Do you use TTM, last FY or projected rev/ebit figures? similarly for comps? and which debt/cash figures?
fredwilson
· 11 months ago
We try to use current FY forecast, but when a company is growing very rapidly, we often use current quarter annualized and sometimes even go with comps based on next year and apply it to next year¹s plan
This is still not a science and we try to adapt to the most realistic method
rosswhiting
· 11 months ago
Thanks for taking the time to put this together. So very helpful. It is a pain the butt. I only wish it will bring about more transparency, and liquidity. It will definitely bring about more data.
bfeld
· 11 months ago
"Pain in the butt" is just the direct system cost. The unintended consequences of this - like many of ridiculous accounting requirements - are going to be insidious
I wrote a teaser about FAS 157 a while ago at http://www.feld.com/wp/archives/2008/06/fas-157.... I realized that I never wrote the follow up post with "the real problem." My partner Jason was working on his "version" of this post yesterday as a guest for another blog - it'll be out soon. I'll do my "and the punch line is" type of post after that.
fredwilson
· 11 months ago
We should tag up all of these posts with FAS157VC or something like that
kidmercury
· 11 months ago
the problem is the currency. all other distortions in valuations of all markets stem from currency instability. this is inescapable, everything is dependent upon the currency. thus control of the money supply is the best gig in town.
only real solution is new currencies. from this new secondary markets that are stable can be born.
new currencies require a new government of sorts to manage the currency.
it's how the nation-state gets disrupted, friends. hold on to your hats, the ride's just getting started!
fredwilson
· 11 months ago
What do you think of barter?
kidmercury
· 11 months ago
i worry it may come to that. if so i think there will be tons of internet opportunities in building barter mechanisms.
i favor virtual currencies. i.e. everyone invests in a fund that is tied to a basket of assets deemed to be the most stable form of diversification, and shares in this fund then are used as currency. i tend to think i am on track to creating something like this, as i think virtual currencies will be an offspring of virtual communities (i.e. social media). my good friend and fellow 9/11 truther marc andreessen could find a virtual currency mechanism for ning to be advantageous as well, and there are some facebook apps that are about virtual currency stuff.
perhaps what we need is an AVC currency for the AVC community! the fred fund. "because only fred can bet the fed." LOL, we could probably get a movie deal out of this too.
dvolatility
· 11 months ago
Very interesting idea. Also what about those virtual Linden Dollars. Wondering if those are keeping their value relative to the USD or if that could be a place to hedge against inflation, lol. Wondering wtf that currency backs anyway. Virtual currencies is where it's at though and money is basically transferred over the internet anyway. We'd pay for things with an e-card like at gas stations.
kidmercury
· 11 months ago
yes, no doubt. biggest problem i foresee is regulation banning virtual currencies, or requiring it to be declared a security, or basically some way for govt to make sure they have monopolized the market for money supply.
though IMO virtual currencies will win in the end. at least that is what i am hoping for.
dvolatility
· 11 months ago
Wait it's ok if its a registered security. Yeah I'd like to know the rules of "legal tender". I don't care if they are in charge, they just can't manipulate it. Places will have the option to take this currency. Should be interesting. -DV
Jeff DiStanlo
· 11 months ago
not to mention the amount of time it takes for the portfolio company to constantly provide model revision after model revision to the funds as input into the valuation process. constantly reconciling models and plans..... i'm all about financial planning (my job), but there is a limit.
fredwilson
· 11 months ago
We try very hard to insulate our portfolio companies from this process and I think we do a good job but hopefully we¹ll hear from some of them in this thread and we¹ll see if they agree
Steven Kane
· 11 months ago
I sympathize with the pain in the butt factor, and also with the silly irrelevent data point factor.
But on the whole I also sympathize with the LPs of the world, who have been getting quarterly statements and making new investments based on entirely fictitious valuations of venture funds, which in the end, returned poor or even negative returns after years of rosy or at lest seemingly calm internal valuations
But Fred, why can't you just ise the old, tried and true 'lower of cost or market' method?
If indeed its the LOWER of the two, the valuation of a fund will almost always be cost. Which ain't perfect but its arguably fair to everyone. Unless of course "market" is lower, in which case the valution would be marked down below cost. Again, defualting to a worser case scenario, which in a situation like this is fair (or equally unfair) to everyone.
Plus, I'm no accountant, but wouldn't 'lower of cost or market' reporting qualify under FAS157? I think it would.
---
One last note, I think we all need to take a deep deep breath and acknowledge the baked in double stanadrd in what we say we want versus what we do want. Myself included. Now that we in the midst of a meltdown of historic proprotions, and the Democrats are back in power and the left is busy blaming everything including the weather on Pres Bush and the Republicans, we say we want greater transparency and more regulation and more economic fairness. Then when it starts to happen, we cry foul and say regulations are impeding the markets and innovation and the like.
