A top-flight valuation practice just had a call with the audit/valuation team at one of the Big 4 accounting firms, in which the auditors expressed several specific points to consider in the context of FAS123R, Share-Based Payments, and 409A valuations. Although we can’t name the players—their detailed conversation makes clear that each auditing team has its own expectations, so practitioners must talk to their auditors early, prior to any engagement:
Here are some of the issues that surfaced in this particular situation:
- Liquidation value: A liquidation premise of value is only appropriate in cases using a PWERM. The OPM (Black Scholes) adequately contemplates the probability of failure in the range of outcomes implied by the calculated volatility, and including a liquidation premise in equity value overstates the probability of failure for a going-concern.
- Reverse OPM. This method should only apply when the latest round of financing is proximate in time. Although there is no ‘bright line’ test for determining proximity, one year would be too great. If the analyst believes a dated investment would be relevant, then the report should describe the supporting facts since the prior round, such as: i) the company’s operating performance has not improved (actuals short of forecasts); ii) the IPO market has not changed; iii) neither have the economy and industry; and iv) the company and its comparables show limited volatility (flat growth).
- Market vs. income approach. These approaches should be closely aligned, not significantly affected by their weights, with the market analysis serving as a “shorthand” for arriving at a discounted cash flow value. In the market approach, the analyst should not “blindly” select the median or mean multiples (unless the company’s performance is in fact average). Rather, objective multiples that best captures the company’s standing among its peers should be used.
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