February 4, 2014
Young Entrepreneur Council (YEC) is an invite-only organization comprised of the world’s most promising young entrepreneurs. In partnership with Citi, YEC recently launched StartupCollective, a free virtual mentorship program that helps millions of entrepreneurs start and grow businesses.
A 409A valuation. Why is it important? Well, as Brad Feld says, “it’s going to impact every employee in your company that gets stock options and is something every board member and the CEO needs to understand clearly.”
In other words, it’s no minor matter. That’s why this week we reached out to our friends at the YEC to help shed some insight on what you need to know about the 409a. Their responses are below. Enjoy
8 Things Entrepreneurs Need to Know Before Getting a 409a Valuation
1. AICPA-Compliant Reports
In addition to a valuation firm that has early-stage experience and offers a guarantee and fast turnaround, you should also specifically look for a firm that advertises AICPA-compliant valuations that endure Big 4 and acquirer scrutiny. If you get acquired, the acquiring company will request an audit, which means they will be looking closely at your 409a valuation. If your valuation firm made certain assumptions or didn’t address things in certain ways, this could slow down the acquisition and/or have a negative economic result. A valuation firm that advertises AICPA-compliant reports means they have the necessary rigor you will need to make it through an acquisition as smoothly as possible.
2. Who They’ve Valued in the Past
There is a lot of competition in the 409a evaluation space. Although pricing matters, at the end of the day, the most important thing is to get the valuation right. We have found that the best indicator of a firm or individual who will value your startup well is whether they have worked with analogous companies, even competitors. If so, they will know the space and provide a more rigorous review.
Don’t let some big firm convince you to drop a ton of cash on a 409a valuation. There are many reputable firms that can do this fast and affordably. Don’t think cost somehow relates to quality with 409a valuations. Often it just relates to the type of companies they work with. Look for a firm that works with companies of your size and stage.
We had a great experience using Scalar Analytics for our 409a valuation. We had a tight timeline before the next board meeting, and they met or beat each deadline we requested. The draft was complete, and the outcome was acceptable to us and our board. We chose Scalar primarily because one of our investors recommended them. After talking to partners at five firms and getting quotes, I found that the rates will all be in the $4,000 to $5,000 range for a post-Series A company like ours, and it ultimately boils down to your relationship with the partner there. Go with someone who treats you and the process professionally and writes back to you promptly. You’ll be fine.
5. Potential for a Strategic Relationship
First do your homework and get a referral from a company that you admire or is at a place that you wish to see your company get to. Think about this firm as a partner in the same way you would view your attorney. You will have an ongoing and lasting relationship with that firm, so pick one you like, can work with and trust. Overall, it is a collaborative process, and you want an ongoing strategic relationship.
6. Level of Expertise
When I started my company in 2006, I never thought I’d sell it, so I didn’t set the proper evaluation parameters into our corporate charter. When it came time to sell my state to other partners, that bit me in the behind. I spent six months trying to sort out this mess and worked with attorneys and evaluation specialists. What I learned was to get an evaluation from a broker who sells companies for a living and who has the professional connections to get a solid foundation in not just value, but market-based value.
7. Your Emotional Response
If you are going to get this sort of valuation done, the first thing you need to do is get mentally and emotionally ready. Odds are you are going to be told your business is worth less than you think it is. This can be a tough dosage of reality. You should accept the information and then begin to work on the things that will drive your valuation higher to the point you want to be at before you sell.
Most entrepreneurs underestimate the value of 409a valuations. You use them to set the strike price for your future stock options and your employees’ stock options. A poorly done 409a could cost you and your employees thousands of dollars or more. Find a firm with experience valuing companies like yours — the same industry, same size and same growth trajectory. Ask for references, and talk to them. Don’t underestimate the importance of your 409a just because it doesn’t feel important now.
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