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Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
Know your valuation for equity compensation and avoid the perils of 409a
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Know your valuation for equity compensation and avoid the perils of 409a

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If you are a CEO or a CFO of a high growth startup, it is vital to understand how to value your company correctly. …

If 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?

This is a limited seat lunch to teach issues of valuation for equity compensation and ask specific questions about your company.
Experts:
- Alicia Amaral, Scalar Analytics
- Scott Goodwin, Wolf & Company

Published in: Business, Economy & Finance
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  • 1. MEMBER OF PKF NORTH AMERICA, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS © 2010 Wolf & Company, P.C. Know  Your  Valua,on  For  Equity   Compensa,on  (and  Avoid  the   Perils  of  409A)     Exclusively  for    
  • 2. 2 Introduc,ons   •  ScoH  Goodwin  –  Wolf  &  Company,  PC   –  Member  of  the  Firm   –  Technology  Services  Team  Leader   –  TCN  board  of  directors  and  program  commiHee  chair     •  Alicia  Amaral  –  Scalar  Analy,cs   –  Managing  Director   –  TuUs  University,  Entrepreneurial  Finance   –  CPA  and  Cer,fied  Valua,on  Analyst,  CVA   –  Past  CFO  
  • 3. 3 Who  is  Wolf  &  Company?   •  Boston  based,  regionally  focused   •  18  owners  and  190  professionals  in  three  offices   •  Niche  focused   –  Technology  Services  Team   •  Provide  our  clients  with  direct  access  to  owner-­‐level   exper,se   •  Ability  to  grow  with  you  
  • 4. 4 Who  is  Scalar  Analy,cs?   •  600+  valua,ons  per  year     •  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  
  • 5. 5 Agenda   •  Overview  of  stock  compensa,on  plans   •  Overview  of  IRC  Sec,on  409A   •  The  who,  what,  why  and  how  of  valua,ons   •  Q&A  
  • 6. 6 Stock  Compensa,on     Overview   •  Common  forms  of  stock  compensa,on   –  Founders  shares   –  Op,ons   –  Restricted  stock     •  Tax  treatment     •  Advantages  and  disadvantages  
  • 7. 7 Overview  of  IRC     Sec,on  409A   •  What  is  it?   •  How  does  it  impact  stock  compensa,on?   •  What  is  the  worst  that  could  happen?   •  What  do  you  as  an  entrepreneur  need  to  know  to   stay  out  of  trouble?   •  What  are  best  prac,ces  at  various  stages  of   development?  
  • 8. Standard  of  Value   •  Fair  Market  Value   –  Assumes  hypothe,cal  buyer   –  This  is  standard  for  409A  (per  IRS)   •  Investment  Value   –  Assumes  strategic  buyer     409A  ≠  VC  investment   8
  • 9. Investment  Valua,on  for  Start-­‐Ups   •  Discounted  Cash  Flow???   •  Berkus   •  Bill  Payne  Method   •  Risk  Factor  Simulation   •  Venture  Capital  Method   9
  • 10. David  Berkus  Method   10 $500k  for  each   •  Good  idea   •  Prototype   •  Quality  Team   •  Quality  Board   •  Ini,al  Sale     Value  $0  to  $2.5  Million  
  • 11. Bill  Payne  Method   Factor   Management     Size  of  Opportunity/Market   Product/Service   Sales  Channels   Stage  of  Business   Other   11 Weight   30%   25%   10%   10%   10%   15%   100%   Ra,ng  100  =  Average,  100+  =  above  average,  100-­‐  =  below   Mul,ply  result  by  $1.75M  
  • 12. Bill  Payne  Method  Example   Factor   Management     Size  of  Opportunity   Product/Service   Sales  Channels   Stage  of  Business   Other   12 Weight   30%   25%   10%   10%   10%   15%   100%   Ra<ng   125   115   110   70   125   80     Total   37.50   28.75   11.00   7.00   12.50   12.00   108.75     Value  =  $1.75M  *  108.75  =  $1,903,125  