Can't have it both ways. A more transparent and regulated marketplace will also have elements of too much bureaucracy and red tape and silliness. A less transparent and regulated market will have more irregukarities and bubbles and shameless explotation etc. I lean right - libertarian - philosophically, but a s apractical matter I lean left - a little mnore regulation and transparency defaults to protecting the little guy and so I'd rather deal with the excesses of the left on this.
fredwilson
· 11 months ago
FAS157 is the end of ³lower of cost or market² because it requires us to write up investments we¹d otherwise choose to carry at cost
markleffers
· 11 months ago
Just to clear a misconception, FAS 157 did not impose a new mark-to-market accounting requirement on anyone. Rather, FAS 157 provides guidance on measuring fair value for accounting purposes where mark-to-market accounting is already required...such as portfolio companies held by investment companies. The only change coming out of the issuance of FAS 157 relates to how fair value is determined. Companies now have to be more rigorous in their approach and, hopefully, more objective. I'm not defending the FASB...I have some issues with certain elements of the measurement hierarchy in FAS 157 from a valuation perspective. My point is you had to switch out of LCM accounting for portfolio companies long before FAS 157 came along. And with the issuance of FAS 157, the FASB signaled its intent to expand mark-to-market accounting beyond its current footprint. Full employment for valuation firms for as long as the FASB continues to exist.
fredwilson
· 11 months ago
Thanks for that clarification
Yes, we should have moved away from LCM a long time ago, but we were able to get away with it with our auditors for the most part until FAS157 came along
Now it¹s a whole new ballgame
David Semeria
· 11 months ago
Fred, you might not wish to comment on this, but do bonuses in your company depend on these valuations? I my view, the practice of awarding bonuses based on unrealized gains was the key driver of the latest bubble.
fredwilson
· 11 months ago
Never
If we have bonus plans, they are based on fundamental, both qualitative and quantitative
I don¹t like comp¹ing people based on stock price or valuation
They already have that incentive because of their stock ownership
Phanio
· 11 months ago
Valuation multiples, WACC, or any other valuation method are just seat of the pants numbers. For any asset, it is only worth what someone else will pay for it. You can do all the calculations that you want, but, if no one will buy, it is worthless.
You would be better off surveying accrediated investors - asking what they would pay to own shares in the firm. That's your only real value. If you, through these methods, say its worth $100 million but investors are only willing to pay $10 million - it is only worth $10 million.
fredwilson
· 11 months ago
That¹s the old way, actually
We often valued the investments at the last round price which is the price a real investor paid
But even then, it¹s tricky
Just because I pay $10mm at a $100mm valuation for a 10% stake in a company, doesn¹t mean it can be sold for $100mm
I might have a dividend, a multiple liquidation preference, or a participating preferred
Or it might have been a strategic investor who overpaid for alterior motives (aka msft¹s $15bn value on Facebook)
There¹s no perfect solution to be honest other than honest, diligent, frank assessments by people who know the investments best and we are sort of moving away from that era
mleffers
· 11 months ago
This entire valuation area is clouded even worse by the current fractured equity markets where similar company comps may have no relevance for valuation purposes. FASB and SEC recently issued clarification on FAS 157 that allows companies to apply little or no weight to exchange traded prices when the markets are effectively broken. They were addressing mortgage backed securities specifically, but their conclusion would apply to equities in a similar circumstance. In this instance. other methods such as capitalization of EBITDA, revenue, etc., discounted cash flow, etc. are more relevant and appropriate.
markslater
· 11 months ago
yes agree - but a DCF pre-supposes an element of certainty around future earnings - with these companies that really is voodoo. imagine convincing someone of a 'tangible non-financial metric (eyeballs or whatever) converting this in to a comparable financial metric, and then going out 5 years.
reminds me of the late 90's when DCFs included 40% discount rates!
CCoulson
· 11 months ago
I would disagree that the SEC had any intention of of allowing exchange prices to be ignored because public markets are depressed.
The SEC clarification specifically excluded exchange markets and other active OTC markets, Level 1 pricing sources under FASB 157, such as NYSE, NASDAQ, FINRA's OTC Bulletin Board and Pink OTC Markets' (my company) OTCQX and Pink Sheets market tiers. Active markets are exchange prices or OTC markets where the broker quotes are firm and reflect actual transactions.
