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Squaring Venture Capital Valuations with Reality

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Re: Squaring Venture Capital Valuations with Reality

#41

Post by pge »

jogjayr wrote: post #17
pge wrote: post #13

Earlier quoted context omitted.

Existing 409A valuations already take all of that into account. When an employee is issued options, the one thing he can be reasonably sure of is that they are not in the money. Options have to be issued at or above the FMV for common stock, or it is taxable compensation to the employee. Note the "at or above" language. An employee's option has to be out of the money the day it is issued, but that could be by .01 or…

Correct me if I'm wrong but the relevant 409A valuation is the most recent one done when you exercise your options and taxes on them become due. I think that's the situation GP was referring to, that this approach might help fix. Unless you're saying that when Square's valuation suggested a share price of ~$15, a 409A done at the same time would have returned a value closer to the ~$5 that the paper suggests is more…

The relevant 409A is the one that is done prior to options being issued. If the company issues options below FMV (i.e. below the FMV determined by an objective third party, "the 409A valuation"), they are giving you in-the-money options, that is, they are giving you something of value at that moment. That's compensation and needs to be taxed as such. Later, when you exercise, either it is because the company was just acquired (and the share is immediately sold and you pay taxes on the profit) or the company has gone public and the shares are now tradable, so FMV is set by the market not by a 409A report. (I am ignoring for simplicity the rarer case where an employee exercises an option that is not freely tradable).

Re: Squaring Venture Capital Valuations with Reality

#42

Post by vintageseltzer »

nurettin wrote: post #33

Reminds me of the over-inflated house prices of Istanbul. (300% increase over the course of 5 years) Perhaps prices aren't as dependent on "complex stock mechanics" as it is dependent on supply/demand. Demand being made up of increasing levels of wealth (or credit) and supply being made up of pure greed.

Isn't the massive devaluation of the lira over that time period the main factor?

Re: Squaring Venture Capital Valuations with Reality

#44

Post by indescions_2017 »

linkregister wrote: post #39
indescions_2017 wrote: post #16

Of equal interest is author's other paper entitled "How Do Venture Capitalist's Make Decisions?" And after 900+ interviews it's neither jockey nor horse nor any other correlation, but spray and pray all around. Am currently negotiating a small ($10k) angel investment in an ecommerce startup in Indonesia. All "go" signals are there: ambitious team, growing market, outside foreign investment, etc. But as far as calcula…

> The fact that in Jakarta you can hire a fresh, world-class engineering graduate for $500 a month to come work for you! That's nuts, considering English teachers make about $1000 per month. Then again, there's such a dearth of opportunity for talent in Indonesia that I don't doubt your figure at all. I can't count how many engineering graduates from Bandung I met who are low-skilled office or vocational careers. I n…

Will definitely post 6 months or so from today! And maybe in a year you can buy my shares ;)

For now, check out this interview with Adrian Li, partner at Convergence Ventures, dedicated to seed investments in Indonesian startups, as well as their portfolio:

Video: Indonesia is the next hyper-growth market

https://www.kauffmanfellows.org/video-indonesia-is-the-next-...

Convergence Ventures | Companies

http://www.convergencevc.com/companies/

Re: Squaring Venture Capital Valuations with Reality

#45

Post by nostromo95 »

stanleydrew wrote: post #11

The rank and file employees of VC-backed companies often receive much of their pay as stock options. The naiive approach, likely used by many of employees, would dramatically overvalue their wealth. For example, the stock options Square issued around the time of its 2014 funding round had a strike price of $9.11.4 The naiive approach would take Square’s 2014 financing round at $15.46 per share and view these options…

Sure, if the option is striking at $9.11 and the underlying asset has an actual value of $5.62, then it's out of the money. That doesn't mean that the option is worthless or even close to worthless though. VC-backed companies are usually hugely volatile which increases the value of options. This is a largely academic point, but there exists a sigma s.t. any call option ~$3.50 out of the money could be valued at $6 by a risk-neutral investor.

Re: Squaring Venture Capital Valuations with Reality

#46

Post by nurettin »

vintageseltzer wrote: post #42
nurettin wrote: post #33

Reminds me of the over-inflated house prices of Istanbul. (300% increase over the course of 5 years) Perhaps prices aren't as dependent on "complex stock mechanics" as it is dependent on supply/demand. Demand being made up of increasing levels of wealth (or credit) and supply being made up of pure greed.

Isn't the massive devaluation of the lira over that time period the main factor?

Average devaluation is 10%/year in other sectors. Doesn't look like a main factor.

Re: Squaring Venture Capital Valuations with Reality

#47

Post by stanleydrew »

robocat wrote: post #37
stanleydrew wrote: post #32

Earlier quoted context omitted.

This is pretty short-sighted though. The definition of "doing well" is relative to the last round's valuation, regardless of business fundamentals. So if your company is actually worth $100M, but you raise $150M at a $1B valuation with a 1x preference, you would get nothing if the company sells for $150M later that year. That would have been a 50% return on the actual true company valuation, had you actually raised a…

In your example the company has lost $100M, not gained 50%... E.g. company has $100M cash and no other assets, receives $150M cash, then later sells company for $150M.

Yes, that's my point. The company "didn't do well" by the standards of the previous round they raised. But had they raised a round that valued them more appropriately, they may have "done well".

Re: Squaring Venture Capital Valuations with Reality

#48

Post by jogjayr »

pge wrote: post #41
jogjayr wrote: post #17

Earlier quoted context omitted.

Correct me if I'm wrong but the relevant 409A valuation is the most recent one done when you exercise your options and taxes on them become due. I think that's the situation GP was referring to, that this approach might help fix. Unless you're saying that when Square's valuation suggested a share price of ~$15, a 409A done at the same time would have returned a value closer to the ~$5 that the paper suggests is more…

The relevant 409A is the one that is done prior to options being issued . If the company issues options below FMV (i.e. below the FMV determined by an objective third party, "the 409A valuation"), they are giving you in-the-money options, that is, they are giving you something of value at that moment. That's compensation and needs to be taxed as such. Later, when you exercise, either it is because the company was jus…

> when you exercise, either it is because the company was just acquired (and the share is immediately sold and you pay taxes on the profit) or the company has gone public and the shares are now tradable,

Nope. I'd argue the most common case of exercising stock options is actually when you leave a company before it has had a liquidity event (and you have to exercise the options because of a 90-day exercise limit). It's also when you want the lowest possible 409A/FMV, so that your taxes are as low as possible. Because you can't sell the shares to pay taxes.

There's also the rarer case (as you said) of employees exercising options of a private company while still remaining employed there. This is done in anticipation of an IPO or similar, to get a head start on the long-term capital gains tax clock. It's still not that rare though.

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