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