Company Valuation. Gideon Shalom Bendor Managing Partner

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2 2 Company Valuation Gideon Shalom Bendor Managing Partner

3 Why try to value a company? Investment purpose M&A and Pre-IPO Tax (409A) Financial Reporting (PPA, ASC 820) ESOP (Employee Stock Option Plan, ASC 718) Legal 3

4 Types of Securities Preferred Stock Common Stock Warrants Stock Options Convertible debt 4

5 What is Section 409A? Enacted as part of the American Jobs Creation Act of 2004 to curb abuses in executive compensation Applies to non-qualified deferred compensation plans such as employee stock option plans (ESOP) Affects ESOs granted and vested after Exercise price may not be less than the fair market value of the stock price on the grant date Companies can avoid the implications of 409A by fixing the exercise price of existing ESOs 5

6 Conditions Deferred compensation would result in current income when it becomes vested unless the plan meets specific requirements: Timing of initial deferral Distribution date must be set at time of deferral No ability to withdraw or accelerate distribution Cannot use offshore trusts 6

7 Penalties for Non-Compliance Non-compliance will result in significant tax consequences to the company and option holder Acceleration of income recognition immediate taxation upon vesting interest charge at the underpayment rate plus 1% 20% penalty tax in addition to the income tax 7

8 Employee Stock Options Employee Stock Options avoid ordinary income: Grant of option is not taxable Value on exercise of option treated as strike price Sale of stock results in capital gain for subsequent appreciation Must hold two years after grant, one year after exercise Only issued to employees Employee can t own more than 10% of company Maximum $100k per year Exercise price can t be less than FMV on grant date Maximum term 10 years Limits on transferability 8

9 Right Associated with Preferred Stock Economic Rights measurable and considered in valuation methods: Preferred Dividends (Cumulative) Liquidation Preference Non Participating Participating (total cap and force conversion) Conversion Rights 9

10 Right Associated with Preferred Stock Voting Rights non measurable and not taken into account in valuation methods: Voting rights and veto rights Board composition First refusal rights Management rights Information rights 10

11 Valuation Approaches Market Approach Similar Companies, M&A The Back-Solve Method (OPM) Multiples Income Approach Discounted Cash Flow Method WACC IP Valuation (Royalty) 11

12 Selection of a Method for Valuing Equity Securities Criteria should be considered: Reflects the going-concern status of the company; The method assigns some value to the common shares unless the company is being liquidated; The results of the method can be independently replicated by other valuation specialists using the same underlying data and assumptions; The complexity of the method is appropriate to the enterprise s stage of development. 12

13 Selection of a Method for Valuing Equity Securities Criteria should be considered: Probability Weighted Expected Return Method Option Pricing Method The current Value Method Hybrid Method 13

14 Company Value The FMV concept Willing Buyer Seller Historical Value Net Realizable Value (inventory) 14

15 Question How can a company have two or more different values at the same time. 15

16 OPM Example Company X is a developer of networking products, both hardware devices and the software necessary to support them. The Company was founded in 2008, and both its headquarters and manufacturing facilities are located in California. Until December 2010, the Company s sole source of equity capital was the founders and their family and friends. Equity capital at that time consisted solely of 4,000,000 outstanding shares of common stock. In late December 2010, the Company completed an offering of Series A convertible preferred stock to the XYZ Venture Capital Group. The issue comprised 1,000,000 shares, convertible into common at the ratio of one share of common for each share of preferred converted. The preferred shares were issued for $35 per share, with total proceeds to the Company of $35,000,000. In addition to the conversion feature, the Series A preferred stock had the following terms and conditions: Liquidation preference. Payments upon a dissolution, merger, acquisition, or sale of assets are to be paid first to Series A preferred shareholders at $35 per share. Any amount remaining is paid to the common shareholders based on their respective ownership. Series A preferred does not participate beyond this initial preference. 16

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18 OPM Breakpoints 1st Payoff 2 nd Payoff 3 rd Payoff Up to $35,000,000 $35,000,000 to $175,000,000 Over $175,000, % to preferred shareholders 100% to common shareholders 80% to common shareholders, 20% to preferred shareholders 18

19 Thank You! Gideon Shalom Bendor 19