The SEC clarification was regarding inactive markets in which they stated "A quoted market price in an active market for the identical asset is most representative of fair value and thus is required to be used (generally without adjustment). Transactions in inactive markets may be inputs when measuring fair value, but would likely not be determinative. If they are orderly, transactions should be considered in management's estimate of fair value. However, if prices in an inactive market do not reflect current prices for the same or similar assets, adjustments may be necessary to arrive at fair value."
Good point and for now I agree. Low volume equities MAY end up in the same place, though.
Simon Brocklehurst
· 11 months ago
Hmmmm.... creating a secondary market where the true value of the underlying assets isn't known? What could *possibly* go wrong?! ;-)
Vinicius Vacanti
· 11 months ago
Mark-to-market sounds fair and reasonable. However, it can also be dangerous when the market breaks down and isn't a fair perception of the value of an asset. The stock market example is a short squeeze where short sellers get margin called as the stock moves irrationally higher (see Volkswagen becoming most valuable company in the world). A more dangerous example is what's happening in the credit market where senior secured debt continues to trade down to irrational levels forcing holders of that debt to keep selling because they have to keep marking down those investments. Is there a danger of this sort of un-virtuous cycle hitting the VC world?
On a personal note, I used to have to do this analysis for Quadrangle Group, a media private equity firm, where I worked before my current start-up. It was hard enough calculating the value of a mature, cash-flow generating company. It must be much more challenging / almost laughable to perform a valuation of an asset without positive cash flow based on metrics like unique visitors per month.
fredwilson
· 11 months ago
I don't see the danger or the un-virtuos cycle because VC funds are illiquid long term investments that don't have repayment requirements or margin calls or such things
David Hornik
· 11 months ago
Thanks for this rundown Fred. The VC community is all dealing with this now. And I personally think that the results are, at best, arbitrary. As you point out, companies having strong quarters do not necessarily correlate with high valuations. Companies like Twitter make clear the problem with trying to value non-public, non-liquid stocks. Twitter's growth has been massive and its influence is increasing by leaps and bounds but its revenues, not so much. So do you mark it down from its last financing? That would be silly. It may be more appropriate to mark it up. But based upon what metric? Are there really comps for Twitter? So I personally think that the whole process is absurd. I believe that the appropriate thing to do is to value a private company based upon its last outside-led financing. Any other valuation is merely a fiction. Over time company valuations will adjust based upon 1) future financings, 2) liquidity events, or 3) going out of business. Any effort to adjust prices in between are necessarily flawed and therefore relatively meaningless.
fredwilson
· 11 months ago
I¹d prefer to value them at a discount to the last round financing to be honest
I think we know what these companies are worth and sometimes they have to grow into their last round valuations
Phanio
· 11 months ago
Is it you know what they are really worth or what they are worth to you?
fredwilson
· 11 months ago
Good question
markslater
· 11 months ago
exactly david - there is value (huge IMO) created in this example but its absurd to have it measured in financial terms at this stage (beyond the stake placed in the ground by the round as you explain) - or to be held to that measure. After all the real true value is what the person risking his (and his LPs) capital at the last round was.
Mark
· 11 months ago
Fred said: "I'm all for transparency and mark to market"
Surely you're referring to this Mark to Market ... www.reiboldt.com
(I have no shame, I know) :-)
fredwilson
· 11 months ago
Yes I am all for that one to mark!
dano
· 11 months ago
Fred - regarding the last full paragraph...when will we see a vibrant secondary market for private company stock, in your opinion? I know a few mgmt teams that would love to explore that option...
fredwilson
· 11 months ago
I think it exists today for at least one (facebook) and possibly a few others
This year I hope we can have a dozen or a couple dozen companies achieve liquid private markets for their stock
I think within five to ten years, it may be a real alternative to the public markets
Phanio
· 11 months ago
Out of my league here but didn't the NASDAQ create a secondary market for these under Rule 144A?
Marc
· 11 months ago
Fred,
Isn't the FASB rule based on the assumption that VCs are (generally) able to value a private company at various stages of its existence (seed, early, late, aso.) when they need to issue a term-sheet? The inter-VC competitive issue set apart, when VCs offer a PPS, it is supposed to be as close as possible of a fair market value. The later defined as expected future value discounted for risk and not including the VCs very own influence on boosting the company valuation.
fredwilson
· 11 months ago
The price we pay is not always the price a buyer will pay. We can put all kinds of 'structure' into a security that makes it possible to pay a nominal valuation that is not close to what we think a buyer might pay. This is complicated stuff
Facebook User
· 11 months ago
Fred - couple comments. First, not sure if you meant 'tortuous' (twisty) or 'torturous' (causing torture; unpleasantly painful) in the title. Second, FASB157 seems to me to make perfect sense... for public PE shops like BX. Investors in that type of firm should be able to rely on their public books to be at least as high quality and reliable as the books of a Goldman, Sachs (stop snickering!) or a Berkshire Hathaway. However, for closely-held investment partnerships that are restricted to sophisticated investors, imposing that level of rigor increases costs without really adding any value.
