Pre-IPO valuations are the magic behind startups almost never making a profit. If they do have a product they are fortunate. They rarely make any revenue. They still have to find customers and employees. And, of course, investors. How can a company with no market value at all attract investors? As a proxy of fair market value, startups trade in the currency they have valued. The company’s current and projected value can be calculated using a number of methods. A startup’s valuation can impact how customers and potential investors respond. The company and its investors desire the best valuation for the business.
You might think that the method for valuing startups is fairly consistent because it is important for future customers or investors. The reality is often the exact opposite. Different methods are used to value different companies and different industries. Investors and customers are shown the valuation so that they can understand what they’re buying. It’s wrong again. Most businesses have at least three valuations. One for public purposes, one for tax purposes and one to be used by accountants. Every type of valuation serves a different purpose, and each one has an impact on companies in a unique way.
You guessed right, the public value of a company refers to the actual valuation the public has seen. It is what the public sees from outside. This valuation is shown in media articles, as well as the employees and customers. This valuation is the one everyone sees. The initial investors as well as their partners in limited partnerships want it as high as they can. This is possible using a variety of methods. Different methods can be used depending on industry, product or location and the stage at which the company is developing. You can use different methods to increase the value. Most people accept the Venture Capital Method for public valuations. Also known as Post-Money Valuation, it is widely used. It is calculated based upon how much investors will make if the company is sold or goes public. This is often shown as: “X company raises $Y at $Z valuation.”
In 2005, the IRS required companies to have a tax valuation. This was in response to the practice by Silicon Valley startup founders of offering stock options for non-cash compensation during the dotcom boom. The IRS did not tax non-cash compensation at the time. Employees only had to pay taxes on cash compensation. The IRS saw a huge loss of tax revenue when the IRS recognized that the IRS was losing a lot more money than it received in non-cash compensation. The IRS created IRC 409a to ensure that the government gets its share of the revenue. This law allows employees to tax the non-cash portion of their compensation. Stock options. Venture companies must obtain a tax valuation in order to determine the stock option’s value so that the IRS can accurately calculate those taxes. The 409a valuation will be used to calculate the stock option tax liability. Shareholders want the valuation to be as low and accurate as possible. It can often be between 30-50% below the post-money value.
Venture funds use accounting valuations to determine the value of an investment. Investors need to demonstrate how their investment performed on their books. ASC 820, formerly FAS157, was developed by the AICPA in 2007. As with most things, however, value can be found in the eyes of the beholder. Even if the guidelines are the same, different investors can value the same portfolio company in different ways. Venture funds are trying to increase the valuation to match the post-money value, as the goal of this valuation is maximize the return for limited partners. Problem is that the post-money valuation presumes all warrants, options and multiple rounds preferred stock have identical rights and terms. This almost never occurs.
This is how pre-IPO valuations work. There are 3 valuations for 3 purposes. The fair value of the company will probably be somewhere between the 3 and the 3. The media, investors and the public only see one of the three valuations. This is the value that the company would like you to view, which happens to be the most expensive. The illusion created by companies of certain values hides the truth from the outside world. Venture funds and limited partners will make more from investments if the public has a higher perception of a company’s value than the actual fair market value. The illusion of astronomical profits could be broken if the outside world were able to see behind it.
Publiated Mon, 16 August 2021 at 09:38:47 +0000