MEMBER OF PKF NORTH AMERICA, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS © 2010 Wolf & Company, P.C.

Know  Your  Valua,on  For  Equity  Compensa,on  (and  Avoid  the  Perils  of  409A)    

Exclusively  for    

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Introduc,ons  

•  ScoH  Goodwin  –  Wolf  &  Company,  PC  –  Member  of  the  Firm  –  Technology  Services  Team  Leader  –  TCN  board  of  directors  and  program  commiHee  chair  

 

•  Alicia  Amaral  –  Scalar  Analy,cs  –  Managing  Director  –  TuUs  University,  Entrepreneurial  Finance  –  CPA  and  Cer,fied  Valua,on  Analyst,  CVA  –  Past  CFO  

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Who  is  Wolf  &  Company?  

•  Boston  based,  regionally  focused  

•  18  owners  and  190  professionals  in  three  offices  

•  Niche  focused  –  Technology  Services  Team  

•  Provide  our  clients  with  direct  access  to  owner-­‐level  exper,se  

•  Ability  to  grow  with  you  

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Who  is  Scalar  Analy,cs?  

•  600+  valua,ons  per  year    •  Majority  of  clients  backed  by  venture  capital  firms  and  angel  groups  

•  Clients  in  virtually  every  industry  •  Work  with  all  of  the  “big  4”  audit  firms  and  countless  regional  firms  

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Agenda  

•  Overview  of  stock  compensa,on  plans  •  Overview  of  IRC  Sec,on  409A  •  The  who,  what,  why  and  how  of  valua,ons  •  Q&A  

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Stock  Compensa,on    Overview  

•  Common  forms  of  stock  compensa,on  –  Founders  shares  –  Op,ons  –  Restricted  stock    

•  Tax  treatment    

•  Advantages  and  disadvantages  

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Overview  of  IRC    Sec,on  409A  

•  What  is  it?  •  How  does  it  impact  stock  compensa,on?  •  What  is  the  worst  that  could  happen?  •  What  do  you  as  an  entrepreneur  need  to  know  to  

stay  out  of  trouble?  •  What  are  best  prac,ces  at  various  stages  of  

development?  

Standard  of  Value  

•  Fair  Market  Value  –  Assumes  hypothe,cal  buyer  –  This  is  standard  for  409A  (per  IRS)  

•  Investment  Value  –  Assumes  strategic  buyer  

 

409A  ≠  VC  investment  

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Investment  Valua,on  for  Start-­‐Ups  

•  Discounted  Cash  Flow???  •  Berkus  •  Bill  Payne  Method  •  Risk  Factor  Simulation  •  Venture  Capital  Method  

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David  Berkus  Method  

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$500k  for  each  •  Good  idea  •  Prototype  

•  Quality  Team  •  Quality  Board  •  Ini,al  Sale  

 Value  $0  to  $2.5  Million  

Bill  Payne  Method  

Factor  Management    Size  of  Opportunity/Market  Product/Service  Sales  Channels  Stage  of  Business  Other  

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Weight  30%  25%  10%  10%  10%  15%  100%  

Ra,ng  100  =  Average,  100+  =  above  average,  100-­‐  =  below  Mul,ply  result  by  $1.75M  

Bill  Payne  Method  Example  

Factor  Management    Size  of  Opportunity  Product/Service  Sales  Channels  Stage  of  Business  Other  

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Weight  30%  25%  10%  10%  10%  15%  100%  

Ra<ng  125  115  110  70  125  80    

Total  37.50  28.75  11.00  7.00  12.50  12.00  

108.75    

Value  =  $1.75M  *  108.75  =  $1,903,125  

Risk  Factor  Simula,on  Method  

Risk  Factor  Management  Stage  Funding  Risk  Regulatory  Manufacturing  Sales  &  Mktg  Compe,,on  Technology  Li,ga,on  Reputa,onal  Exit  

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Risk  Factor  +$500k  +$250k  -­‐$250k  

0  +$250k  -­‐$500k  +$250k  +$250k  

$0  -­‐$250k  +$250k  $250k  

Valua<on  Base  $1.75M  Risk            250k  Value            $2.0M  

Venture  Capital  Method  

Determine  the  •  Investor’s  required  rate  of  return  (ROI),  and  

• Terminal  Value  (TV)  

Work  backwards  to  get  valua,on  (Post  $)    

TV  can  be  either  exit  or  next  round  14

VC  Method  Example  

•  TV  based  on  es,mated  revenues  and/or  Net  Income  in  terminal  year  

•  Example:    –  Es,mated  revenue  in  Year  5  is  $40M  –  Average  mul,plier  for  industry  =  2  –  So  your  es,mated  value  of  the  company  at  the  end  of  year  5  ,  or  TV  =  $40M  *  2  =  $80M  

 *Note:    Can  also  es,mate  TV  based  on  Net  Income  and  apply  average  P/E  mul,ples  

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VC  Method  Example  

•  ROI  •  Say  I  sell  an  investment  for  $100M  that  I  purchased  for  $20M.  What’s  my  ROI?  

