409A Valuations are important to startups and founders in the early stages. As the CEO of your company, it is your duty to make sure these are done in a reasonable and defensible way.
If you’re in this stage or have questions about 409A Valuations, keep on reading. We are going to answer many of the common questions we get around this topic and help you understand 409A Valuations as they relate to privately held companies.
409A Valuation: What is It?
In the startup stage of your business, it is very important that you know the value of your company’s common stock. This is because many startups want to structure stock-option grants as tax-free events for their employees. To do that, you have to show that the fair market value of your stock which you have calculated is reasonable. A 409A Valuation is the only method you can use to make this happen.
How Often Should A 401A Valuation Be Done?
Typically, these should be done every 12 months. Additionally, if any event has occurred which may have potentially changed the value of your stock, you should perform another valuation. Examples of these events include the issuance of new equity, secondary sales, or significant change to the financial situation of your company. Finally, if a company is going to approach an IPO, they should perform a 409A Valuation more often, such as quarterly or even monthly.
What are the three steps for undertaking a 401A valuation?
Step 1: Calculate the enterprise value.
Step 2: Determine the value of your company’s common stock.
Step 3: Apply a discount to account for the fact that the company stock is not publicly traded.
You should involve your auditor at the earliest stage possible to ensure you’re all on the same page about the methodologies to be used.
What are the methodologies I can use to calculate enterprise value for the first step of my 401A valuation?
- Market approach: the company is compared to a group of publicly traded companies that are similar to it by industry.
- Income approach/discounted flow method: this approach uses the company’s long-range financial projections to determine the likely income levels and then discounts them back to the present value.
- Asset approach: this approach uses replacement costs or the appraised value of all of the company’s assets and liabilities to determine its enterprise value.
How do I determine the value of my company’s stock for the second step of my 401A Valuation?
This is done by taking your company’s enterprise value and dividing it among your different share classes to determine the fair market value of your common stock. The most common method used to allocate the value of the different classes is the Black Scholes model.
Why do I discount the value of my company stock for step 3 of my 401A Valuation?
The stock of privately held companies is less valuable than that of publicly traded companies because there’s no active market trading on the stock. To adjust for this lack of marketability, you should apply a discount to calculate the fair market value.
You need to know these pieces of information about your company to do a 409A Valuation:
- Your business sector or industry
- Formation documents (charter, articles of incorporation, information about the stock)
- Most recent cap table
- Any board or presentation pitch deck recently prepared
- Company historicals and profit and loss cash balance debt projections
- Five or more publicly traded companies that are comparable to your company
- Any significant events that have happened since your last 409A Valuation
To learn more about 409A Valuations, check out Episode 016: Let’s Talk About 409A Valuations.
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