When does secondary market data trump model-based estimates?Exclusive highlights from AICPA Cheap Stock Practice Aid

BVWireIssue #109-4
October 26, 2011

Following the slump in IPO markets and the sluggishness in venture-backed exit strategies over the past 10 years, the private secondary markets “have become an increasingly important avenue for liquidity” for certain investors and employees holding private company stock options, says a new chapter from the updated AICPA Cheap Stock Practice Aid. Neil Beaton (Grant Thornton), a member of the Cheap Stock Task Force, gave BVWire a “sneak peek” at the chapter “Inferring Value from Transactions in Private Company Stock,” which is currently under SEC and FASB review.

The proposed new chapter focuses on private stock transactions facilitated through the secondary markets. Whether these transactions provide a relevant indication of fair value for share-based compensation—preferable to model-based estimates—will depend on many factors, the Aid says. Key among them: “whether the market represents an exit market for current employees.” If so—and if repeated transactions occur around a given price level at or near the valuation date, then “there is a presumption that the traded price is the fair value for the stock.” If not, then the trading price may only be another indication of the employee’s primary exit market price. In all cases, it’s necessary to consider the specific characteristics of the secondary market, the Aid emphasizes, as indicated by these factors:

  • Timing of transaction data;
  • Equilibrium between supply and demand;
  • Sophistication of the buyers;
  • Supply of information to value the investment and make an investment decision;
  • Pattern of trades;
  • Possible market biases, costs of holding, hedging, or trading the securities; and
  • Employee access to the market.

This is just a glimpse of what’s to come in the updated Cheap Stock Practice Aid, which the Task Force hopes to release by the end of this year, depending on the speed of regulatory review, says Beaton. Be sure to catch his complete presentation on the final proposal at the upcoming AICPA National BV Conference in Las Vegas, Nov. 6-8. Note this—Beaton may be defying the laws of physics, presenting in five AICPA sessions over three days, joining such noted experts as Ron Seigneur, Nancy Fannon, Gary and Linda Trugman, Kevin Yeanoplos, Jim Alerding, Mark Zyla, and others.

Vast majority of BV appraisers still want unified standards

Nearly three-quarters (73.3%) of respondents to our latest online poll believe that there should be a single set of BV standards. This parallels the nearly 80% who answered “yes” to the same question in 2007—but notably, the more recent survey garnered over twice the number of responses, 149 compared to 72 four years ago, indicating that this hot-button issue has grown even more heated.

Importantly, respondents are split over the “ideal” number of BV credentials that the profession could support from one or more professional organizations. Barely one-eighth (12.5%) of survey participants believe that one credential would be best; nearly a third (32.1%) said two would be optimal, while 16.% answered “three” and only 8.9% supported four. 

Written comments were even more divided, from one respondent who said, “When there is only ‘one’ of anything there is no motivation or incentive to do anything other than the status quo,” to another who believes, “Unless we unite, the accountants will continue to define valuation standards and make us do their bidding.” Some claim that the market will “force” unification, while several believe that the number of credentials turns on what the market will bear. The multiplicity of credentials may be causing more judges and attorneys to make the ultimate valuation decisions in courtroom cases, says one respondent, while another—who boasts five BV credentials plus a number of forensic certifications—says, “I find that they add to the weight given my testimony by judges and juries,” and that it’s “a hoot” to see opposing experts wasting their direct testimony explaining why they do not need them. Finally, one participant believes the profession would be better off without any credentials, due to the politics of “promoting ideology over good research.” Look for a complete discussion and summary of current opinions in a future Business Valuation Update.

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