaluate the benefits of incentivizing your customers vs the inevitable dilution
- Consider the potential impacts on commission structures. Through dilution, the shareholders are certainly playing a role in customer acquisition, so commission structures should take this into account
A final word
Aligning your interest with your customers is one of the best ways to incentivize your customers and create a loyal relationship with those you supply and service. Conserving cash, while forming long and valuable customer relationships is something that could benefit almost every business. Don’t forget that you are giving away a piece of your company, but who better to give it away to than your customers. Lastly, make sure you know how the accounting will impact your top line.
If you have an accounting question, don’t hesitate to contact a Henry+Horne professional adviser.
Steve Pope, CPA