•  Answer:  $100M  /  20M  =  5x  •  Same  as  TV/Post$  =  ROI  •  To  solve  for  Post$:  Post$  =  TV/ROI  

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VC  Method  Example  

•  Say  in  our  example  that  investor  needs  a  20X  ROI  •  Post  $  =  TV/ROI  •  Post  $  =  $80M  /  20  •  Post  $  =  $4,000,000  

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Three  Valua,on  Methods  

Valua,on  Methods  409A  

1. Asset  Approach  

2. Market  Approach  

3.  Income  Approach  

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2.  Market  Approach  

a)  Recent  securi,es  transac,ons  method  b)  Comparable  (guideline)  public  company  method  c)  Comparable  transac,on  method  d)  Industry-­‐specific  mul,ples  

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2b.  Market  Example:  Guideline    Public  Company  Method  

Data  for  similar  public  companies  in  same  industry  •  Salesforce.com,  Inc.  •  Concur  Technologies,  Inc.  •  Kenexa  Corp.  •  LogMeIn,  Inc.  •  Constant  Contact,  Inc.  

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In  thousands  of  dollars  (000) LTM  Revenue LTM  EBITDA NTM  Revenue NTM  EBITDA

Venture  Co. $6,812.0 ($6,337.8) $14,380.7 ($3,166.6)

Mean  Multiple 5.0x 22.1x 4.0x 19.2x

Implied  Enterprise  Value $33,809.2 N/A   $57,270.2 N/A  

Average  Enterprise  Value $45,539.7

Plus  Cash $4,441.9

Market  Value  of  Invested  Capital $49,981.6

Steps  in  the  Valua,on  Process  

1.  Take  weighted  average  of  applicable  methods  (asset,  market  or  income)  to  come  up  with  enterprise  value  

2.  Allocate  the  enterprise  value  among  classes  of  stock  

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Valuation

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Step 1 – Determine enterprise value using weighted average of applicable methods (Asset, Market and Income)

Fair  Market  Value  of  Venture  Co.  as  of  September  30,  2012 Market  Value  of Method Weighted  

In  actual  dollars Invested  Capital Weighting Value

Adj.  Book  Value  of  Assets  (Cost) $5,914,647 0.0% $0

Invested  Capital  (Cost) $22,182,037 0.0% $0

Recent  Securities  T ransaction  Backsolve  (Market) $42,932,012 25.0% $10,733,003

Public  Comps  Valuation  (Market) $49,981,604 25.0% $12,495,401

Acquisition  Comps  Valuation  (Market) $55,094,153 25.0% $13,773,538

Discounted  Cash  Flow  Valuation  (Income) $44,606,522 25.0% $11,151,631

Weighted  Market  Value  of  Invested  Capital $48,153,573

Less  Debt ($1,750,000)

Weighted  Equity  Value $46,403,573

Step  2:  Alloca,on  

•  Simply  means  “who  gets  what”  in  the  event  of  an  exit    •  Common  shareholders  get  paid  aUer  preferred  

Remember  that  the  purpose  of  409A  is  to  value  common  stock  

 

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Option  Value  Analysis Option  1 Option  2 Option  3 Option  4 Option  5 Option  6 Option  7 Option  8 Option  9 Option  10

Definition:  Before  this  breakpoint… Series  C  

liquidation  

preference

Series  B  &  A  

liquidation  preference

Common  

participates

Allocated  options  

exercise

Series  A  converts  to  

common

Common  

Warrants  

exercise

Unallocated  

options  

participate  in  

value

Series  B  converts  

to  common

Series  C  reaches        

3.0x  

participation  cap

Series  C  converts  

into  Common  

stock

Break  Points $0 $20,771,210 $22,182,037 $25,812,886 $27,793,293 $28,582,104 $39,428,548 $56,429,660 $301,546,405 $421,162,792 Infinity

Current  Equity  Value  (Price) $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573 $46,403,573

