Does My Early-Stage Company Need a Third-Party Valuation?


By: Jonathan Adelson

ASC 178 and Section 409A equity compensation valuations play a sizeable role in the world of private equity.

Market changes related to the COVID-19 pandemic are a potential material event consideration warranting changes to your company’s 409A valuation. VRC’s valuation professionals can work with your firm, board members, and legal counsel to help determine if your company needs an updated 409A valuation and meet your annual filing requirements.

We recommend firms proactively consider modeling the financial reporting implications as a defensive measure to avoid forcing the hand of compensation committees, CEOs, or CFOs to make sudden and potentially drastic decisions.

For founders and management pursuing capital raises and planning for future business growth, “valuation” may seem to be a subjective concept. Early-stage companies are challenging to value as they work on developing a product and market, and may be years removed from normalized operations and financial metrics.

It is not unusual for reasonable founders, venture capitalists, lenders, and angel investors to differ on current estimates of value as their views on risk, opportunities, and milestones may diverge or be driven by their own unique investment and operational experiences. Despite these challenges, a robust valuation is possible.

If your company has, or is about to offer incentive equity to employees or others, then founders cannot afford to disagree on necessary support documentation. A company is best served by obtaining a Section 409A valuation, which is an appraisal of the fair market value of your company’s common stock.

Required by the IRS, this analysis is different from “my company is worth $100 million.” Bringing in an experienced third-party valuation firm makes sense, as it provides safe harbor protection, placing more burden of proof on the IRS if they take issue with the valuation—and penalties can be severe.

If your company performs its own Section 409A valuation, no matter how qualified your team, that burden shifts. Moreover, for options, the value of the common stock also needs to be determined to meet accounting requirements. If you are pre-IPO, the SEC closely reviews pre-IPO stock awards. Having an objectively prepared opinion in the file can keep an IPO on track.

Simply put, if your company plans on closing a new funding round, or already has, and is on a trajectory towards success, now is the time to consult with a valuation firm about the required analysis and documentation to support your conclusions and take exposure to risk off the table.