Preferred Stock Financings with Common Share Repurchases Offered at the Preferred Price

Transcription

1 Preferred Stock Financings with Common Share Repurchases Offered at the Preferred Price Can we conclude that repurchases occurred at fair value without killing the 409a? Naomi Derner, CFA Derner Valuation Consulting LLC Fair Value Conference November 12, 2014

2 Company A Company overview: Smartphone tools, LTM revenues under $5.0 million Funding history: 2009/10: $1.3mm Series A/A-1, Series $0.48, $0.59 Series B round, June 2013: Lead investor invests $6.1mm, other investors could join up to cap of $14.5mm. All proceeds raised above $5.6mm would be allocated towards repurchase of shares by the company. All shareholders invited to tender at $2.15. Founder had to tender enough such that lead investor held 20% interest in the company post-transaction. Founder ultimately sold 1.75mm shares at $2.15 per share. We performed a common stock valuation as of Sept Common was valued at $0.70 per share based on a backsolve OPM from posttransaction cap table and Series B price of $2.15. We ignored the tender price as an indication of FV or FMV of common stock on grounds that the tender offer was a one-off event, there was an embedded control premium in the founder s shares repurchased, and option holders could not realistically expect a buyback event with a large premium going forward given the new structure of the company. Auditor signed off on the 409a valuation in Oct

3 Company A Cap Table By Security Security # Shares diluted # Shares diluted Series A Preferred Shares 1,528, % 1,378, % Series A-1 Preferred Shares 1,233, % 1,131, % Series B Preferred Shares 0 0.0% 5,530, % Common Shares 5,449, % 3,695, % Series A Warrants 111, % 96, % Series B Warrants % 88, % Options Outstanding 2 1,616, % 1,478, % Option Pool 319, % 1,551, % Fully Diluted Shares 10,258, % 14,951, % By Shareholder Pre-Series B Pre-Series B Post- Series B Post- Series B Shareholder # Shares diluted # Shares diluted Founder - common 5,000, % 3,236, % Tier 1 VC (Series B) 0 0.0% 3,060, % VC arm of strategic (Series B) 0 0.0% 1,809, % Angel fund (Series A) 113, % 44, % Angel fund (Series A) 51, % 51, % Early stage tier 2 VC (Series A-1, B) 527, % 724, % Smaller VC (Series A-1, B) 127, % 175, % Other Preferred Shareholders 2,052, % 2,359, % Other Common and Optionholders 2,066, % 1,937, % Option Pool 319, % 1,551, % Fully Diluted Shares 10,258, % 14,951, % Series B transaction was intended to move control of the company from the common shareholders, particularly the founder, to the preferred shareholders, mostly the new investors, and to clean up the cap table of some early F&F investors. 3

4 Trouble One Year Later During Company A s 2013 audit, Auditor raised a red flag regarding the value of the common shares repurchased by the Company from the founder. Auditor was concerned that the 409a valuation indicated that the founder s stock repurchase occurred at a price higher than fair value, triggering the company to book the repurchase as a multi-element transaction under ASC This incident alarmed attorneys for the founder, who could face expensive tax consequences if it is determined that the 1.75 million shares repurchased at $2.15 were transacted at a price that is $1.35 above FMV. Big Four Auditor wanted us to address the ASC issue and revise the historic Sept a for audit. Auditor s valuation reviewer indicated that they were most interested in specific guidance from the AICPA Practice Aid 2013 regarding the use of the $2.15 Series B purchase and general tender offer price in both the calculation of the fair value of the repurchased securities in the transaction and the calculation of the 409a value. 4

5 Company A s argument Reviewer was most interested in guidance from Chapter 8: Inferring Value from Transactions in a Private Company s Securities. Section 8.03(e) discusses 4 types of factors mitigating reliance on the transaction price in purchases of common stock at the same price as preferred stock. We argued that: Common shares were a portion of the whole transaction, but reflected a shift of control from the founder to the preferred shareholders. There was no strategic reason behind the investment. There was no strategic reason behind the repurchase beyond shifting control. This did not represent a repeatable liquidity event for common shareholders. This was our main argument for why the $2.15 repurchase of common doesn t need to be considered in the 409a valuation indicates that a transaction in an identical security must be Orderly to be considered a primary indication of value. Although the transaction did not occur in an active market, it had proper exposure to the market for participants (30-60 days), allowed for marketing activities (everyone got an offering memo), and no party involved was forced. This was our main argument as to why the repurchase occurred at fair value. 5

6 Company A s argument (continued) 8.09 discusses other factors to consider when determining the amount of weight to put on a transaction price in a fair value measurement: The volume of the transaction. Company A had a large transaction. Comparability of securities. They are identical securities. Proximity of transaction to measurement date: The repurchase was on the measurement date. Auditor indicated that they did not need to see control premium studies or calculations during this exercise, and we did not provide any during the process. Auditor concurred that: The common shares were repurchased by the company at fair value of $2.15 per share, and The 409a valuation of common shares dated September 2013 indicating a common share value of $0.70 would hold for stock option issuance in the 2013 audit. 6