Exercise $0 $20,771,210 $22,182,037 $25,812,886 $27,793,293 $28,582,104 $39,428,548 $56,429,660 $301,546,405 $421,162,792 Infinity

Riskfree  Rate 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31% 0.31%

Maturity  (in  years) 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0

Volatility 54% 54% 54% 54% 54% 54% 54% 54% 54% 54% 54%

d1 28.942 1.333 1.264 1.103 1.025 0.995 0.654 0.275 (1.501) (1.855) 0.000

d2 27.998 0.389 0.320 0.159 0.081 0.051 (0.290) (0.669) (2.445) (2.799) 0.000

Call  Option  Value: $46,403,573 $28,763,403 $27,871,048 $25,735,075 $24,660,647 $24,249,313 $19,421,999 $14,152,891 $929,712 $405,738 $0

Incremental  Option  Value $17,640,170 $892,355 $2,135,972 $1,074,429 $411,334 $4,827,313 $5,269,108 $13,223,179 $523,975 $405,738

Option  Value  of  Security Option  1 Option  2 Option  3 Option  4 Option  5 Option  6 Option  7 Option  8 Option  9 Option  10

Series  C $17,640,170 $0 $488,775 $204,543 $67,632 $795,364 $799,205 $1,933,391 $0 $60,031

Series  B $0 $697,195 $0 $0 $0 $0 $0 $414,235 $19,010 $12,542

Series  A $0 $195,160 $0 $0 $40,566 $229,734 $230,844 $566,020 $26,281 $17,340

Common $0 $0 $1,647,197 $689,319 $227,924 $2,680,416 $2,693,361 $6,604,011 $306,632 $202,309

Allocated $0 $0 $0 $180,567 $59,705 $702,136 $705,527 $1,729,925 $80,322 $52,995

A  Warrants $0 $0 $0 $0 $15,507 $87,821 $88,245 $216,372 $10,046 $6,628

Common  Warrants $0 $0 $0 $0 $0 $331,842 $307,524 $754,035 $35,011 $23,099

Unallocated $0 $0 $0 $0 $0 $0 $444,402 $1,005,190 $46,672 $30,793

Total $17,640,170 $892,355 $2,135,972 $1,074,429 $411,334 $4,827,313 $5,269,108 $13,223,179 $523,975 $405,738

Total  Option  Value Option  Value Total  Shares

Share  Value  

(Marketable)

Marketability  

Discount

Share  Value  (Non-­‐

Marketable)

Series  C $21,989,112 5,934,632 $3.705 0.0% $3.705

Series  B $1,142,982 1,239,906 $0.922 0.0% $0.922

Series  A $1,305,945 1,714,171 $0.762 0.0% $0.762

Common $15,051,167 20,000,000 $0.753 35.7% $0.484

Allocated $3,511,178 5,239,012 $0.670 35.7% $0.431

A  Warrants $424,620 655,276 $0.648 35.7% $0.417

Common  Warrants $1,451,511 2,283,567 $0.636 35.7% $0.409

Unallocated $1,527,057 3,044,179 $0.502 35.7% $0.323

Total $46,403,573 40,110,742

Summary  

•  STEP  1    Enterprise  Value      $48,153,573    Less  Debt          (1,750,000)    Equity  Value        $46,403,573  

•  STEP  2    Alloca,on  to  common    $15,051,167    Divided  by  #  shares      ÷  20,000    Price  per  share      =  $0.753  

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Discount  

•  Discount  for  lack  of  marketability  (DLOM)  ü  25  –  45%  

•  Discount  for  Venture  Co.  =  35.7%  •  Price  per  share  $0.753  less  35.7%  =    

 $0.484  per  share  

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Other  Points  

•  Value  is  based  on  a  number  of  assump,ons  that  have  a  material  impact  on  the  result  –  Projected  cash  flows  –  WACC  –  DLOM  –  Comparable  companies  

•  Important  to  have  a  “DEFENDABLE  VALUE”  (IRS  and  auditors)  

•  Important  to  review  report  for  reasonableness  of  assump,ons.  You  know  your  business.  

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QUESTIONS  AND  ANSWERS  

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Thank  You!  

ScoH  Goodwin,  CPA  sgoodwin@wolfandco.com  (617)  428-­‐5407      Alicia  Amaral  alicia.amaral@scalaranaly,cs.com  (617)  684-­‐5510    

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Resources  

 

To  be  posted  to  TCN  website:    •  Detailed  outline  and  PowerPoint  presenta<on  •  Scalar  Analy<cs  –    white  paper,  “Sec<on  409A  –  Common  

Stock  Valua<on”