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When you’re managing your investment portfolio, you need accurate financial reports to help you make knowledgeable decisions and keep your LPs informed of the current state of the fund’s investments. That’s where ASC 820 comes in. 

What is ASC 820?

ASC 820 is an accounting standard that requires investments to be reported at fair value. ASC 820 stands for Accounting Standards Codification 820 and is part of the Financial Accounting Standards Board’s (FASB) Generally Accepted Accounting Principles (GAAP) guidance. 

ASC 820 classifies assets based on their level of liquidity. The more liquid an asset, the easier it is to determine its value. Level 1 assets are the most liquid, while Level 3 assets are the least liquid. A Level 1 asset could be a publicly-traded stock on NASDAQ, for example, while a Level 3 asset might be preferred stock in a private VC/PE-backed company. The AICPA released guidance around how best to value a Level 3 asset in mid-2019. Though the AICPA generally provides guidance in line with GAAP, the ASC 820 guidance was written to be in line with both GAAP and IFRS.

Do I need an ASC 820 valuation?

If you’re a venture capital firm, hedge fund, private equity firm, or insurance company, it’s crucial to assess the value of your investments each financial reporting period. It can be challenging to value your investments when they are not traded in an active market, but a professional valuation specialist can help. At Carta, we help investors determine the value of their private holdings by relying on methodologies and considerations in line with guidance from the AICPA to ensure an audit defensible analysis.

Fair value measurement according to ASC 820

There are two steps to valuing the holdings in your portfolio companies. 

Step 1: Calculate the enterprise value of a company

A company’s enterprise value is an estimate of its total worth, taking into account its equity value, debt, and cash balance. There are three valuation methods that can be relied on to calculate enterprise value

Income approach 

Also known as a discounted cash flow or capitalized cash flow analysis, the income approach estimates the cash flow a company is expected to generate in the future. The income approach may be best for late-stage companies that are generating positive cash flow or nearing profitability. 

Market approach 

Market approach methods rely on observable market indications to arrive at the enterprise value of the portfolio company:

1) The guideline public company (GPC) method uses a list of reasonably comparable public companies (in terms of size, revenue model, and target audience) and examines the implied multiples of relevant financial metrics to arrive at an enterprise value of the portfolio company.  

2) Similar to the GPC method, the guideline transaction method looks at recent mergers and acquisitions of reasonably comparable target companies and examines the implied multiples of relevant financial metrics to arrive at an enterprise value of the portfolio company.

3) The backsolve or post-money valuation method relies on the portfolio company’s most recent equity financing round to determine the value of the portfolio company. 

A market approach may be best for companies that cannot accurately predict long-term future performance or those that have not completed a round of financing within the last 12 months.

Asset approach

The asset approach determines the value of a portfolio company based on the value of the company’s net assets. This approach may be appropriate for very early stage companies with a simple capitalization structure.

Step 2: Allocate the value across all share classes 

The second step in determining the fair value of an investment is to allocate the subject company’s enterprise value across each of its share classes. This can be done using four potential allocation methods:

Waterfall 

The waterfall method accounts for the rights and preferences of the equity holders. It may be a good option if the company has a complex cap table and there is visibility into a near-term acquisition.

Option pricing model (OPM)

The OPM considers the rights and preferences of the shareholders, as well as the anticipated exit timeline and market volatility when considering a continuous distribution of outcomes. The OPM could be a great option for early-stage companies with less visibility into the timing or form of a future exit. 

Common stock equivalent (CSE)

The CSE moves away from the consideration of rights and preferences, instead allocating value to equity holders assuming all preferred shares have converted to common shares. This allocation method is typically used in conjunction with the post-money method or when a company is nearing an IPO.

Probability weighted expected return method (PWERM)

PWERM focuses on distinct future outcomes, including likely future exit dates and anticipated exit values, then assigns weighting to each of those outcomes and allocates that value to each share class.

Use Carta for your ASC 820 valuation

The unusually high volatility of the public and private markets during 2020, combined with the recently finalized ASC 820 guidance from the AICPA can make it tricky to appropriately measure the fair value of less liquid investments. And maintaining manually calculated waterfalls and market inputs can leave you prone to errors that can result in huge audit headaches. 

For an easier and more accurate valuation, it’s a good idea to work with a reputable and experienced provider like Carta. At Carta, we offer ASC 820 valuations, and products and services like fund administration.

Here are a few benefits of using Carta for your valuations:

  • Our calibration tool can help you estimate the changes in portfolio company valuations in bulk, plus identify which portfolio companies may warrant an in-depth ASC 820 valuation.
  • Our automation features mean your cap table updates automatically with new equity issuances. 
  • Our customizable selections give you the ability to choose and run your own valuations with methodologies and allocation methods in line with your internal valuation policy. And for more complex analyses, our team of valuation experts can assist in preparing an analysis we will defend to your auditor.

With Carta’s ASC 820 valuation offerings, you can save time, prevent errors, and rest easy knowing your valuations are audit-defensible and in line with industry best practices. 

 

DISCLOSURE: This communication is being sent on behalf of Carta Valuations, LLC, an affiliate of eShares, Inc. dba Carta, Inc. (“Carta”).  This communication is not to be construed as legal, financial or tax advice and is for informational purposes only. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.

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