  • 13. Risk  Factor  Simula,on  Method   Risk  Factor   Management   Stage   Funding  Risk   Regulatory   Manufacturing   Sales  &  Mktg   Compe,,on   Technology   Li,ga,on   Reputa,onal   Exit   13 Risk  Factor   +$500k   +$250k   -­‐$250k   0   +$250k   -­‐$500k   +$250k   +$250k   $0   -­‐$250k   +$250k   $250k   Valua<on   Base  $1.75M   Risk            250k   Value            $2.0M  
  • 14. Venture  Capital  Method   Determine  the   • Investor’s  required  rate  of  return  (ROI),   and   • Terminal  Value  (TV)   Work  backwards  to  get  valua,on  (Post  $)     TV  can  be  either  exit  or  next  round   14
  • 15. VC  Method  Example   •  TV  based  on  es,mated  revenues  and/or  Net   Income  in  terminal  year   •  Example:     –  Es,mated  revenue  in  Year  5  is  $40M   –  Average  mul,plier  for  industry  =  2   –  So  your  es,mated  value  of  the  company  at  the  end  of  year   5  ,  or  TV  =  $40M  *  2  =  $80M     *Note:     Can  also  es,mate  TV  based  on  Net  Income  and  apply  average  P/E  mul,ples   15
  • 16. VC  Method  Example   •  ROI   •  Say  I  sell  an  investment  for  $100M  that  I   purchased  for  $20M.  What’s  my  ROI?   •  Answer:  $100M  /  20M  =  5x   •  Same  as  TV/Post$  =  ROI   •  To  solve  for  Post$:  Post$  =  TV/ROI   16
  • 17. VC  Method  Example   •  Say  in  our  example  that  investor  needs  a  20X  ROI   •  Post  $  =  TV/ROI   •  Post  $  =  $80M  /  20   •  Post  $  =  $4,000,000   17
  • 18. Three  Valua,on  Methods   Valua,on  Methods  409A   1. Asset  Approach   2. Market  Approach   3. Income  Approach   18
  • 19. 2.  Market  Approach   a)  Recent  securi,es  transac,ons  method   b)  Comparable  (guideline)  public  company  method   c)  Comparable  transac,on  method   d)  Industry-­‐specific  mul,ples   19
  • 20. 2b.  Market  Example:  Guideline     Public  Company  Method   Data  for  similar  public  companies  in  same  industry   •  Salesforce.com,  Inc.   •  Concur  Technologies,  Inc.   •  Kenexa  Corp.   •  LogMeIn,  Inc.   •  Constant  Contact,  Inc.   20 In  thousands  of  dollars  (000) LTM  Revenue LTM  EBITDA NTM  Revenue NTM  EBITDA Venture  Co. $6,812.0 ($6,337.8) $14,380.7 ($3,166.6) Mean  Multiple 5.0x 22.1x 4.0x 19.2x Implied  Enterprise  Value $33,809.2 N/A   $57,270.2 N/A   Average  Enterprise  Value $45,539.7 Plus  Cash $4,441.9 Market  Value  of  Invested  Capital $49,981.6
  • 21. Steps  in  the  Valua,on  Process   1.  Take  weighted  average  of  applicable  methods   (asset,  market  or  income)  to  come  up  with   enterprise  value   2.  Allocate  the  enterprise  value  among  classes  of   stock   21
  • 22. Valuation 7 Step 1 – Determine enterprise value using weighted average of applicable methods (Asset, Market and Income) Fair  Market  Value  of  Venture  Co.  as  of  September  30,  2012 Market  Value  of Method Weighted   In  actual  dollars Invested  Capital Weighting Value Adj.  Book  Value  of  Assets  (Cost) $5,914,647 0.0% $0 Invested  Capital  (Cost) $22,182,037 0.0% $0 Recent  Securities  Transaction  Backsolve  (Market) $42,932,012 25.0% $10,733,003 Public  Comps  Valuation  (Market) $49,981,604 25.0% $12,495,401 Acquisition  Comps  Valuation  (Market) $55,094,153 25.0% $13,773,538 Discounted  Cash  Flow  Valuation  (Income) $44,606,522 25.0% $11,151,631 Weighted  Market  Value  of  Invested  Capital $48,153,573 Less  Debt ($1,750,000) Weighted  Equity  Value $46,403,573
  • 23. Step  2:  Alloca,on   •  Simply  means  “who  gets  what”  in  the  event  of  an  exit     •  Common  shareholders  get  paid  aUer  preferred   Remember  that  the  purpose  of  409A  is  to  value   common  stock     23
