With the valuation of a business, the investment uncertainty reduces to a great extent. And even though 409A valuations for startups are reforming the way the market works, the practice still requires a high-degree of judgement. The valuation is done using some top practices instead of set standards. Moreover, early-stage companies are very different from others. So finding the right kind of 409A valuation provider for your startup valuation is tough. That is where Eqvista comes into the picture.
409a Valuation for Startups
A startup valuation helps in letting us know the worth of a business – what its idea is, the service or product and so on. For a company that has already been established, getting the 409A valuation done can be easy since you have a lot of information and parameters to use. But with a startup, it’s more difficult as the company has just started. So, the steps used here are very different.
What is a 409a valuation for startups?
The IRC Section 409A is meant to regulate how companies treat “nonqualified deferred compensation” that they give to their employees. So, a 409A valuation helps companies set a reasonable strike price for the stock options. The price of the shares have to be either equal to the Fair Market Value or above it. And the best way to get the value of your company is by getting a qualified third-party 409A valuation provider to prepare it for you.
What is a 409a valuation used for?
The 409A valuation is meant to make sure that the proper income taxes are paid on deferred compensation plans. In addition to this, it also helps in making sure that company options are covered by the IRS safe harbor. If a company decides to not comply with IRC 409A, the company and its employees receiving the options would end up paying extra federal income tax to the government. Along with this, the government would also impose hefty fines along with taxes.
To explain more, the tax increases by 20% more and there are additional interest payments on top of that. This would not just make the employees in the company very unhappy, this would also create a lot of issues for the firm and its future acquisition plans. After all, which buyer would have to deal with the IRS and handle a lot of tax risks that the company incurred? Hence, it is very important to get the 409A valuation for startups done by a 409A valuation provider.
How is a Startup Valuation different from a normal valuation?
Valuation is a word that is used often when it comes to talking about startups and the stock market. But, it can be confusing since there are many types of valuations. Each type of valuation comes into play at different times in a company’s lifecycle. For instance, there are the private company valuation and then there are public market valuations, for which stocks are traded and predictions are made of what value they would have in the future. Then comes 409A valuations for startups.
Here are the differences between all the business valuations types to help you understand it better:
#1 Startup valuations = what someone is ready to pay for the company
This valuation depends on:
- Your capital needs, including how much you plan to spend, on what, and what would be the impact.
- Traction, which is measured in downloads, revenues, users and so on.
- Team, including the members’ reputation, track record, domain expertise, and history before success.
- Size of the opportunity, which is measured by market growth rate.
- Preferred stock participation preference
- Option pool, where the size of this is considered. So, the larger the pool, the lower the valuation.
- Comparables based on recent financings or exits.
- How hot space is at any given moment, which is also called the market sentiment.
#2 Business valuations = price of the company
This is calculated based on:
- Market sentiment
- Existence of readily identifiable potential strategic buyers
- Value of physical and intangible assets
- Cash flows – projected and current
#3 409A valuations = the value of the common stock of the business, which is used for issuing stock options
This valuation is based on:
- Strategic partnerships
- The industry’s competitive dynamics
- Company milestones
- Company’s investor base
- Quality of the management team
Difficulties with Startup Valuations
Startup companies have a lot of difficulties when it comes to valuing them due to many factors. Even though startups and young companies are different from each other, they have some common characteristics that can be problematic when undergoing a valuation. These include:
- Dependence on private equity: Early-stage companies are usually dependent on equity from private sources, rather than public markets. And VC (venture capitalists) normally are the source for the capital given to these companies in return for share in the ownership in the company.
- Little to no revenues: Revenues are low or almost non-existent in new companies, and their expenses are usually high. So, they normally are not able to generate a lot of sales.
- No history: Startups usually do not have any history or data on any financings and operations.
- Multiple claims on equity: By attempting to raise equity, other investors in the company end up being at risk to have their value reduced by deals offered to subsequent equity investors.
- Survival: A lot of startups do not survive, although there are a few that do succeed.
- Illiquidity of investments: The equity investments in startups are privately held and are hence, more illiquid than their publicly traded counterparts.
One of the main issues here is that startups have a limited history, which makes them very difficult to value. And analysts normally come across challenges when they use the intrinsic valuation method like the discounted cash flow method, or when using the relative valuation method, which uses the guideline public company or guideline private transaction method.
In short, there are a lot of challenges that analysts face when valuing a startup company. Those who are professionals and have enough experience are the ones who are able to work and get the 409A valuation for startups done accurately and with less complications.
Do you need a 409a valuation for your Startup?
Well it all depends on the situation. Let us say that you want to hire top talent in the industry who have a lot of experience but you do not have the money to pay them at market prices. So, in this case, you may choose to give stock options and shares in the company instead of giving them a higher salary. When a company wants to offer stock options to their employees, then the company needs to get a 409A valuation that complies to the federal tax code based on the strike price.
Normally, startups are requested to put off their company’s valuation until their Series A funding since a 409A valuation costs about $5,000. But what many do not know is that there are companies that offer better services and for much lower prices like Eqvista. Whatever the situation, if you are about to give out options, you will need to get the IRS 409A valuation to make sure that the option plans are covered by the IRS safe harbor.
To explain better, if your answer to any of the following questions is “yes”, then you need a 409A valuation:
- Have you raised a new round of funding since your last grant date?
- Do you plan to issue stock options and set your strike price?
- Are you trying to value the common stock of a company?
- Has it been 12 months since your last 409A? (Fair Market Value of your shares might have changed)
Eqvista as your 409a Valuation provider
With all this clear, you now know why you need a 409A valuation provider to help you. So if you are about to issue shares or give out stock options, you need to get an expert valuer to help you. Eqvista is the top 409A valuation provider that can help you in getting the most accurate and safe-harbor valuation.