Good morning. Andrew here. Ever heard of double trigger R.S.U.s? These restricted stock units are some of the most important yet overlooked compensation tools in the unicorn world. As the biggest artificial intelligence companies prepare to go public, they’re worth paying attention to. DealBook contributor Rob Price takes us inside this compensation netherworld. Also: DealBook’s Sarah Kessler has a fascinating interview today about the crucial social cues executives often miss. And don’t miss this week’s news quiz. (Was this newsletter forwarded to you? Sign up here.)
After the I.P.O., a billion-dollar bill
When does it become “probable” that a start-up will go public? It’s a seemingly arcane question that can have serious implications for investors. Is an I.P.O. probable when the board of directors first discusses the possibility? When the company starts confidentially engaging with the Securities and Exchange Commission? Or when it files its S-1 registration document publicly? Do we start the clock 30 or 7 days out? Over the past decade, Wall Street and the big accounting firms have converged on a surprising answer: As companies from Uber to Robinhood have prepared to list their shares, they’ve taken the position that an I.P.O. isn’t probable until the moment before it actually occurs. This extremely conservative definition of “probable” has allowed companies to defer booking billions of dollars in expenses until after their I.P.O. — a practice that new research argues may hurt retail investors. At the center of the debate is a type of stock-based compensation that has become popular with start-ups. Known as a “double-trigger restricted stock unit,” it means that shares are not issued to employees until after a liquidity event, such as a public offering, and they’re not required to appear on company income statements until that event becomes “probable.” A significant proportion of large start-ups now grant employees at least some double trigger R.S.U.s. When those companies take the stance that the I.P.O. isn’t probable until it happens, their compensation expenses may look very different as a public company than when private. And in the quarter they have their I.P.O.s, companies sometimes post billions of dollars in catch-up expenses. These now-routine spikes in expenses are associated with stock price declines, according to a new paper from Sven Riethmueller, a professor at Yale Law School. He argues that companies have exploited accounting rules around stock-based compensation to present artificially rosy financials before they go public, and that the basic disclosures currently provided about the upcoming charges may be routinely breaking securities law. As investors brace for a string of mega I.P.O.s at start-ups like Anthropic and OpenAI, how regulators and the companies that grant double trigger R.S.U.s handle this question could have big consequences. Anthropic and OpenAI did not respond to requests for comment about their use of double trigger R.S.U.s. “I can tell you one thing that you will hear practitioners talk about, but they’ll never put it in writing,” Riethmueller said in an interview. “Once the company files its S-1 or is close to filing its S-1, then the likelihood of the I.P.O. happening is quite high.” Catch-up costsHistorically, companies seeking to compensate workers with equity reached for stock options, which give employees the right to buy the company’s stock at a pre-specified price at a later date. Cashing those options in after an I.P.O. can give them a windfall. But over the past decade, options have been increasingly supplanted by grants of company stock that vest over time. Many start-ups now use double trigger R.S.U.s, which issue the employee stock only if two conditions, or “triggers,” are met. The first is a “service” condition — the employee must stay employed for a minimum period of time. The second is a “performance” condition — that the company experiences a liquidity event, typically an I.P.O. If there’s no I.P.O. before the R.S.U. expires (often after seven years), the stock grant is worthless. This mechanism means workers aren’t saddled with tax bills after being granted stock in a private company they can’t easily sell. It also keeps the company’s reported expenses low, unlike with options, which are automatically recognized over the vesting period. Determining the probable threshold has been left to the companies and their auditors. For example, on July 1, 2021, Robinhood publicly filed its S-1, and its I.P.O. took place four weeks later, on July 29. But on June 30, a day before the S-1, Robinhood took the position that its I.P.O. was “not probable,” it later attested in a financial filing. Pinterest similarly declined to recognize the expenses even after its S-1 was filed, and just 18 days before its I.P.O. The result: Huge catch-up charges post I.P.O., plus a wave of additional expenses in future quarters as the remainder of the pre-I.P.O. R.S.U.s are recognized on an accelerated schedule. Robinhood saw an average of $6 million in stock-based compensation expenses per quarter in the fiscal year before going public, then a catch-up expense of $1 billion in its I.P.O. quarter, while Pinterest jumped from $3.7 million per quarter as a private company to a $975 million catch-up expense after it went public. Robinhood and Pinterest declined to comment. Disclosure shortfallsHow much do catch up expenses affect stock price after an I.P.O.? It’s hard to say exactly. The multitude of factors that influence a stock price mean it can be hard to prove causality for any one company. But in aggregate, Riethmueller’s analysis found the companies that posted $107 million or more in catch-up expenses saw an average stock decline of 10.1 percent as measured from 10 days before the results to 10 days afterward, when adjusted for the overall performance of the Nasdaq, while the companies below that threshold underperformed the market by a smaller amount, 3.2 percent. Companies with catch-up expenses above the threshold were also at higher risk of stock price declines of any size. Riethmueller, a former general counsel at a life sciences firm, examined 91 “unicorn” companies with a pre-I.P.O. valuation of more than $1 billion that went public between 2014 and 2024. Many of the companies failed to explicitly assess the effect the deferred expenses would have on their operations in their S-1s, which Riethmueller argues is required, and largely failed to break down the future costs that would occur after the immediate I.P.O. quarter. Cybersecurity firm Rubrik, for example, disclosed impending catch-up expenses of $621.5 million in its S-1, but did not quantify until after the I.P.O. the additional costs of $475.6 million relating to pre-I.P.O. grants that hadn’t yet fully vested. Rubrik