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Can a company set a fair market value of its stock below what an investor recently paid in exchange for common shares?

My company recently received external investment. According to management, they did not receive preferred shares; they received common shares like we employees have through our incentive stock options. Assuming this is true, I know for sure that the investors paid something like twice as much for their common shares as we were told the fair market value was soon afterward. Is this legal? I find it hard to believe the IRS wouldn’t take issue with an investor paying $10/share, and then a few months later the company claiming their shares are only worth $5/share (which of course helps keep stock option exercise prices and AMT taxes down), without something significant occurring to reduce the company’s value.

Answer 12012

In short, yes it is legal - This sounds like it’s a private company (not a plc) but the principle is the same. If someone outside the company see potential in it for whatever reason they’ll have to pay over the odds to get in on the action.

I publicly traded companies, if for example, one company offers to take over another, the have to offer a premium (often around 20% on top of what they’re being traded at) investment funds then might buy these shares while the whole takeover is being approved by competition authorities (which can take 6 - 12 months) on the expectation that the takeover will be approved and they’ll be able to sell then to the takeover company at the 20% gain.

With a non-publicly traded company, the information as to how much the shares are worth and other factors aren’t as well know so they end up paying even more - this is good for you if you already own shares as they’re concentrated (increased) the price per share

Answer 12061

Yes, the company can sell common shares to investors at a price above fair market value. If it is a one-time or infrequent occurrence, then it may not impact the fair market value. But if it becomes a frequent or repeated event, then it can become a strong indication of fair value. Many companies will also obtain a 409A valuation on an annual basis to help them determine fair market value.

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