409A · Valuation

Good firm to do 409a valuation?

Zachary Stewart Founder at SwoopRide.com

May 19th, 2015

I've read the two other threads regarding 409A valuations. There are two questions I'm still looking for guidance on.

1) Do you have recommendations of a good firm to use for a 409a valuation of a illiquid corporation? What was the cost? It seams that the price of a valuation was coming down in 2013, I'm wondering if Ican afford to do this on my own dime, pre-funding, in order to lock in the best valuation for my first hire.

2) Mine is an illiquid corporation with no customers, no patents, no investors, no nothing except my own experience in the subject matter, big plans, and some code that I happen to think is really slick. It's been years since I formed the corporation, and all of my shares have vested (par value strike price). Would it be safe to say we're STILL at or near par value? Or is there more value to the company even though we don't quite have anything solid yet?

Anonymous

May 19th, 2015

Hey Zach - I've worked with Scalar and it cost $2500, which I was told was about standard. We had just done a $2m seed, so there was more info to go off of than you have now but the truth is they almost always at early stages get very close to the valuation in your last round.  Can make an intro if that helps. A 409A is basically a CYA for boards and don't actually have to be followed when pricing options, but everyone does because it's safer to have a 3rd party give the number.  In short, not sure you need to spend those sort of dollars just yet. 

Peter Weiss President at American Outlook, Inc.

May 20th, 2015

Who is getting the shares and why?  

Peter Weiss President at American Outlook, Inc.

May 20th, 2015

Why are you doing a valuation?  409(a) is principally used to justify the strike price on stock options because there are tax implications if you underprice them.  If you are raising money your valuation will be a result of the negotiation with the investor.  If you're trying to hire someone and want to issue options given the way you've described the company you can probably use any reasonable value the parties agree on and save the valuation fee.

409(a) allows the company to do its own valuation if you meet a few criteria including being less than ten years old, having the analysis done by a competent professional (the regs are not specific on this but if you have a CFO or VP-Finance with lots of experience and/or professional credentials it is probably fine) and a few others.  

If you decide you really need an outside valuation the prices mentioned above are in line.

Roseanne MBA Founder & CEO / COO | Finance, Strategy, Operations & Business Development |Advisory for Growth Companies, North America

May 21st, 2015

You can try a very experienced valuation person and former investment banker Ron Quintero.  He can figure out a valuation method that makes sense for where you are in your stage of development.  Hope he is helpful and here is his contact information:

Ronald G. Quintero, CPA, CFA, ABV<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Managing Director

Chartered Capital Advisers, Inc.

375 Park Avenue, Suite 2607

New York, NY 10152

(212) 327-0200 • (212) 327-0225 FAX

(201) 220-9181 Mobile

www.charteredcapital.com

Tim Sullivan CEO at Oceanic Partners, Inc.

May 19th, 2015

I’ve found the following resource to be fairly priced as well as experienced and timely: Josette C. Ferrer, Managing Director Clairent Advisors LLC 201 Spear Street, Suite 1100; San Francisco, CA 94105 415 658 5589 | Fax 415 871 2618 | Cell 415 272 5191 jferrer@clairent.com | www.clairent.com

Zachary Stewart Founder at SwoopRide.com

May 20th, 2015

Thanks everyone, very helpful!  Several sources are telling me it's pretty reasonable to make up my own valuation in this illiquid situation, but personally, I'm probably not qualified to do so (and I'm the only one here).  Perhaps I could estimate conservatively high? 

However, a restricted stock purchase agreement with buyback clause is also looking like a good option.  The shares still need a price though, so I'm not sure why it seams that no valuation seams to be required for this method.  Anyone have experience with this method?

Benjamin Olding Co-founder, Board Member at Jana

May 21st, 2015

Well +1 to you...  Congrats.  If you ever do it over again, though, don't worry about a S (Federal distinction) or LLC (state distinction).  Instead, just do not incorporate.  Until you have revenue or investment, there's no upside to any kind of incorporation.  Celebrate your enthusiasm with a party - it would be a better use of those funds.  You can sign some agreement with your cofounder, but you should only work with a cofounder you're willing to trust, so even then I wouldn't be too uptight; that's me though: others who have been burned by cofounders pre-incorporation will likely tell you something different I imagine.  

You can file a form with the IRS change to an S right now if you want (an S can actually be a type of C), then change back when you have investment.  This is only worth doing if you anticipate not getting investment in 2015 - the upside is just that the losses you're incurring on the C will pass back to you through a K-1 and end up...  back on your personal schedule C, which is (in my opinion) where everything should have been this whole time.  Water under the bridge at this point - I like your combination of enthusiasm and legal compliance.  Keep at it.

Anyway, same principle applies here: if you don't have an option pool, don't start creating one until you have investment.  As a rule of thumb, I'd keep my legal & accounting fees to less than 10% of my expenses (ideally a lot less).  If you can't afford good legal or accounting by this rule of thumb, it's an indicator you should be looking to avoid the situation entirely that requires it; don't cut corners on either and don't let their fees dominate your business' expenses.