All that said, I do wonder if writing down the value of your portfolio companies that are doing great doesn't actually make sense. The equity risk premium for ALL equities has shrank dramatically in the past year; that even includes tiny venture backed companies hoping for an IPO some day. The market may be irrational but it's still the market.
mleffers
· 11 months ago
Writing down to market is easy. No one argues with that...including the auditors. But, who will have the courage to write UP and record a gain when that day comes? And, on IPO day, there had better not be a gain recorded (at least not a disproportionally large gain anyway)...the stock should have been adjusted taking into account the probability of the IPO closing and the expected pricing. M2M based on anything other than reliable, verifiable market data is a treacherous path.
jsinclair
· 11 months ago
Speaking from a portfolio company perspective we have not felt any of the FAS157 pain as the info required from us are things we are already providing.
With regards to your silver lining, I think the FAS157 valuations will be much more useful showing an interesting trend than 409a valuations. Although with all of these valuation requirements for private equity (common and preferred shares) you wonder if there will be some normalization of methods by FASB. But I seriously doubt it.
fredwilson
· 11 months ago
Jack thanks for stopping by and letting us know what a portfolio company CFO things. Very helpful and interesting perspective too.
Ed French
· 11 months ago
I know it's no comfort, but we had the same issues with the same type of change in the UK a while ago- sorry no easy answers from this side of the pond! Good luck with it.
Debunkr
· 11 months ago
"explaining away certain numbers that are on the books but make no sense." Actually the valuations do make sense considering that the exit for any of your companies at any point in time will be heavily influenced by the level of public market valuations. If you sell to a public company or go public, one of the key data sets that will be utilized in setting the price will be comparable public company valuations. Additionally, when a company does an accretion/dilution analysis, the valuation levels of its equity will directly effect its break-even points.
startupcfo
· 11 months ago
I sympathize with your pain. I prefer the old way. The truth is, that in the absence of an actual 3rd party transaction (financing or sale), valuation is subjective and relative. There are so many assumptions that you can almost make the valuation move any way you want. I have seen this on the 409A valuations we do. Debating over 1 or 2 assumptions can have a massive impact on the end result.
I guess now that Sar-box has settled down, the auditors needed something else to keep the fees going.
Charlie
· 11 months ago
It seems to me that FASB 157 is a step forward for the vast amount of capital deployed in Private Equity (e.g.: LBO and Hedge Funds) and a step backward from LCM for Venture Funds. Especially, early stage funds, which, when executing their mission and investing in new markets, or disrupting existing one's, the concept of comparables to public companies is almost meaningless.
I suspect this will cause VC firms to adopt one set of valuation criteria for accounting purposes, and another to really determine how their fund is performing and communicating that to their existing and prospective LP's.
Doug Redding
· 11 months ago
Hi Fred - Long time reader, first time commenter. When we closed our latest fund about a year ago, in our LP agreement, we expressly excluded an audit in accordance with GAAP to get around the FAS157 issue. Our auditors do everything except value the assets. For those, they do a "report on agreed upon procedures" that tells our LPs that the assets are valued in accordance with our valuation policy which is basically LCM as you described early in your post. I don't think there would be any reason you couldn't modify your existing LP agreement if you could get all LPs to go along.
Doug
fredwilson
· 11 months ago
That's interesting. Opt out of GAAP. Our LPs prefer LCM for the most part so we could possibly do this. I am not sure I want to amend an LP agreement though
andrewparker
· 11 months ago
I'm all in favor of this. Definitely something to consider for a future fund if it's a realistic option.
Doug Redding
· 11 months ago
Next fund for sure!
Gregg Smith
· 11 months ago
We did the same thing. We issued tax basis financial statements that allowed us to use LCM. This was 4 years ago though (got back in to running companies).
andrewparker
· 11 months ago
Fred accurately captured our valuation process and methodology. I think the new FAS 157 guidelines in defining fair value are annoying for two reasons:
1) FAS 157 (as interpreted -- i have not read it directly) encourages comparing two companies at a snapshot in time, and do not account for growth rate. If company A and company B both have 20MM in revenue, but company A is growing revenue aggressively and company B is growth is flat, A should be worth more than B, but often times these valuations exercises don't value growth well. We try using different methodologies (such as forward rev comps instead of current rev comps) in different circumstances to best capture the value of growth, but it's a bit of a black art, and rather subjective.
