Stock Based Comp, for Dummies
Is stock based comp a real expense?
On multiple occasions I’ve exposed the wonders and horrors of employee stock options - they can make you rich over night, but may force you to shake out the couch cushions to own them.
What’s less talked about is the impact of granting stock on the issuing companies.
Stock based comp is a non cash expense that shows up on a company’s profit and loss statement. A non cash expense means you record a charge on the P&L, but no cash actually leaves the building. It’s kind of like a theoretical hit you have to take when you report your financials. As a result, it increases your operating expenses and decreases your net income. And if you trace it all the way through, it makes your earnings and earnings per share go down.
Mechanically, stock based comp gets expensed on the P&L as employee stock options vest (typically over a four year period). As they come to fruition, accountants assess the value of equity that employee hold and record the non cash expense.
Riveting stuff, I know.
As a bit of background, here’s how I ended up going down this rabbit hole… While sitting on my in-laws couch, enjoying a fat bowl of cookies and cream with editor in chief Walter (from a premium local establishment, of course, not any of that Turkey Hill shit), I was draw to Expensify’s efficiency - they are producing more than $170,000,000 with less than 140 employees.
Buuuuuut…. the plot thickens! Then I realized they were actually losing money and operating at a loss.
What?! How much are they paying these people? How many Super Bowl commercials did they buy? Also, good for you, 2 ChAINz!
The real answer lies in the massive amount of stock based comp they’ve been strapped with. From a free cash flow perspective, Expensify is printing crispy hundreds. But when they factor in the non cash SBC expense, it drags their operating profits into the abyss.
As you can see, Expensify spent $63M on COGS + $122M on OPEX = $185M in total spend. But $52M (28%) of that is SBC. So they are technically losing $27M a year on paper, or 33 cents per share.
I reckon they’d look like a beacon of profitability if it weren’t for SBC.
(Note: But they’d also pay more in taxes…)
So why do we jump through these quasi-real hoops?
Charge it to the game
Well, basically, the accounting police (Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS)) acknowledges that one of the most powerful levers a company can pull to incent their employees is to offer them a piece of the company.
And they’ve got a point - the company’s cash payroll expense would be a TON higher if it weren’t for stock based comp. I know I would be negotiating a lot differently if it were not for stock. Cut the check, my G!