With the advent of accounting (FASB 123R) and income tax (IRC 409A) guidelines regarding the valuation of equity-based compensation, it has become increasingly important for entrepreneurs to become familiar with complex equity securities and the valuation of equity-based compensation such as stock or option grants.
This typically arises in the context of venture capital funding. Providers of early stage institutional funding provide growth capital for emerging companies and therefore, are interested in the return of the their capital (often called liquidation preference) but also participating in the “upside” or increase in equity value of the business, hence achieving a return commensurate with the risk involved.