understanding valuation for equity compensation and avoiding the perils of 409a
DESCRIPTION
Alicia Valuation Presentation 04-29-13 f you are a CEO or a CFO of a high growth startup, it is vital to understand how to value your company correctly. Here is a quick list of questions this lunch will help you answer: Do you offer or are you planning to offer your employees stock options? Do you know the difference between ISOs and non-ISOs? Do you understand the general valuation concepts and approaches that the IRS has outlined, especially as they apply to early-stage companies? Did you know that if you run afoul of the 409A rules, your employees could have an unpleasant tax surprise and that some of that responsibility could revert back to you as the employer? Do you know if and when you need to engage an outside expert to assist with a valuation? www.thecapitalnetwork.orgTRANSCRIPT
Understanding Value for Equity Compensation and Avoiding the Perils of
409A April 30, 2013
Today’s Speakers
• Managing Director, Scalar Analy8cs
• Visi8ng Professor, Clark University and Tu@s University
• CPA and CVA
• Prior CFO
Scalar Analy*cs specializes in business valua*ons including 409A valua*ons.
• CPA, Wolf & Company
• Accoun8ng and audi8ng
• Leads the High Tech prac8ce
• BOD and program chair commiJee at TCN
Wolf & Company, PC, is a 100 year old regional firm with 19 owners and 185 professionals, focused on CPA core competencies with a dedicated tech services team.
ScoJ Goodwin Alicia Amaral
About Scalar Analy8cs
• Collabora8ve approach • 550 valua8ons per year (50% are 409A) • Majority of clients backed by venture capital firms and angel groups
• Clients in virtually every industry • Work with all of the “big 4” audit firms and countless regional firms
Valua8on Purposes
• M&A • Li8ga8on • Estate & Gi@ • Stock op8on expensing • Purchase price alloca8on • Buy/Sell agreements
• Compensa8on – Restricted stock 83b – Op8ons 409A
Standard of Value
• Fair Market Value • Rev. Rule 59-‐60 “The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts.”
• Important because this does not assume a strategic buyer.
• This is the standard for 409A
Standard of Value, con’t
• Investment Value • “The value to a par8cular investor based on individual investment requirements and expecta8ons”
• Value is different depending on synergies • Applies to specific buyer rather than hypothe8cal buyer
• 409A ≠ VC or angel investment
Standard of Value, con’t
• Intrinsic Value • Based on present value of future dividends • Applies to public companies
• Fair Value • SFAS 141 and 142 “The amount at which an asset (or liability) could be bought or sold in a current transac8on between willing par8es.”
• May include synergies
Three Valua8on Methods
1. Asset Approach
2. Market Approach
3. Income Approach
1. Asset Approach
• Applicable only for companies in early stage (difficult to defend, last resort if there are no other data points)
• The Asset Approach establishes value based on the cost of reproducing or replacing the property, less deprecia8on.
• Applied to specific assets, such as land improvements, special-‐purpose buildings, special structures, systems, special machinery and equipment, and certain intangible assets.
2. Market Approach
• Based on the assump8on that the value of an asset (including a company) is equal to the value of a subs8tute asset with the same characteris8cs.
• Infer value by finding similar assets that have been sold in recent transac8ons.
2. Market Approach
a) Recent securi8es transac8ons method b) Comparable (guideline) public company
method
c) Comparable transac8on method
d) Industry-‐specific mul8ples
2. Market Approach
a) Recent securi5es transac5on method. Based on recent transac8ons of company’s securi8es Ex: preferred stock sold to angels. Exhibit B (backsolve method). Uses OPM based on preferred rights
b) Comparable public co. M&A data in company’s industry. See page 20. Compare to Salesforce, etc. Uses revenue mul8ples, EBITDA mul8ples, etc
c) Comparable transac5on method. See pg 21. Similar to b) See Exhibit F. Why it’s important to review your report.
d) Industry specific mul8ples (N/A). Ex: headcount, backlog, revenue per employee, # of customers, # of users
3. Income Approach
• Discounted Cash Flows (DCF) • Present value of future cash flows • Discount rate is based on rela8ve riskiness of investment
• See page 51 for required rates of return for private venture backed companies
Enterprise Value
• Each method comes up with different value of the enterprise
• Analyst determines which are appropriate and weights them to come up with es8mated enterprise value
• See page 22 of Venture Co.
Alloca8on Methods
• The previous methods determine an enterprise value of the company as a whole
• The next step is to allocate among various classes of equity
• Example (page 22): Enterprise value $48,153,573
Less Debt ($1,750,000) Equity value = $46,403,573
Breakpoints
• Simply means “who gets what” in the event of an exit
• Remember that the point of a 409A is to value common stock
• Preferred shareholders get paid first • Common shareholders get what’s le@ over
• Enterprise value is the value today • Exit is value in X# of years
Alloca8on Methods
• Current Value Method (“CVM”) – assumes value today is same as exit value – Appropriate only if liquidity value is known as in a pending deal
• Probability Weighted Expected Return (“PWERM”) – weighted average of various scenarios based on probability (IPO, sale, bankruptcy) – Probability based on appraiser’s judgment
• Op8on Pricing Method (“OPM”) – same logic as PWERM but considers more scenarios – Probability based on Black Scholes
OPM
• In the event of an exit, preferred gets paid first • Common only gets if there’s anything le@ over
• Vola8lity and 8me to liquidity are important factors in determining range of outcomes
• Greater vola8lity is beJer for common (lower lows but who cares because below zero is same as zero)
• Longer life is beJer because more opportunity to grow
OPM
• See Exhibit M Breakpoint Analysis • Common stock only has value only if funds available exceed liquida8on preferences of preferred
• See also Capshare Demo Company
Discount
• Discount for lack of marketability (DLOM) 25 – 45%
• Discount for Venture Co. = 35.7%
Valua8on Summary
• Value is based on a number of assump8ons that have a material impact on the result – Projected cash flows – WACC – DLOM
– Comparable companies
• Important to have a “DEFENDABLE VALUE” (IRS and auditors)
• Important to review report for reasonableness of assump8ons. You know your business.
