Stock-based compensation (ASC 718)

Every option or restricted stock grant is measured at fair value on the grant date and expensed over the vesting period. Options are valued with a model, usually Black-Scholes, whose inputs are the stock price, exercise price, expected term, volatility, and risk-free rate. For a private company the stock price comes from the 409A valuation, and volatility comes from a peer group because the company has no trading history.

The expense is non-cash and is added back in the operating section of the cash flow statement, which is why it explains most of the gap between net loss and operating cash burn. It is real compensation nonetheless, and public investors watch it as a percentage of operating expenses.

The common errors are grants made before the 409A that priced them, awards with performance conditions expensed as if service-only, and modifications, such as repricings and acceleration on termination, not accounted for. Each is a first-audit adjustment waiting to happen.