2.5 Economic Interest Holders
ASC 718-10
15-4 Share-based payments awarded to a grantee by a related party or other holder of an economic interest in the entity as compensation for goods or services provided to the reporting entity are share-based payment transactions to be accounted for under this Topic unless the transfer is clearly for a purpose other than compensation for goods or services to the reporting entity. The substance of such a transaction is that the economic interest holder makes a capital contribution to the reporting entity, and that entity makes a share-based payment to the grantee in exchange for services rendered or goods received. An example of a situation in which such a transfer is not compensation is a transfer to settle an obligation of the economic interest holder to the grantee that is unrelated to goods or services to be used or consumed in a grantor’s own operations.
ASC 718-10 — Glossary
Economic Interest in an Entity
Any type or form of pecuniary interest or arrangement that an entity could issue or be a party to, including equity securities; financial instruments with characteristics of equity, liabilities, or both; long-term debt and other debt-financing arrangements; leases; and contractual arrangements such as management contracts, service contracts, or intellectual property licenses.
An economic interest holder of a reporting entity may issue share-based payment awards in the reporting entity’s equity for goods or services provided to the reporting entity. If so, the reporting entity typically records the transaction as if it had issued the awards (with a corresponding capital contribution from the economic interest holder) since the entity benefits from the compensation paid to the grantees.
2.5.1 Investor Purchases of Shares From Grantees
On occasion, investors intending to acquire or increase their stake in a
nonpublic entity may purchase shares from the founders of the nonpublic entity
or other individuals who are also considered grantees. The presumption in such
transactions is that any consideration in excess of the fair value of the shares
is compensation paid to grantees. See Section 4.12.3.2 for more information.
2.5.2 Share-Based Payments in an Economic Interest Holder’s Equity
An economic interest holder may issue awards of its own equity to grantees that provide goods or services to a reporting entity (these can be employees of a reporting entity or nonemployees providing goods or services to a reporting entity). An economic interest holder could be, for example, a parent entity, another subsidiary of the parent (e.g., a sister subsidiary), an equity method investor, an unrelated investor, or a third party. If there are various ownership and legal entity structures (particularly partnerships and limited liability companies), it may be difficult for a reporting entity to determine whether the awards are subject to ASC 718 or other U.S. GAAP (e.g., ASC 323 or ASC 815). The determination of which guidance to apply could affect the awards’ classification, measurement, and recognition in the reporting entity’s financial statements as well as the required disclosures. Accordingly, the reporting entity should evaluate the following:
- Which legal entity is issuing the awards and whether the awards are indexed to or settled in that entity’s equity — For example, if awards are settled in the equity of an unrelated investor, they may not be share-based payments of the reporting entity that are accounted for under ASC 718.
- The economic substance of the legal entity issuing the awards — The evaluation should include whether the entity has other substantive (1) investments or operations (outside of its ownership in the reporting entity) and (2) investors. For example, if a legal entity that is an investor in the reporting entity grants awards to employees of the reporting entity but is created solely as a holding company (with no operations) by the reporting entity to issue awards to the reporting entity’s employees, the legal entity’s purpose may be to issue awards to employees that are effectively indexed to the reporting entity’s equity. In this circumstance, issuance of the awards may not be substantively different from the reporting entity’s issuance of equity to its employees. Accordingly, it may be appropriate to account for those awards under ASC 718. See Example 2-5.
- The legal entity’s relationship with the reporting entity — If the legal entity whose equity is the basis for the awards has economic substance other than to issue awards to the reporting entity’s employees or nonemployees, the accounting will depend on that entity’s relationship with the reporting entity. For a discussion of awards issued by an entity to providers of goods or services of another entity within a consolidated group, see Sections 2.8 and 2.9. For a discussion of awards issued by an equity method investor to providers of goods or services of its equity method investee, see Section 2.10.
- Whether the grantees are common law employees of the reporting entity — For example, if a parent entity grants awards of its equity to employees of an entity that is (1) unrelated to the subsidiary reporting entity (e.g., an unrelated management or advisory company) and (2) providing nonemployee services to the reporting entity, the awards may be subject to ASC 718. However, the accounting for nonemployee awards could be different under ASC 718 from that for employee awards (see Chapter 9).
- Whether the reporting entity has an obligation to settle the awards issued — For example, if the reporting entity has an obligation to settle awards granted to its employees or nonemployees in the equity of another entity that is not the reporting entity’s parent, the awards may not be subject to ASC 718. For a discussion of awards issued by a reporting entity that are settled in the equity of an unrelated entity, see Section 2.11.
Example 2-5
Entity C, the reporting entity, is a privately held limited liability company that is wholly owned by Entity B, a limited partnership and holding company with no operations or assets other than its investment in C. Entity B is controlled and consolidated by Entity A, a management company and the general partner, but B is also owned by other investors. The ownership interests are as follows:
- Entity A — 15%
- Other investors — 82%
- Entity D — 3%
Entity D was created by A as a holding company with no operations or assets
other than its investment in B (which also has no
operations or assets other than its investment in C).
Under this structure, recipients of the awards invest
through D (an upper-tier LLC) and remain employees at C
(the lower-tier LLC). Entity D obtained the 3 percent
ownership interest in B solely to grant equity awards
equivalent to its ownership interest in B to certain
employees of C for services provided to C. The
share-based payment awards will be settled in D’s
equity, which is a substantive class of equity that
derives its value entirely from the value of C.
Entity C determines that the equity issued by D is substantively equivalent to its own equity. That is, D’s equity derives its value exclusively from C as a result of D’s 3 percent ownership in B. Entity B’s equity, in turn, derives its value exclusively from B’s 100 percent ownership of C (B and D hold no other assets). Therefore, it is reasonable to conclude that the share-based payment awards issued by D to the employees of C should be accounted for in C’s financial statements under ASC 718 as C’s share-based payment awards since C’s employees effectively received share-based payment awards in C’s equity. That is, in substance and in accordance with ASC 718-10-15-4, D (the economic interest holder) made a capital contribution to C (the reporting entity), and C then made a share-based payment to its employees in exchange for services rendered.