409a valuations are a dinosaur industry. They cost a lot of money for little benefit. Carta is working to change that.
ASC 820 offers guidance on how to value illiquid assets. 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. Level 1 assets are the most liquid, for example a stock traded on NASDAQ. Level 3 assets are the least liquid, for example, preferred stock in a private VC-backed company.
Why you need an ASC 820 valuation, how they work, and what’s changing
Do I need an ASC 820 valuation?
As a venture capital firm, hedge fund, private equity firm, or insurance company, valuing your portfolio or liabilities can be challenging when they don’t have an active market or easily identifiable market value. US GAAP require fair value measurement for financial reporting. These financial reports on holdings must be shared with investors (i.e. limited partners) and creditors. ASC 820 valuations help VCs put together these reports.
At Carta, we help venture capitalists measure the value of the private companies in their portfolios with ASC 820 valuations. This post will cover the basics of ASC 820, why ASC 820 matters, and what’s changing with FASB guidance for VCs.
Fair value measurement according to ASC 820
To value each company in a VC’s portfolio, there are two steps in the valuation process. First, an ASC 820 provider, like Carta, calculates an enterprise value for the company. Next, they allocate that value across individual shares, based on the capital structure.
Step 1: Calculate the enterprise value of the company, in one of three ways:
- Income approach: Also known as a discounted cash flow or capitalized cash flow analysis, the income approach is typically used for more mature companies that are already generating positive cash flows or that will be transitioning to profitability in the near term.
- Market approach: This method looks at market indications of the value of the company, using option pricing model (OPM) backsolve, post-money valuation method, or comparing multiples for comparable publicly-traded companies.
- Asset approach: This method is most appropriate for companies whose main value is derived from a simple set of assets with low volatility.
Step 2: Allocate value across all share classes for each portfolio company, in one of three ways:
- Waterfall: This method considers the rights and preferences of the equity holders and is most appropriate if there is near-term visibility to an acquisition.
- Option pricing model (OPM): Similar to the waterfall method, except that the OPM considers volatility and time to exit.
- Common stock equivalent (CSE): CSE moves away from the consideration of rights and preferences and allocates value equally between shares, regardless of class. If an analyst uses the post-money valuation to calculate the enterprise value, they should use the CSE method to allocate that value.
Recent updates to ASC 820
To help improve consistency across ASC 820 valuations, FASB released a draft of the ASC 820 guidance on May 15th, 2018. Comments were due on August 15th, 2018, and the final guidance will likely be available in May 2019. For those of us at Carta, the most interesting takeaways from the draft guidance are:
- Market participant perspective The guidance suggests that VCs can approach valuations from the same perspective as the market participants, i.e., the perspective of a general partner (GP) at VC fund. While auditors will likely continue to prefer quantitative analyses, auditors should accept some qualitative arguments from GPs, as they represent the primary buyer in the VC market.
- Discounts (control and marketability): The draft guidance seems to suggest incorporating some qualitative judgement into discounts for control and marketability.
- Backtesting: When your fund experiences a liquidity event, the guidance suggests circling back and comparing the actual price per share with the most recent calculated FMV.
The best way you can insure your ASC 820 valuation is done properly is to choose a reputable and experienced provider, like Carta.
Or, to learn more about ASC 820, watch the webinar below hosted by Aaron Jacobs.
DISCLOSURE: This communication is being sent on behalf of Carta Valuations, LLC, an affiliate of eShares, Inc. dba Carta, Inc. (“Carta”). Certain transactional fees may apply. 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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