A cheap-stock review is an accounting question, not a tax one

The record

The SEC's Division of Corporation Finance maintains a Financial Reporting Manual that, as retrieved on 16 September 2026, sets out what its staff examines when a company going public has granted stock-based compensation using valuations of its own, not-yet-public stock. Topic 7520, last updated 30 June 2009, states that in evaluating such a valuation the staff considers 'the proximity of the issuance to the offering, intervening events, transfer restrictions and exercise dates, and profitability and financial condition,' and that if the estimated fair value is 'substantially below the IPO price, the registrant should be able to reconcile the difference.' Topic 9520, last updated 6 February 2014, adds that the staff looks for specific critical-accounting-estimate disclosures about the valuation method and may comment where a valuation appears to have risen unusually steeply before the offering, the pattern commonly called a 'cheap stock' issue.

What the documents establish

The Manual is the staff's own description of what it reviews, not a law firm's paraphrase of SEC practice, and it is explicit that its comments on valuation are meant 'to elicit analyses...not for the purpose of requesting changes to disclosure' by themselves. A concrete instance from the same review process: the staff's 15 June 2021 letter to ForgeRock, Inc. asked for a breakdown of stock-based compensation granted in the six months before its draft S-1 and for an explanation of 'any significant fluctuations in the fair values,' the same inquiry Topic 7520 describes in general terms, applied to one filer's own draft registration statement. Separately, Treasury's regulations under Internal Revenue Code Section 409A set independent safe-harbor methods for valuing private stock for deferred-compensation tax purposes; that is a different inquiry answering a different question, and a valuation that satisfies the 409A safe harbor is not thereby immune from an SEC cheap-stock comment about the same stock's value relative to the IPO price.

The operating read

Editorially, a company preparing to go public should expect its pre-IPO valuations to be read twice, for two different purposes: a 409A valuation supports the tax treatment of options and deferred pay, while the registration statement's own disclosure must independently explain, to the SEC staff's satisfaction, why the valuations used for compensation expense differ from the price the underwriters set. Treating the two as one exercise risks arriving at the registration process with a valuation memo that answers the tax question but not the accounting and disclosure question the Manual describes.

What to check before you decide

Before assuming a private-company valuation will withstand IPO-stage review, check the following.

• Can the company reconcile, in writing, any gap between its pre-IPO compensation valuations and the eventual offering price, using the factors Topic 7520 names?
• Does the draft registration statement's critical-accounting-estimates disclosure describe the valuation method and its material assumptions, as Topic 9520 asks?
• Is the 409A safe-harbor valuation being treated as sufficient for SEC disclosure purposes, when the two serve different legal functions?

This is a description of the SEC's own published review criteria, not advice on how to value any particular company's stock.