AICPA Guidance for Valuing Complex Equity Capital Structures

By: Robert Barnett

AICPA Guidance for Valuing Complex Equity Capital Structures

[Transcription]

Hello, I’m John Bintz and I’m a Managing Director at Valuation Research Corporation. I’m here with Rob Barnett who’s a Senior Vice President. Rob has extensive experience in valuing complex equity capital structures and we’re here to talk about the new guidance related to valuing these types of securities. Rob, what is the significance of the updated guidance for privately held companies?

Rob Barnett: First up, John, this really solidifies the groundbreaking methodologies introduced around equity allocation analysis in 2004. And secondly, it formalizes eight years of professional practice involving the valuation of these complex equity structures. So, the release of the guide will, one, entrench methodologies based on financial economic theory. And two, it will put professional valuation practitioners on equal footing with respect to complex valuation issues in private equity securities. Overall, I think this will prompt both the investing and the financial communities to move toward more rigorous and well-defined approaches to value, that will overall enhance the audit and review processes.

John Bintz: Are there one or two methodologies that are particularly important to be aware of?

Rob Barnett: Yes, I think most prominently the guide introduces both the hybrid and the backsolve methods. Now these new methods are offshoots of existing equity-allocation methodologies such as the OPM and the PWERM. But, each is suited to a particular fact pattern. The hybrid is most effective when multiple financing and liquidity options are foreseeable, meaning the timing, the form, and the potential range of values, whereas the backsolve is especially applicable when a company has had a recent round of financing, say, within the last six months.

The goal of the hybrid method is to capture additional information about the equity outlook for a company without increasing the uncertainty in the modeling process, whereas, in the backsolve, we’re working essentially in a market approach, where we use the latest round of financing to imply both the total equity value of the company and its individual equity securities. So the latest round of financing serves as the governing value, but does so in a way that’s very different, say, from a post-money valuation construct that investment firms frequently use.

John Bintz: So this new valuation framework, with respect to asset managers and venture capital or private equity funds, how have they accepted it?

Rob Barnett: I believe well, and increasingly so. We’re seeing both private equity and venture capital firms seeking independent third-party valuations to support their own marks. I mean, after all, by definition these companies specialize in private equity investments and frequently participate in components of a complex equity structure. Particularly, the guide… I think the PE community will be interested in new commentary on the treatment of debt, secondary-market transactions, and the calculation of a marketability discount, while I think the VC community will remain attuned to the use of the backsolve method and its resulting implied total of an individual equity values.

John Bintz: And do you think this updated guidance is of a material or a significant improvement?

Rob Barnett: I do. The expanded methodologies show how far the valuation process has come since these original equity-allocation analyses were introduced. It embodies professional practice and group thinking over time, which will improve both the consistency and the quality of the valuation. And overall, this will enhance the audit and reporting processes.

John Bintz: Rob, thank you very much for your time, your expertise, and your knowledge on this subject matter.

Rob Barnett: Thank you, John.