So what's the solution?  In this case, I'd sign a contract between your C corp and this developer.  The contract should contain:
1) Legal assignment of all IP created to the company, including source code.
2) A non-disclosure of some kind.
3) The statement that a recommendation for an option grant of x shares will be put forward to the board *after* a minimum investment of some dollar amount has been obtained.  Put a clock on this too (it can be long - 2 years for example - but something).
4) Since he's likely to balk at the idea that you're just guaranteeing presenting the recommendation rather than guaranteeing the grant (which is the correct language - only your board should grant options, and you don't want to grant them until after the investment), give an alternative cash payment in the event (and only in the event) the board rejects the recommendation; it should not be applicable in the event you fail to get the investment.  If he's worried you'll get profitable without needing investment, you can put in that contingency too.  Basically, pick a monthly rate...  that you're unlikely to ever be in a situation to have to pay.

If he doesn't like this, point out that the options are worthless if you don't get an investment, and this protects him from any tax liability in that event.  If he's worried about not naming the strike price now, offer to pay him (*after the investment* and only in the event of an investment) a lump sum of the difference between the granted option strike price and some strike price you agree on now (par value, for example) on a 1099.  This will prove a modest amount.

You are correct that RSUs would be another approach here, and at least given what you told me, I'd have no issue telling the SEC that par value was absolutely the correct value (that's just me though).  However, a contract that does not involve affecting the cap table prior to investment is more valuable to you both.  Your goal prior to investment is to not make mistakes and not spend money.  You can achieve these things by basically trying not to do anything whenever possible.

Now go forth and stop talking to lawyers, accountants, and professional consultants in general until you get some funding...  And even then, at a minimum, try to follow my 10% rule.  No matter what they tell you, those guys don't add value: the good ones just don't subtract it.  You add value by working on your business - put all resources towards that as long as you can.  Good luck.

Chris Murphy Director of Corporate and Legal Affairs at E2open

May 19th, 2015

If you will need valuations regularly, and most likely you will, you should definitely at least consider eShares 409A as a service option.  https://www.esharesinc.com  

Benjamin Olding Co-founder, Board Member at Jana

May 21st, 2015

Actually, on thinking about it, I am concerned you're asking the wrong question.

+1 to Peter's question: who is getting these shares and why?  Not sure options is the right approach (strike price aside).

Also, your description of your company has me nervous: 1) you set this up years ago; 2) it has no IP other than some code you created; 3) it's "pre-funding" but you've clearly had professional expenses of some kind, which I assume means your cash; 4) you set up a vesting schedule for yourself that you've completed - so the company is possibly more than 4 years old?  Not sounding right to me; I would have treated this situation as a "sole proprietorship" and filed through a schedule C on your personal taxes.  Did you have a cofounder bail on you or something?

Have you been filing taxes on an annual basis on a state & federal level the past 4+ years for this company?  Are you incorporated in the state you live in?  Nonprofitable unfortunately does not exempt you from filing (or, sadly, from paying taxes in most states).

The reason I ask is that it sounds like you're about to involve someone else in the company...  There might be bigger problems here than your opinion of fair market share price.  

There may in fact be professional work that does need to be done here, but it's not by a valuation firm.  I spent years dealing with some incorporation documents my cofounder eagerly filed in his excitement at "starting a company."  Ignorance of compliance does not exempt anyone from compliance unfortunately.  Still have the scars.

Benjamin Olding Co-founder, Board Member at Jana

May 21st, 2015

We use Scalar.  They are fine.  This is a cya exercise; it has no meaning apart from the SEC.  Investors certainly don't care about their opinion of stock value.  You should not be stressing about this at your stage.  You should not be spending money on this.  Don't go talking to a valuation firm's salesperson - their job is to sell you a valuation.

The way you would get "in trouble" is that, years from now, someone at the SEC (not even IRS!) would come back and try to tell your option-holder they owe a small amount of back taxes because the discount you set was not quite right, years before liquidity.  I've never heard of this happening.  I'd expect you'd have to royally and personally piss someone off to have anyone look at this and even then, the only situation your lawyer couldn't get you out of would likely be if you set the strike price to $0.  When you raise your next multimillion dollar round, spend a few grand to get someone else to set the discount at that point (and only at that point).

Typically, a company like Scalar accepts the preferred price investors paid as the true value of preferred and then calculates the discount of common.  We didn't use them for our priced seed round, but just set the common strike price as 10% of our preferred price.  Years later, at our series A, Scalar recommended we increase it to around 20-25% of preferred, if I remember correctly.

Do you not have a concept of preferred stock yet because you have not had a priced round?  Find a friend who you think is or was at a similar stage who did a priced round and use his or her pre-money valuation.  If there's some reason you know why you couldn't get an investment right now, add a discount for that fact.  Divide by the total number of shares on a fully diluted basis (i.e. current shares outstanding plus warrants plus option pool) - there's a good faith swag at the preferred price per share.  Apply a very aggressive discount (minimum 80-90%).  There is a good faith estimate of your common strike price.  Go get a beer: you've thought about this too much already.

Also, just as an aside, if you haven't had a priced round yet, you're not vested: you're the owner.  A vesting  schedule is meaningless without partners: when you do a priced round, expect the investors to ask you to start a new vesting schedule (and do not object: that's a reasonable request; negotiate on how much you need to vest - try for 75-80%).