2) It's simply takes too much time. We spent too many hours discussing valuations or aggregating the necessary materials for the purpose of valuations... and that's time that could be better spent sourcing new opportunities, working with existing portfolio companies, networking, etc... I think there's an opportunity to create a private market valuation consulting firm that handles the valuation of a VC portfolio for less than the cost of our time.
I can appreciate the silver lining that Fred mentioned above, but I'm not quite as optimistic as him about the value of all the work we are doing. All this work is pegged against current public market comps.... so I think this corpus of private company valuations says more about the state of the public market at the time of the valuation than it does about the company being valued.
fredwilson
· 11 months ago
That last line is so true andrew
Misty faucheux
· 11 months ago
Thanks for the explanation. These are some confusing times, but thanks for breaking it down for us.
Misty Faucheux Social Media/Community Relations Manager, www.Viscape.com
Boris M. Silver
· 11 months ago
I could be wrong, but from what I've read/understand this reeks of "short termism" and puts an unnecessary burden on VC firms.
I don't think there should be such an emphasis on the valuations carried in the books. If anything it should only be mark down rules that apply. i.e. In the cases where you are "uncomfortable" marking up companies to the comps that you find in the market, you should be able to carry them at cost.
Erring on the side of conservative is always better, but it's stupid to apply such short term rules in an asset class like VC where the comps are often hard to really justify and the outlook is often much longer term.
Yokum
· 11 months ago
Fred - If you're doing this much valuation analysis, will you also be doing the 409A valuations for your portfolio companies, as it seems like you would meet the "significant knowledge and experience" requirement for preparing written valuation reports under 409A?
fredwilson
· 11 months ago
We outsource the 409a work to third parties that specialize in it
Hank Barry
· 11 months ago
Unrealized gains are not gains.
In the FAS 157 context "market" means "the last round of financing." But here is the problem: just because a company raises a round of capital where it sells 10% of the company for $10M does not mean that the company could be sold any time soon for $100M. The "valuation" paid by a venture investor is simply the arithmetic product of a deal that says "I will buy X fraction for Y dollars." It is NOT valid to imply from that event that the whole company is worth Y divided by X. In other words, the "post-money" value is not the "street" value.
And yet, in the financial statements of all US venture firms, and therefore in the financial statements of our university endowments and retirement and pension funds, all of these investments are being carried at the "whole company" value. Because the companies are still private or have not yet been purchased, the differences between the implied whole company price at the time of the original investment and the implied whole company price at the date of the statement is reported as a "gain". Of course, because there is no gain (in the old-fashioned "real" sense), it is called an "unrealized" gain. This reporting is mandated by law, but makes no sense.
And this rule leads to abuses. One is to make a very large investment at one valuation, which is shortly followed by a very small investment by a new investor at a much higher implied valuation. All of the money invested in the early large round is then "marked up", and unrealized gains reported, simply because there has been some market event. And of course there are venture firms who simply "follow" other (leading) firms, "paying up" whatever the more successful firm wants for later round stock in a portfolio company, just to be able to say they invested alongside the more prestigious firm. In the baroque manifestation of this, if there has not been any market event financing for a period of time, some firms will mark up an investment and report "unrealized gains" simply because time has passed and the company has not gone out of business - so something good must be happening.
None of these practices result in an accurate report of the condition of the money/value invested.
Until FAS 157 was mandated, the most successful and conservative investors always carried investments at the LOWER of cost or market, until there was an actual (REALIZED) gain, as in $$$. This is how they do it in Europe and it makes eminent sense.
fredwilson
· 11 months ago
I totally agree Hank. You made my point better and quicker than I did.
Drama 2.0
· 11 months ago
Can you please run the following numbers for me:
Annual Revenue: $105,000. EBIDTA: Negative, Roger. Unique Visitors: 975,000/month. Pageviews: 10 million/month. Comparable M&A in the past 6 months: none.
Thanks in advance.
bernardlunn
· 11 months ago
A market research veteran (not financial specialist) once said to me - there is "data to know" and "data to tell". It seems that all this "pain in the butt" is about "data to tell". And it does seem like a lot of make-work. LPs should focus on actual past returns and ignore the rest. There are no "widows and orphans" to protect in VC world. Why all this work as if you are public company? Looks like a huge distraction from the real job of picking and nurturing winners
jdrive
· 11 months ago
We definitely feel your pain, Fred. FAS 157 can lead to all kinds of unintended consequences. Frankly, we don't put in the same effort as it sounds like you guys do; we go old-school at lower of cost or market, with some adjustments where directly attributable data points exist. We'll do the FAS stuff as required for reporting purposes (within reason), but neither we - nor most of our LP's - put much stock in it. Hence we give them what we really think.