did not respond to requests for comment. Academics who reviewed Riethmueller’s paper told DealBook they would like to see further statistical analysis of his claims of the risks of stock price decline. “The evidence is certainly consistent with investors not fully anticipating these costs, but firms with very large deferred R.S.U. expenses differ in other important ways that could also affect subsequent returns,” Partha Mohanram, a professor at the University of Toronto’s Rotman School of Management who has studied stock-based compensation, wrote in an email. Riethmueller said he was not arguing catch-up expenses necessarily cause stock price declines, but are a risk factor for such drops that should be more clearly disclosed. His analysis indicated size alone was not a statistically significant indicator of a higher risk of decline, he said. A strong conventionThe position that an I.P.O. is not probable until it occurs has been backed by the “Big Four” accounting firms — Deloitte, EY, KPMG, and PwC — who were engaged by 50 out of 51 of the companies with significant deferred expenses. They have variously argued that I.P.O.s are always subject to significant uncertainty, or are reliant on factors outside the company’s control. “For an event to be probable, it needn’t have occurred yet,” said Steven Balsam, an accounting professor at Temple University’s Fox School of Business. “There’s an accounting principle called conservatism. And basically, conservatism says: ‘We recognize an expense as soon as possible, as opposed to revenue, which we wait on.’ To me, this violates the principle of conservatism.” The S.E.C., which reviews S-1 filings before companies go public, has allowed the “probability” convention to stand. Not everyone agrees with Riethmueller’s recommendation to proactively recognize double-trigger R.S.U. expenses on a company’s accounts before it goes public. “Maybe the S.E.C. and other regulatory bodies should consider, or companies should consider, if there are better ways to disclose this as a risk,” John Berlau, the director of finance policy at the Competitive Enterprise Institute, said. “But I don’t think it’s accurate accounting to count this against earnings.” The period Riethmueller examined ended in 2024, but he expects the use of catch-up expenses to continue. In fact, the problem may be about to get worse, he said: If the S.E.C. follows through on its proposal to allow semiannual rather than quarterly financial reporting, it could delay the “R.S.U. reckoning” even further after a company goes public.
Inflation showed little improvement in August. Data released on Friday showed overall inflation remained elevated at an annual pace of 3.4 percent. That keeps pressure on the Fed to raise interest rates at its meeting next week. Worries about inflation also contributed to a global bond sell-off this week. Oil prices surged. Brent crude, the international benchmark for oil, rose amid concerns that the war in the Middle East was intensifying and that the Houthi militia, Iran’s ally, has a foothold at a bottleneck in the Red Sea and could further disrupt shipping there. The average price of diesel hit records on Thursday and Friday, according to AAA. President Trump reignited a trade war with Canada. After Canada introduced retaliatory tariffs on American goods on Tuesday, Trump moved to add more products subject to a 50 percent tariff and to ban a small set of Canadian imports entirely. More big deals. LIV Golf filed for bankruptcy. The Justice Department is investigating Nvidia’s deal with the A.I. chipmaker Groq. And the prominent dealmaker Michael Aiello will leave the law firm Weil, Gotshal & Manges for Cravath, Swaine & Moore, according to Reuters. How to read the roomPamela Meyer believes there’s a mountain of research in psychological sciences, law enforcement and the intelligence world that people in business ought to know. “We miss all the micro signals if we’re not trained to look at them,” she told DealBook. “How to see the conversation underneath the conversation is in and of itself an incredibly important leadership skill.” In her first book, “Liespotting,” she applied such research to the art of detecting deception. Her new book, “How to Read the Room,” released this week, uses it to explain the discipline of social observation. Sarah Kessler spoke with Meyer about the basics. The interview has been condensed and edited for clarity. Why should business executives learn about social observation? Our culture really rewards speaking, it doesn’t reward watching. Yet someone is going to have the best edge if they come in and quiet themselves down, and start to observe carefully. What’s the first step? You want to get a soft focus on the vibe. Is it ambivalent? Is it peppy? Is it cool? Just name it. The same way you know from emotion training: If you name the emotion, it helps you understand it. How can you tell who has influence? The most important thing you can do in the room is train yourself to watch reactions and not just to watch the action. Look and see who everyone is looking at after something happens. You write that blind spots and ego can derail otherwise successful leaders. Why? If you’re a person in power, and now particularly as a person in power relying on sycophantic A.I., people flatter you all the time — they tell you it’s a good idea, they laugh at your jokes. And so you have to be brutal about asking people for feedback and figuring out what your blind spots are. Teams fail socially much faster than they fail intellectually. If you cannot manage and navigate the complexity that is social first, the team will withdraw and you’re not going to get the best work out of them. Do you have any social observation tips for people in negotiations? The most powerful question you can ask is, do you have anything else to tell me? More than 50 percent of respondents will come forth with more information.
This question comes from a recent article in The Times. Click on an answer to see if you’re right. (The link will be free.) On Wednesday, Apple unveiled a unveiled a foldable iPhone that costs $1,999. Analysts said the iPhone Duo, which is the most drastic change to the iPhone lineup in 19 years, is part of an experiment in how Apple can continue to expand its biggest business. The iPhone Duo is expected to account for what percent of iPhone shipments next year, according to Counterpoint Research, which tracks smartphone markets? We hope you’ve enjoyed this newsletter, which is made possible through subscriber support. Subscribe to The New York Times. Thanks for reading! We’ll see you Monday. We’d like your feedback. Please email thoughts and suggestions to dealbook@nytimes.com. Follow DealBook on Instagram: @nytdealbook
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