How can Fintech Companies manage a 409a valuation?
Here is a summary of the 409a valuations for Fintech companies performed by Eqvista.
Fintech is a popular industry that has been rapidly growing in the last decade. A lot of this industry’s products have affected your everyday life. To explain better, a fintech company is the one that operates in the financial service sector and leverages technology to make this automatic, simple, and to improve the delivery of financial services to their customers. Sounds familiar? Your online banking account is one of these services. But with all this, getting the value of the fintech industry can be tough since it is not the same as the traditional finance industry. So, how to value a fintech company? Let us find out!
Fintech company 409a valuations by the numbers
*Most 409a valuations for Fintech companies do not use EBITDA multiples
409a Valuation for Fintech Companies
The fintech companies can be classified into multiple sub-sectors including cross-border remittances, insurance, lending and borrowing, crowdfunding, investment management, payments and so on. In January 2019, there were more than 12,000 fintech companies operating globally. And the most number of fintech companies have been in the US, with India and the UK following it. This is just increasing as the other countries join in and many companies keep starting up.
Fintech industry introduction
The Fintech (Financial Technology) industry is used to describe the companies that aim to enhance and automate the use of financial services. It is used to help consumers, business owners and companies manage their financial processes, operations and lives by using a specialized software on their smartphones and computers. This industry emerged in the 21st century and was used only for back-end systems of established financial institutions.
However, since then, there has been a shift to more consumer-oriented services and that is why many companies were created to make consumer’s lives better. Fintech is now in different sectors including retail banking, education, nonprofit, fundraising, investment management and many more. Fintech also includes the crypto-currency companies as well. Due to the way that these companies are different from the traditional companies, obtaining the 409a valuation for fintech companies isn’t the same as getting the value of the traditional companies.
Why Do Fintech Companies Need 409a Valuation?
When a company is about to give out shares to their employees, they usually need to get the 409A valuation done as per the rule set by the IRS. With the valuation, the company can easily prove to the IRS that they have offered the shares of the company at the right strike price. The IRS needs this value since it is used to obtain tax from the shareholder who received shares from the company. Nonetheless, if the company fails to get the proper IRS-defensible valuation or get the wrong value for their business, they may have to pay penalties to the IRS.
The valuation helps us get to know the exact worth of the company. The value of the fintech industry would help you plan for the future of the company. Your fintech company’s value will let you know your exit plan or IPO plan. If you are about to enter an M&A deal, you will need to know the value of your company. In short, obtaining the value of your business using the fintech valuation methods is important for many steps in a business.
Valuation Approaches of Fintech Sectors
Valuing a fintech company is not as easy as it sounds. In fact, there are different kinds of companies that come under this industry which also makes it an important part of how we value the company. The fintech industry has been divided into many sub-sectors as shared below:
Modern global banks are a combination of wealth management, investment banking, commercial banking and advisory services. If we are valuing a traditional bank, it would be on the parameters like the EPS, comparable PE multiples, return on assets, and net interest margins. The first two parameters measure the returns that accrue to shareholders, taking into account the expected growth in earnings and the capital structure, while the second two measure the efficiency of the bank and how efficiently capital is being deployed. All this takes the business model of the bank into account.
#2 Insurance companies
To get the value of an insurance company, the parameters used would be the return on equity. A few of the relevant factors to value insurance companies include:
- Premium growth in the company or market – How fast is the income of the company growing? Is it gaining market share? Is the market growing or saturated? A new company usually has more potential to grow than an existing one.
- Returns consistency – The payout ratio is not usually predicted clearly and can be volatile. Due to this, the consistency of the income of the insurance company is considered to see if over a long period they make consistent returns or not.
- Other comprehensive income (investment income) – The insurance company’s income includes both the investment income and premium income. This method shows the level of returns from its investments.
#3 Wealth management companies
Wealth management (WM) companies are a part of Asset Management Companies (AMCs). Hence, their valuations are done in a similar way. It is normally correlated to the AUM (assets under management), fee rates and revenue. Nonetheless, their business models are different from pure mutual funds companies whose setups are more standardized and institutionalized. Wealth management companies are more boutique-y and are less regulated.
So the value that the investment managers add is customized to the risk appetite of clients. And for sales, relationships are key where loyal clients invest based on comfort, trust, and their relationship with a manager. Hence, valuing the WM firms is much more complex where all these variables have to be added to get the final value.
#4 Mutual fund companies
AMCs (asset management companies) are normally valued as a percentage of AUM. This measures the capability of the AMC to generate cash flow based on the total size of funds that it has under the management. It can be based on the underlying asset class including fee structures, fixed income, equity and so on. We can also look at the AUM’s market capitalization. Its goal is to correlate growth in income potential with the size of the fund. And this is based on the assumption that AMCs that have greater AUMs cannot grow income as fast as larger ones. The variables that need to be considered when obtaining the value of the AMCs are:
- Public and regulated vs private and less regulated fee structures.
- Growing vs stable base of investors.
- Size of the absolute investor base.
Common Valuation Methods for Fintech Companies
As mentioned above as well, getting the value of the fintech industry and the companies in it is not easy. It is not the same as the other financial companies. Hence, the fintech valuation methods are very different and include:
#1 Discounted cash flow method
This is the same method used for all the valuation processes. It is also used to obtain the 409a valuation for fintech companies. It is a traditional model that discounts future cash at the average cost of capital to arrive at the present value of the company.
#2 Revenue Multiples
When we take the valuation of a company from its known data, and determine how the revenue relates to this output, investors can get a proper idea on how much the company is worth. This estimation can be made more accurate by breaking the all the various fintech companies and then calculating the revenue multiples for each category. And with this, a more accurate assessment will be made of that company’s value.
#3 Book Value (Intangible Asset valuation)
Another method for calculating the value of a fintech company is from its balance sheet and finding the book value. As in the case with fintech and software companies, a separate valuation of the company’ intangible assets would be conducted. In most cases this value is off balance sheet, and needs to be adjusted for in order to get a more accurate value of the company.
How do we work on the 409a Valuation for Fintech Companies?
When we are about to value the fintech industry or a company in the industry, we consider some things – the key differences between the conventional businesses and the early businesses based on:
- The nature of the problem that the company solves and scalability-this would indicate growth % and affect the valuation multiples
- The historical performance of the company and future forecasts
- The cost structure and how much is needed for operational expenses
Using all these points and the various fintech valuation methods, Eqvista is able to easily get the final value of the fintech companies.
Here is a sample of our 409a valuation report of an example fintech company:
Why choose Eqvista for Fintech Company 409a Valuation?
Eqvista has a group of highly skilled and certified professionals who have worked on and provided 409a valuation for fintech companies for a long time. These valuations have not just helped the companies know their value but have also worked well to act as a safe harbor for the IRS. It is also the reason why many companies trust us and come back to us to obtain their company’s value. We have the right knowledge and experience to find the value of the Fintech industry and we can help you too. Find out more and place an order for getting your company’s 409A valuation here!