CCoulson
· 11 months ago
I am one of the brave soles operating a secondary market that does not require SEC registration. So take my words with a grain of salt, but we are trying to create a new platform for pre-NASDAQ companies to become publicly traded without SEC registration.
Part of the value of having an independent secondary market do the valuation is that it creates a credible valuation source for investors and employees. Right or wrong as investors can be, it is an independent source that makes the accounting and performance score keeping simpler. FASB has recognized this in 157 as well as Statement 115, Accounting for Certain Investments in Debt and Equity Securities, by recognizing exchange prices, and the prices from public OTC markets such as mine.
With the SEC'S recent changes to Rule 144, many non-SEC reporting companies can now have shares held by non affiliates become publicly traded on the OTC market one year after making the investment without SEC registration.
My company, Pink OTC Markets www.pinkotc.com, has in taken our Pink Sheets market tier fully electronic and provides a valuable service to the broker-dealer community in helping them get best execution for their customers in securities that are not listed on exchanges and efficiently trade over 100 billion of dollar volume. However the Pink Sheets is a broker-quoted market and by its nature has a huge variability in quality of securities traded.
Thus we created our OTCQX market tier that added an issuer listing process so OTC traded companies could give investors the trading transparency, information availability, broker access and quality control of an exchange listed security without SEC registration. We have designed OTCQX to fit U.S. laws using the London Stock Exchange AIM market's sponsored listing process as a model.
The AIM took over 10 years of hard work to be called a success, and now with markets out of favor, there are still critics. But it has helped many sub-NASDAQ companies access capital in the past and will help in the future. We have two U.S. companies that raised capital on the AIM and are using OTCQX to start building U.S. investor trading after the one year 144 holding period.
We hope that the value of what we are creating with OTCQX will create a better, more informed and trusted market for investors that opens up a new opportunity for companies to grow into a NASDAQ listing.
fredwilson
· 11 months ago
This is starting to make sense to me now
I agree that the more transparency we have on the value of private companies the better for everyone
Kris Brown
· 11 months ago
I remember the old days well. My how times have changed.
All Comments
rapidly, we often use current quarter annualized and sometimes even go with
comps based on next year and apply it to next year¹s plan
This is still not a science and we try to adapt to the most realistic method
I wrote a teaser about FAS 157 a while ago at http://www.feld.com/wp/archives/2008/06/fas-157.... I realized that I never wrote the follow up post with "the real problem." My partner Jason was working on his "version" of this post yesterday as a guest for another blog - it'll be out soon. I'll do my "and the punch line is" type of post after that.
only real solution is new currencies. from this new secondary markets that are stable can be born.
new currencies require a new government of sorts to manage the currency.
it's how the nation-state gets disrupted, friends. hold on to your hats, the ride's just getting started!
i favor virtual currencies. i.e. everyone invests in a fund that is tied to a basket of assets deemed to be the most stable form of diversification, and shares in this fund then are used as currency. i tend to think i am on track to creating something like this, as i think virtual currencies will be an offspring of virtual communities (i.e. social media). my good friend and fellow 9/11 truther marc andreessen could find a virtual currency mechanism for ning to be advantageous as well, and there are some facebook apps that are about virtual currency stuff.
perhaps what we need is an AVC currency for the AVC community! the fred fund. "because only fred can bet the fed." LOL, we could probably get a movie deal out of this too.
though IMO virtual currencies will win in the end. at least that is what i am hoping for.
-DV
think we do a good job but hopefully we¹ll hear from some of them in this
thread and we¹ll see if they agree
But on the whole I also sympathize with the LPs of the world, who have been getting quarterly statements and making new investments based on entirely fictitious valuations of venture funds, which in the end, returned poor or even negative returns after years of rosy or at lest seemingly calm internal valuations
But Fred, why can't you just ise the old, tried and true 'lower of cost or market' method?
If indeed its the LOWER of the two, the valuation of a fund will almost always be cost. Which ain't perfect but its arguably fair to everyone. Unless of course "market" is lower, in which case the valution would be marked down below cost. Again, defualting to a worser case scenario, which in a situation like this is fair (or equally unfair) to everyone.
Plus, I'm no accountant, but wouldn't 'lower of cost or market' reporting qualify under FAS157? I think it would.
---
One last note, I think we all need to take a deep deep breath and acknowledge the baked in double stanadrd in what we say we want versus what we do want. Myself included. Now that we in the midst of a meltdown of historic proprotions, and the Democrats are back in power and the left is busy blaming everything including the weather on Pres Bush and the Republicans, we say we want greater transparency and more regulation and more economic fairness. Then when it starts to happen, we cry foul and say regulations are impeding the markets and innovation and the like.
