
Valuation Shell Game: the 409A valuation - tim_sw
https://www.nytimes.com/2017/03/08/business/dealbook/valuation-shell-game-silicon-valleys-dirty-secret.html
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jeronpaul
The fact is that nobody can really know with certainty the true valuation of
an early-stage company. Even venture investors just come to a negotiated deal
and subsequent events often prove them wrong. That said, the definition of
true value is probably whatever price is implied by a market deal between a
willing seller and buyer both of which have access to all relevant facts and
neither of which is under any compulsion to do a deal (so basically a venture
capital transaction would qualify). The article correctly points out that
valuation firms aren't market participants (i.e., actual buyers) so they are
just doing their best to guess at a value--not establishing a value. The
article also points to false precision--which most honest valuation folks
agree to. They still have to do their best to come up with a defensible
valuation but they recognize that it is just an educated guess. Finally the
article points to the difference between common and preferred stock prices as
if that is a scam. While you can definitely debate how close the two should be
relative to each other, it's totally crazy (IMHO) to say that common should
have the same value as preferred.

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nugget
On Tuesday I spend a hundred bucks and start a Delaware LLC that has no assets
and no business plan - what's the company worth? Most would say $0 or close to
$0.

After breakfast on Wednesday I spend a couple hours on an abstract powerpoint
deck, make a bunch of phone calls, and by dinner time (based on past successes
and personal network) I have $1m in seed funds committed at a $5m pre-money
valuation. What's the company worth then?

It's one of the best tax incentives out there, in that successful founders and
very early employees usually pay long-term capital gains on near zero-basis
stock.

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jalonso510
Couple of things that are not correct in the article:

(1) a $50,000 fee for a valuation is crazy- early stage companies pay less
than 1/10th that.

(2) companies typically do not get a valuation done more than once per year.
the article makes it sound like you get a new one every time you issue
options, they actually have a shelf life of one-year, unless there is a new
financing or other event that requires a new report to be obtained.

Not saying its a good system (it's not), just odd that the NYT would get some
basic facts wrong.

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snarf
The funny thing is that the author of this article is a former (longtime)
investment banker. I found the line where he describes the lack of liquidity
in private shares "falls especially hard on early investors who are not
company employees, those so-called 'series A' or 'series B' venture-capital
investors" especially amusing. As if we are supposed to feel more sorry for
VCs who are diversified in many investments than employees who aren't.

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rdlecler1
We need an overhaul of private stock options in general. These shares sit at
the bottom of the capital stack which means as that stack gets higher risks
increase. The fact that someone needs to pay tax before these options are
excerised is ridiculous. If the US wants to stimulate innovation they should
stop gouging risk taking employees and focus their efforts on Wall Street.

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jpeg_hero
We scam you with the 409a and you scam us with the AMT.

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hkmurakami
This is... Actually beautifully succinct.

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timriser
The article says that 409a valuations are imprecise, costly, and unnecessary
tools that enable founders to prevent the secondary sale of company stock, and
disenfranchise employees and early investors.

This is almost 100% hyperventilation.

I took to Medium to try and explain that 409a valuations are: a government-
required, largely commoditized service; a consistent, objective approach to
dealing with the uncertainty of startups; nothing more than the translation of
the startup’s underlying business fundamentals.

Link: [https://medium.com/@tim.riser/startup-valuations-are-no-
shel...](https://medium.com/@tim.riser/startup-valuations-are-no-shell-
game-47e7c9c9595c#.8w370fkzs)

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lacker
Getting a 409A did seem to be pretty dumb. It's just a super-expensive process
to figure out how much taxes you have to pay on option grants. If the rules
were just, a grant of startup stock doesn't get taxed until an IPO or
acquisition, so you don't have to do options in the first place, that would be
much saner!

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jeronpaul
Btw, full disclosure I founded and sold Scalar Analytics, a valuation firm and
am currently the CEO of Capshare.

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Buge
This article is frustrating because it never mentions why low 409A valuations
would be helpful to anyone. It seems to say the companies are benefiting from
different 409A and investor valuations, but not why. Does it mean someone pays
less tax or something?

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lacker
If you give an option where the strike price is "the current fair value", the
employee doesn't have to pay taxes. But "the fair value" is defined by the
409A. The company usually doesn't care about the strike price and would rather
just give the employee as much value as possible. A low 409A is much better
for the employee, a teeny bit worse for the company, and so companies just go
for a low one.

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calcsam
It's pretty common knowledge that 409a valuations are underestimations of real
value. What isn't well known is by how much. It would be great to see VCs with
20 years of data compare how much their preferred shares were worth vs of they
had held common instead. Then again, publicly available data like that might
invite an SEC crackdown. Be careful what you wish for.

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jdavis703
My understanding is the 409A is supposed to be a true valuation of the
company, not of the shares. The price of shares sold to investors (probably
with liquidation preferences, extra voting rights, maybe a board seat, etc) of
course costs more than the company's value divided by number of shares.

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jpeg_hero
409a includes the valuation of the stock held, which is often discounted by
"accepted discount factors" such as illiquidity discount and marketability
discount. The latter being the fact that a common shareholder often has resale
restrictions on their stock.

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advisedwang
If you are going to tax values of the shares then you have to decide _some_
price. What is the alternative? Using the last financing round is just as
crazy and even easier to game.

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lacker
A simple alternative would be to tax startup shares when they turn into real
money, not when they are granted and all sorts of shenanigans are possible
around their value.

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briandear
Exactly. The current system is taxing eggs before they hatch into chickens.
You're paying taxes on potential income rather than actual income. If the eggs
break before they hatch -- too bad.

The weird thing is that if a stock loses value, you can't claim a deduction
for the loss until that loss is actually realized, yet you can get taxed on
shares before any gain is realized.

It's all Monopoly money until it becomes actual cash.

