Navigating Through Uncertainty…
Privately-held companies have valuations performed by qualified appraisers for a variety of reasons, including financial and tax reporting, to support business decisions, such as acquisitions or fundraising efforts, and for compliance related to agreements a company has signed. Included in these reasons is getting a valuation to help a company’s Board of Directors determine an appropriate exercise price for new options, otherwise known as a 409A valuation.
In general, a company will obtain a 409A valuation when it plans to issue deferred compensation, usually stock options or potentially profits interests, RSUs, or other forms of compensation where the payout to employees will be realized at some point in the future. Based on guidance from the IRS, a company’s Board of Directors is able to rely on a 409A valuation for up to one year or until there is a “material event.” Typical occurrences that qualify as a “material event” include a new fundraising round, an acquisition of another company or divestiture of a business line, and large, unexpected developments that change the trajectory of a company. For most companies, this means that they get a new 409A valuation once per year or possibly sooner if they complete a fundraising round or make an acquisition.
However, the ongoing coronavirus pandemic, which has infected more than 1.75 million people worldwide and led to more than 100,000 deaths, reported figures that increase daily, if not hourly, would certainly qualify as a “material event.” This is true even if a company is not specifically impacted by either the virus itself or by the shelter-in-place orders that have been instituted in almost every state and major city in the US as well as in a number of countries worldwide.
As a result of the coronavirus pandemic, companies should carefully consider whether their most recent 409A valuation is still valid or if the valuation date should be changed for an ongoing project. This is especially important because the most critical date is when new options are actually granted, since it is the responsibility of the Board of Directors to determine whether they can still rely on the 409A valuation or if events after the valuation date but prior to the option grant date need to be considered. This determination depends on a number of factors, such as where in the world a company conducts its operations, whether it relies on in-person interactions and was forced to effectively shut down its business or if it can continue at full or partial capacity using remote workers and digital communication, if a company depends on clients or systems that have been greatly impacted by the pandemic and shelter-in-place orders, and any company-specific factors that need to be considered.
For most companies, the coronavirus pandemic will cause some downward impact on value, although the degree is incredibly variable depending on the factors listed above. In addition, there are some companies that have seen and will continue to experience significant growth as the world shifts to more digital communications and a growing percentage of the workforce is required to stay at home rather than going to work.
Moreover, even companies that have not had their operations impacted by the coronavirus pandemic might find capital more difficult to come by, at least in the short-term, and their new projections might be extended, both to reflect an overall reduction in growth rates and a delay in planned exits because the public markets are significantly down from their highs just a couple of months ago.
Furthermore, because of the increased volatility in both the markets and with the pandemic overall, the traditional expectation that companies get 409A valuations every 12 months may be impacted. Companies may not only want to reconsider the current use of a 409A valuation prepared in late 2019 or even early 2020 (but prior to the outbreak of the pandemic outside of China), but companies should revisit this question at least every month or two until the worst of the pandemic has passed and values become more stable.
If you are a current Teknos client, we recommend that you speak with the manager of your most recent 409A valuation to discuss whether your Board of Directors should continue to rely on that valuation. If you are not a Teknos client, however, we are still happy to discuss this with you so that you are able to determine the best path forward, whether that’s continuing to rely on your most recent valuation if the impact on your business from the pandemic is minimal or getting a new valuation that better reflects your current thinking.
Who are we and how can we help?
If you are a current Teknos client, we recommend that you speak with the manager of your most recent 409A valuation to discuss whether your Board of Directors should continue to rely on that valuation. If you are not a Teknos client, however, we are still happy to discuss this with you so that you are able to determine the best path forward, whether that’s continuing to rely on your most recent valuation if the impact on your business from the pandemic is minimal or getting a new valuation that better reflects your current thinking. To learn more, contact Teknos Associates at email@example.com.