Can't have it both ways. A more transparent and regulated marketplace will also have elements of too much bureaucracy and red tape and silliness. A less transparent and regulated market will have more irregukarities and bubbles and shameless explotation etc. I lean right - libertarian - philosophically, but a s apractical matter I lean left - a little mnore regulation and transparency defaults to protecting the little guy and so I'd rather deal with the excesses of the left on this.
write up investments we¹d otherwise choose to carry at cost
Yes, we should have moved away from LCM a long time ago, but we were able to
get away with it with our auditors for the most part until FAS157 came along
Now it¹s a whole new ballgame
If we have bonus plans, they are based on fundamental, both qualitative and
quantitative
I don¹t like comp¹ing people based on stock price or valuation
They already have that incentive because of their stock ownership
You would be better off surveying accrediated investors - asking what they would pay to own shares in the firm. That's your only real value. If you, through these methods, say its worth $100 million but investors are only willing to pay $10 million - it is only worth $10 million.
We often valued the investments at the last round price which is the price a
real investor paid
But even then, it¹s tricky
Just because I pay $10mm at a $100mm valuation for a 10% stake in a company,
doesn¹t mean it can be sold for $100mm
I might have a dividend, a multiple liquidation preference, or a
participating preferred
Or it might have been a strategic investor who overpaid for alterior motives
(aka msft¹s $15bn value on Facebook)
There¹s no perfect solution to be honest other than honest, diligent, frank
assessments by people who know the investments best and we are sort of
moving away from that era
reminds me of the late 90's when DCFs included 40% discount rates!
The SEC clarification specifically excluded exchange markets and other active OTC markets, Level 1 pricing sources under FASB 157, such as NYSE, NASDAQ, FINRA's OTC Bulletin Board and Pink OTC Markets' (my company) OTCQX and Pink Sheets market tiers. Active markets are exchange prices or OTC markets where the broker quotes are firm and reflect actual transactions.
The SEC clarification was regarding inactive markets in which they stated "A quoted market price in an active market for the identical asset is most representative of fair value and thus is required to be used (generally without adjustment). Transactions in inactive markets may be inputs when measuring fair value, but would likely not be determinative. If they are orderly, transactions should be considered in management's estimate of fair value. However, if prices in an inactive market do not reflect current prices for the same or similar assets, adjustments may be necessary to arrive at fair value."
The full SEC release is available at:
http://sec.gov/news/press/2008/2008-234.htm
On a personal note, I used to have to do this analysis for Quadrangle Group, a media private equity firm, where I worked before my current start-up. It was hard enough calculating the value of a mature, cash-flow generating company. It must be much more challenging / almost laughable to perform a valuation of an asset without positive cash flow based on metrics like unique visitors per month.
honest
I think we know what these companies are worth and sometimes they have to
grow into their last round valuations
Surely you're referring to this Mark to Market ... www.reiboldt.com
(I have no shame, I know) :-)
This year I hope we can have a dozen or a couple dozen companies achieve liquid private markets for their stock
I think within five to ten years, it may be a real alternative to the public markets
Isn't the FASB rule based on the assumption that VCs are (generally) able to value a private company at various stages of its existence (seed, early, late, aso.) when they need to issue a term-sheet? The inter-VC competitive issue set apart, when VCs offer a PPS, it is supposed to be as close as possible of a fair market value. The later defined as expected future value discounted for risk and not including the VCs very own influence on boosting the company valuation.
All that said, I do wonder if writing down the value of your portfolio companies that are doing great doesn't actually make sense. The equity risk premium for ALL equities has shrank dramatically in the past year; that even includes tiny venture backed companies hoping for an IPO some day. The market may be irrational but it's still the market.
With regards to your silver lining, I think the FAS157 valuations will be much more useful showing an interesting trend than 409a valuations. Although with all of these valuation requirements for private equity (common and preferred shares) you wonder if there will be some normalization of methods by FASB. But I seriously doubt it.
CFO things. Very helpful and interesting perspective too.
I guess now that Sar-box has settled down, the auditors needed something else to keep the fees going.
I suspect this will cause VC firms to adopt one set of valuation criteria for accounting purposes, and another to really determine how their fund is performing and communicating that to their existing and prospective LP's.
Doug
1) FAS 157 (as interpreted -- i have not read it directly) encourages comparing two companies at a snapshot in time, and do not account for growth rate. If company A and company B both have 20MM in revenue, but company A is growing revenue aggressively and company B is growth is flat, A should be worth more than B, but often times these valuations exercises don't value growth well. We try using different methodologies (such as forward rev comps instead of current rev comps) in different circumstances to best capture the value of growth, but it's a bit of a black art, and rather subjective.
