- ASC 820
- What is ASC 820?
- ASC 820 fair value hierarchy
- ASC 820 disclosure requirements
- Do I need an ASC 820 valuation?
- ASC 820 valuation methodology
- Income approach
- Market approach
- Asset approach
- Allocation methods
- Waterfall
- Option pricing model (OPM)
- Common stock equivalent (CSE)
- Probability weighted expected return method (PWERM)
- Use Carta for your ASC 820 valuation
What is ASC 820?
ASC 820 is an accounting standard that provides a framework for defining, measuring, and reporting the fair value of investments. By standardizing how fair value is measured and disclosed, ASC 820 ensures financial statements provide stakeholders, investors, regulators, and decision-makers with reliable details about a company’s assets, financial liabilities, and equity. ASC 820 is part of the Financial Accounting Standards Board’s (FASB) Generally Accepted Accounting Principles (GAAP) guidance, and is used broadly where fair value is required or permitted.
ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, known as the exit price.
The way fair value is calculated can vary by investment type, including:
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Market-based: Fair value is determined by the market perspective, not the reporting entity.
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Exit price: Fair value is measured at the price an asset can be sold, separating it from the entry price, transaction price, or initial acquisition cost.
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Principle market: Fair value assumes transactions occur in the market with the greatest volume or activity for the asset. Or, in its absence, the most advantageous market, which maximizes value for the entity.
ASC 820 fair value hierarchy
ASC 820 categorizes assets into a three-level fair value hierarchy based on their liquidity. The more liquid an asset, the easier it is to determine its value.
Level 1: Direct market prices
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Definition: Uses quoted prices from active markets for identical assets.
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Example: Publicly traded stocks on the New York Stock Exchange (NYSE) or exchange-traded funds (ETF).
Level 2: Observable market data
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Definition: Uses pricing inputs other than direct quotes from active markets. These inputs are observable, including quoted prices for similar items or derived values from market data.
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Example: Interest rate swaps valued on yield curves, and commodity swaps priced using forward market data.
Level 3: Unobservable inputs
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Definition: Based on pricing inputs not readily observable in the market. These involve internal methodologies relying on management’s best estimate of fair value.
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Example: Preferred stock in a private company.
The American Institute of Certified Public Accountants (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 International Financial Reporting Standards (IFRS).
ASC 820 disclosure requirements
ASC 820’s disclosure requirements report the valuation techniques and inputs used for fair value measurements in financial reporting. Key disclosure requirements include:
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Fair value measurement by level: Entities must categorize assets and liabilities into Level 1, Level 2, or Level 3 of the fair value hierarchy, the amounts within each level, and any transfers between levels.
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Valuation techniques: Entities must disclose the valuation approach (market, income, or cost approach) used for Level 2 and Level 3 measurements and the inputs applied, like discount rates, yield curves, or price multiples.
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Level 3 measurement details: Entities must provide detailed quantitative disclosures about unobservable inputs used in the valuation, and a description of the process for developing unobservable inputs.
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Fair value measurement changes: Entities must disclose changes in fair value measurements over the reporting period.
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Nonrecurring fair value measurements: For assets measured on a nonrecurring basis, entities must disclose the reasons for the measurements, the fair value hierarchy level, and the valuation techniques used.
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Impact of market conditions: Entities must disclose the effect of market conditions, like volatility or illiquidity, on fair value measurements.
Do I need an ASC 820 valuation?
If you’re a venture capital firm, private equity firm, hedge fund, 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.
→ Learn more: ASC 820 valuations from Carta.
ASC 820 valuation methodology
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:
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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.
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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.
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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.
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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.
Allocation methods
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 liquidation 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.
→ Download: Carta's free waterfall modeling glossary.
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
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 fund administration services.
Here are a few benefits of using Carta for your ASC 820 valuations:
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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.
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Our automation features mean your cap table updates automatically with new equity issuances.
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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 on behalf of eShares, Inc. dba Carta, Inc. ("Carta"). This communication is for informational purposes only, and contains general information only. Carta is not, by means of this communication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. 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. © 2024 Carta. All rights reserved. Reproduction prohibited.
