Stock-Based Compensation (SBC)

SBC is expensed on the income statement at fair value (usually Black-Scholes for options, stock price for RSUs) over the vesting period. On the cash flow statement, it's added back in operating cash flow as a non-cash charge. The offsetting entry increases shareholders' equity (additional paid-in capital). When options are exercised, new shares are issued, diluting existing shareholders.

Most adjusted EBITDA calculations add back SBC, treating it as 'non-cash.' Critics (including Warren Buffett) argue SBC is a real cost because it dilutes shareholders — if you didn't pay with stock, you'd pay with cash. In DCF models, there are two approaches: (1) exclude SBC from FCF and use diluted shares, or (2) treat SBC as a cash expense. Either way, you must account for dilution somewhere. Tech companies with heavy SBC require extra scrutiny.

For tech companies, SBC can be 15–30% of revenue, making it impossible to ignore. A company with $1B revenue and $200M SBC has a much lower 'true' profitability than EBITDA suggests. When comparing tech companies, look at SBC as a percentage of revenue and compare both GAAP and non-GAAP (ex-SBC) margins. In M&A, acquirers typically replace the target's equity plans with cash or new equity, so SBC becomes a real cost consideration.