2) It's simply takes too much time. We spent too many hours discussing valuations or aggregating the necessary materials for the purpose of valuations... and that's time that could be better spent sourcing new opportunities, working with existing portfolio companies, networking, etc... I think there's an opportunity to create a private market valuation consulting firm that handles the valuation of a VC portfolio for less than the cost of our time.
I can appreciate the silver lining that Fred mentioned above, but I'm not quite as optimistic as him about the value of all the work we are doing. All this work is pegged against current public market comps.... so I think this corpus of private company valuations says more about the state of the public market at the time of the valuation than it does about the company being valued.
Misty Faucheux
Social Media/Community Relations Manager, www.Viscape.com
I don't think there should be such an emphasis on the valuations carried in the books. If anything it should only be mark down rules that apply. i.e. In the cases where you are "uncomfortable" marking up companies to the comps that you find in the market, you should be able to carry them at cost.
Erring on the side of conservative is always better, but it's stupid to apply such short term rules in an asset class like VC where the comps are often hard to really justify and the outlook is often much longer term.
In the FAS 157 context "market" means "the last round of financing." But here is the problem: just because a company raises a round of capital where it sells 10% of the company for $10M does not mean that the company could be sold any time soon for $100M. The "valuation" paid by a venture investor is simply the arithmetic product of a deal that says "I will buy X fraction for Y dollars." It is NOT valid to imply from that event that the whole company is worth Y divided by X. In other words, the "post-money" value is not the "street" value.
And yet, in the financial statements of all US venture firms, and therefore in the financial statements of our university endowments and retirement and pension funds, all of these investments are being carried at the "whole company" value. Because the companies are still private or have not yet been purchased, the differences between the implied whole company price at the time of the original investment and the implied whole company price at the date of the statement is reported as a "gain". Of course, because there is no gain (in the old-fashioned "real" sense), it is called an "unrealized" gain. This reporting is mandated by law, but makes no sense.
And this rule leads to abuses. One is to make a very large investment at one valuation, which is shortly followed by a very small investment by a new investor at a much higher implied valuation. All of the money invested in the early large round is then "marked up", and unrealized gains reported, simply because there has been some market event. And of course there are venture firms who simply "follow" other (leading) firms, "paying up" whatever the more successful firm wants for later round stock in a portfolio company, just to be able to say they invested alongside the more prestigious firm. In the baroque manifestation of this, if there has not been any market event financing for a period of time, some firms will mark up an investment and report "unrealized gains" simply because time has passed and the company has not gone out of business - so something good must be happening.
None of these practices result in an accurate report of the condition of the money/value invested.
Until FAS 157 was mandated, the most successful and conservative investors always carried investments at the LOWER of cost or market, until there was an actual (REALIZED) gain, as in $$$. This is how they do it in Europe and it makes eminent sense.
Annual Revenue: $105,000.
EBIDTA: Negative, Roger.
Unique Visitors: 975,000/month.
Pageviews: 10 million/month.
Comparable M&A in the past 6 months: none.
Thanks in advance.
Part of the value of having an independent secondary market do the valuation is that it creates a credible valuation source for investors and employees. Right or wrong as investors can be, it is an independent source that makes the accounting and performance score keeping simpler. FASB has recognized this in 157 as well as Statement 115, Accounting for Certain Investments in Debt and Equity Securities, by recognizing exchange prices, and the prices from public OTC markets such as mine.
With the SEC'S recent changes to Rule 144, many non-SEC reporting companies can now have shares held by non affiliates become publicly traded on the OTC market one year after making the investment without SEC registration.
My company, Pink OTC Markets www.pinkotc.com, has in taken our Pink Sheets market tier fully electronic and provides a valuable service to the broker-dealer community in helping them get best execution for their customers in securities that are not listed on exchanges and efficiently trade over 100 billion of dollar volume. However the Pink Sheets is a broker-quoted market and by its nature has a huge variability in quality of securities traded.
Thus we created our OTCQX market tier that added an issuer listing process so OTC traded companies could give investors the trading transparency, information availability, broker access and quality control of an exchange listed security without SEC registration. We have designed OTCQX to fit U.S. laws using the London Stock Exchange AIM market's sponsored listing process as a model.
The AIM took over 10 years of hard work to be called a success, and now with markets out of favor, there are still critics. But it has helped many sub-NASDAQ companies access capital in the past and will help in the future. We have two U.S. companies that raised capital on the AIM and are using OTCQX to start building U.S. investor trading after the one year 144 holding period.
We hope that the value of what we are creating with OTCQX will create a better, more informed and trusted market for investors that opens up a new opportunity for companies to grow into a NASDAQ listing.
I agree that the more transparency we have on the value of private companies
the better for everyone
Nice article Fred.