  • 24. 24 Option  Value  Analysis Option  1 Option  2 Option  3 Option  4 Option  5 Option  6 Option  7 Option  8 Option  9 Option  10 Definition:  Before  this  breakpoint… Series  C   liquidation   preference Series  B  &  A   liquidation  preference Common   participates Allocated  options   exercise Series  A  converts  to   common Common   Warrants   exercise Unallocated   options   participate  in   value Series  B  converts   to  common Series  C  reaches         3.0x   participation  cap Series  C  converts   into  Common   stock Break  Points $0 $20,771,210 $22,182,037 $25,812,886 $27,793,293 $28,582,104 $39,428,548 $56,429,660 $301,546,405 $421,162,792 Infinity Current  Equity  Value  (Price) $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 Exercise $0 $20,771,210 $22,182,037 $25,812,886 $27,793,293 $28,582,104 $39,428,548 $56,429,660 $301,546,405 $421,162,792 Infinity Riskfree  Rate 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% Maturity  (in  years) 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 Volatility 54% 54% 54% 54% 54% 54% 54% 54% 54% 54% 54% d1 28.942 1.333 1.264 1.103 1.025 0.995 0.654 0.275 (1.501) (1.855) 0.000 d2 27.998 0.389 0.320 0.159 0.081 0.051 (0.290) (0.669) (2.445) (2.799) 0.000 Call  Option  Value: $46,403,573 $28,763,403 $27,871,048 $25,735,075 $24,660,647 $24,249,313 $19,421,999 $14,152,891 $929,712 $405,738 $0 Incremental  Option  Value $17,640,170 $892,355 $2,135,972 $1,074,429 $411,334 $4,827,313 $5,269,108 $13,223,179 $523,975 $405,738 Option  Value  of  Security Option  1 Option  2 Option  3 Option  4 Option  5 Option  6 Option  7 Option  8 Option  9 Option  10 Series  C $17,640,170 $0 $488,775 $204,543 $67,632 $795,364 $799,205 $1,933,391 $0 $60,031 Series  B $0 $697,195 $0 $0 $0 $0 $0 $414,235 $19,010 $12,542 Series  A $0 $195,160 $0 $0 $40,566 $229,734 $230,844 $566,020 $26,281 $17,340 Common $0 $0 $1,647,197 $689,319 $227,924 $2,680,416 $2,693,361 $6,604,011 $306,632 $202,309 Allocated $0 $0 $0 $180,567 $59,705 $702,136 $705,527 $1,729,925 $80,322 $52,995 A  Warrants $0 $0 $0 $0 $15,507 $87,821 $88,245 $216,372 $10,046 $6,628 Common  Warrants $0 $0 $0 $0 $0 $331,842 $307,524 $754,035 $35,011 $23,099 Unallocated $0 $0 $0 $0 $0 $0 $444,402 $1,005,190 $46,672 $30,793 Total $17,640,170 $892,355 $2,135,972 $1,074,429 $411,334 $4,827,313 $5,269,108 $13,223,179 $523,975 $405,738 Total  Option  Value Option  Value Total  Shares Share  Value   (Marketable) Marketability   Discount Share  Value  (Non-­‐ Marketable) Series  C $21,989,112 5,934,632 $3.705 0.0% $3.705 Series  B $1,142,982 1,239,906 $0.922 0.0% $0.922 Series  A $1,305,945 1,714,171 $0.762 0.0% $0.762 Common $15,051,167 20,000,000 $0.753 35.7% $0.484 Allocated $3,511,178 5,239,012 $0.670 35.7% $0.431 A  Warrants $424,620 655,276 $0.648 35.7% $0.417 Common  Warrants $1,451,511 2,283,567 $0.636 35.7% $0.409 Unallocated $1,527,057 3,044,179 $0.502 35.7% $0.323 Total $46,403,573 40,110,742
  • 25. Summary   •  STEP  1    Enterprise  Value      $48,153,573    Less  Debt          (1,750,000)    Equity  Value        $46,403,573   •  STEP  2    Alloca,on  to  common    $15,051,167    Divided  by  #  shares      ÷  20,000    Price  per  share      =  $0.753   25
  • 26. Discount   •  Discount  for  lack  of  marketability  (DLOM)   ü  25  –  45%   •  Discount  for  Venture  Co.  =  35.7%   •  Price  per  share  $0.753  less  35.7%  =       $0.484  per  share   26
  • 27. Other  Points   •  Value  is  based  on  a  number  of  assump,ons  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   assump,ons.  You  know  your  business.   27
  • 28. 28   QUESTIONS  AND  ANSWERS  
  • 29. 29 Thank  You!   ScoH  Goodwin,  CPA   sgoodwin@wolfandco.com   (617)  428-­‐5407       Alicia  Amaral   alicia.amaral@scalaranaly,cs.com   (617)  684-­‐5510    
  • 30. 30 Resources     To  be  posted  to  TCN  website:     •  Detailed  outline  and  PowerPoint  presenta<on   •  Scalar  Analy<cs  –    white  paper,  “Sec<on  409A  –  Common   Stock  Valua<on”          

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