PREPARING FOR YOUR 409A VALUATION

Having been a CFO of two venture-backed companies I completely understand the sense of urgency to have something like a 409A quickly completed in advance of a board meeting or to issue option grant letters in a timely way to your employees. That said, I would certainly value quality over speed with something as important as a 409A valuation.

Our standard answer to how fast we can provide a 409A valuation is ten business days from when we receive the information we need from the client. We can get it done faster if we are told a specific date we need to hit (e.g. upcoming board meeting). The big caveat in there that many clients do not think about is the phrase, “from when we receive the information we need from the client.” Most clients have the information we request readily available. However, many clients have the information spread between various executives and their outside counsel. So if time is of the essence, getting everything together can speed things up tremendously.

Below is a list of the items likely to be needed along with the rationale for why they are needed and the situations in which they may or may not apply:

• You will need to select a valuation date
  • Note: We will discuss in another post how you decide what date you want to use but the valuation firm will need you to make the call on this
• Provide a Balance Sheet as of the selected valuation date
  • Note 1: Your 409A valuation is determining the value of common shares and as such needs to drill down from Enterprise Value to Equity Value and an up-to-date balance sheet is needed for this
  • Note 2: The Balance Sheet is less important if your company has just completed an equity financing, as the value of common equity will be imputed based on the recently established value of preferred shares. Nonetheless as part of knowing the client if a current Balance Sheet is at all possible to provide it will be needed
• Provide Latest Twelve Month (“LTM”) operating results (Income Statement) as of the selected valuation date
  • Note 1: Market-based valuation methodologies generally look at multiples relative to LTM operating results so if comparable transactions or comparable public company analysis is being used then an LTM Income Statement is critical
  • Note 2: Again this is less important if the valuation is being performed using a recent capital raise as the benchmark for value, but it is still important for a valuation firm to know their client and as such this should be provided if at all possible
• Provide your most recent three calendar years of financials including full year Income Statements, end-of-year Balance Sheets, and ideally full year Statements of Cash Flows
  • Note 1: Generally these financials are not directly used in valuation metrics, but they are very important for a valuation firm to know their client and to use as a sanity check if Discounted Cash Flow Analysis is being used in the valuation
  • Note 2: Many companies getting 409A valuations do not have three calendar years of results. But companies should provide whatever they can as looking through historical operating results is key for a valuation firm to know their client and to take into account as they perform the valuation
• Provide five to ten years of projected operating results along with expected capital expenditure needs and what you believe any working capital demands may be to achieve the projections
  • Note 1: This is so your valuation firm can perform Discounted Cash Flow analysis. The value of any asset is the present value of its future cash flows adjusted for risk.
  • Note 2: If a company has recently (generally within the most recent 90 days) raised a round of equity capital then Discounted Cash Flow Analysis is not going to be used and this will not be necessary
  • Note 3: Even if there is not a recent equity financing round if the degree of uncertainty of future results is too high then Discounted Cash Flow Analysis might not be chosen as a valuation methodology
  • Note 4: This is probably the hardest item for companies to prepare as most do not have this readily available. Five years is a major stretch and in practice ten years is almost never used by practitioners
• Provide your most up-to-date Articles of Incorporation or Organization that reflect your current capital structure
  • Note 1: This is used by your valuation firm to know everything they need to know about the features of the various types of securities in the capital stack
  • Note 2: On multiple occasions we have received old Articles – the valuation firm needs the latest and greatest or at the very least needs to understand exactly what the features are of all securities in the capital stack
• Provide a detailed, up-to-date capital table that contains full detail of all classes of the company’s capital stock
• Provide full detail on the company’s option ledger including the number of stock options currently outstanding, grant dates, and the strike prices at which they were issued
  • Note: To some extent a summary table may suffice, but the more detail you can provide, the better
• If the company has any debt, provide term sheets or all key information about the debt
• Agreements or term sheets for any instruments convertible into equity
• If there have been any recent transactions (most recent twelve months) in the company’s stock then provide all supporting information on those transactions
  • Note: This includes not only equity capital raises but also any known secondary transactions in the company’s equity
• Provide the most likely timing to an eventual liquidity event
  • Note: This is your best estimate and is typically between one to five years
• Estimate the number of stock options you expect to issue over the next twelve months
  • Note 1: This is used as part of the fully diluted share count per AICPA guidelines
  • Note 2: This is another item that most companies do not have readily available, but providing your best estimate is needed
• Indicate if you intend to raise equity capital in the near-term (e.g. next quarter)
• Provide a company presentation, executive summary, or detailed business description to help your valuation firm know your company well and select appropriate comparable companies for their analysis
  • Note: A kickoff phone call is also very helpful in discussing your company’s business model and understanding current and future revenue and cost structure
• Your valuation firm can do their own research, but as the executives living your business every day, provide what you feel are the most comparable public companies and any recent M&A transactions of companies similar to yours of which you are aware
  • Note: This is a big part of the work your valuation firm does, but your input on this is very helpful and valuable
• Provide your corporate business address
• Provide contact information for your external legal counsel if applicable
  • Note: This can help the valuation firm confirm their understanding of any technical issues (e.g. unique warrants or other securities)
• Provide contact information for your audit firm if applicable
  • Note: This can help your valuation firm confirm in advance that your auditor agrees with judgments like the appropriate valuation methodologies to apply with your particular situation
• Provide details on any key items you feel impact the value of your business that may not have been captured in the other requested items
  • Note 1: For example your company may have created intellectual property value that is not captured on your balance sheet
  • Note 2: Frequently for very early-stage pre-revenue or beta-revenue companies a valuation firm will work with a company to perform a Cost to Recreate Analysis that captures what it would cost to recreate intellectual property created by the company
• Provide detail on any previous 409A valuations performed on the company’s common stock
• Provide any additional thoughts you may have that may be important for you valuation firm to know as they perform your 409A valuation

This may seem a bit overwhelming, but most of the above items really are either readily available without additional work or can be quickly discussed as part of a kick-off call with your valuation firm (e.g. valuation date, exit horizon, estimated options to be issued, etc.).