Know Your Valuation For Equity Compensation (and Avoid the Perils of a 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. 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?
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Know Your Valuation For Equity Compensation (and Avoid the Perils of a 409A)
- 1. MEMBER OF PKF NORTH AMERICA, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS © 2010 Wolf & Company, P.C.
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- 23. • Discounted Cash Flow • Recent Transactions Method – Backsolve Method based on recent equity financing – Utilizes an Option Pricing Model (“OPM”) • Hybrid Method – Combination of the OPM and other methods/scenario analyses 23
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- 25. • First Step – Determine the Business Enterprise Value “BEV” • BEV – Is the value of the entire business • Equity Value is: – BEV minus debt plus cash = Equity Value – Sometimes used interchangeably but they are not the same thing • Equity Value is then Allocated to the various share classes • That is a common stock valuation 25
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- 27. • Use of this approach very limited • Adjusts the Assets of the Company to their FMV or FV – Replacement cost method – Relief from Royalty Method • Sometimes used when initial funding is a convertible note and little accomplished in way of intellectual property development 27
- 30. • 30 Terminal Value - Revenue Multiple Method 2019 Revenue $ 12,025,700 Revenue Exit Multiple 2.00x Terminal Value $ 24,051,400 Present Value Period 5.00 Present Value Factor 18.9% 0.421 Present Value of Terminal Year $ 10,121,179
- 32. 32 Scherlis and Stage of Development (1) Plummer (2) Sahlman (3) Start-up (4) 50% - 70% 50% - 70% First stage or "early development" (5) 40% - 60% 40% - 60% Second stage or "expansion" (6) 35% - 50% 30% - 50% Bridge/IPO (7) 25% - 35% 20% - 35%
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- 34. 34 Breakeven Breakeven Breakeven Point #1 Point #2 Point #3 Series A Common Series A Liquidation Options @ Converts @ Description Preference $0.15 $1.00 Conversion/Exercise Breakeven Point Per Share $ 0.15 $ 1.00 Liquidation Preference of Series A Preferred Stock $ 1,370 $ 1,370 $ - Less: Net Effect of Proceeds from Options $ (17) $ (17) Equity Value at Conversion/Exercise Breakeven Point (Strike Price) $ 1,370 $ 2,418 $ 8,449 Shares Included in Breakeven Point Calculation Series A Preferred 1,370 Common Shares 6,985 6,985 Common Options @ $0.15 110 110 Total Shares Included in Breakeven Point 7,095 8,465 Multiply: Conversion/Exercise Breakeven Point Per Share $ 0.15 $ 1.00 Value Allocated to Common Units, Shares/Warrants, and Converted/Participating Preferred $ 1,064 $ 8,465
- 35. 35 Call Call Call Description Option #1 Option #2 Option #3 Equity Value (Underlying Asset) [a] $ 4,000 $ 4,000 $ 4,000 Conversion/Exercise Breakeven Point (Strike Price) $ 1,370 $ 2,418 $ 8,449 Time Until Liquidity/Next Round of Financing (In Years) 1.00 1.00 1.00 Risk Free Rate 0.33% 0.33% 0.33% Volatility (Standard Deviation) [a] 50% 50% 50% Variance 0.250 0.250 0.250 Dividend Yield 0% 0% 0% Call Option Value $2,641 $1,714 $85 Tranche Description Value Equity Value - Call Option 1 Tranche 1 $ 4,000 $2,641 $ 1,359 Call Option 1 - Call Option 2 Tranche 2 $ 2,641 $ 1,714 $ 927 Call Option 2 - Call Option 3 Tranche 3 $ 1,714 $ 85 $ 1,628 Allocation of the Remainder Tranche 4 $ 85 $ - $ 85 Totals $ 4,000
- 36. 36 Series A Tranche Preferred Common Common Description Value Stock Stock Options Totals Tranche 1 $ 1,359 $ 1,359 $ 1,359 Percent Allocated 100.00% 100% Tranche 2 $ 927 $ - $ 927 $ 927 Percent Allocated 100.00% 100% Tranche 3 $ 1,628 $ 1,603 $ 25 $ 1,628 Percent Allocated 98.45% 1.55% 100% Tranche 3 $ 85 $ 14 $ 70 $ 1 $ 85 Percent Allocated 16.18% 82.52% 1.30% 100% Total Value By Round $ 4,000 $ 1,373 $ 2,601 $ 26 $ 4,000 Total Units By Class 1,370 6,985 110 8,355 Value Per Share $ 1.00 $ 0.37 $ 0.24
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- 40. 40 Description Amount Implied Equity Value $4,000 Implied Value of the Series A Share $ 1.00 Common Stock Value Minority, Marketable Basis $0.37 Discount for Lack of Marketability/Liquidity 20% Common Stock Value Minority, Non-Marketable Basis $0.30 Common as a Percentage of Series A Preferred Share 29.7%
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