Asset Approach Method
What is the asset method and why was it used?
According to the AICPA guidance for 409a valuation, the asset approach is the most reliable indicator of fair market value for companies that are in the very early stages of development, have not yet raised any arms-length financing, or when there is a limited (or no) basis for the application of the Income Approach or the Market Approach. This method defines an enterprise's fair market value as the sum total of the enterprise's assets minus the sum total of the corresponding liabilities. In the case that an enterprise's assets are not sufficiently captured on its balance sheet, the cost to recreate method assumes that the enterprise's fair market value is consistent with the replacement cost (i.e. cost to recreate) of the enterprise's assets.
What drives the price of common stock in the Asset Approach?
The replacement cost of the company is the primary input in the Asset Approach. The replacement cost is calculated by approximating the market salaries of the company's personnel as well as overhead and additional costs associated with operating the business.
How are the guideline public comparable companies selected?
We leveraged the public companies provided in the Carta 409a request form, performed industry research on Standard & Poor’s Capital IQ database of more than 60,000 publicly traded companies, and relied on Carta's database of private companies to curate the most applicable set of comparable companies. We understand that it is almost always the case that the public comparable companies are significantly larger and more established and as a result, we do take that into account and make adjustments to the relevant inputs that are derived from the selection of the public comparable companies.
How does the volatility selection affect the valuation?
We analyzed the range of volatilities of the guideline public companies to approximate an appropriate volatility for your Company. Volatility selection is based on the range provided by comparable public companies, industry, and stage of company. Small changes in the volatility selection often have no material impact on the FMV of common stock. While an increased volatility could potentially increase the DLOM calculation, an increased volatility would potentially offset any decrease in the common share price caused by a higher DLOM because a higher volatility increases the marketable (pre-DLOM) share price due to the increased optionality in the OPM.
How do we define cash and cash equivalents?
Cash and cash equivalents refer to the line item on the balance sheet that reports the value of a company's assets that are cash or can be converted into cash immediately. These include bank accounts, marketable securities, commercial paper, Treasury bills and short-term government bonds with a maturity date of three months or less. Marketable securities and money market holdings are considered cash equivalents because they are liquid and not subject to material fluctuations in value.
How does the industry classification affect the valuation?
Just as in picking a selection of similar public comparable companies, there typically isn't an exact single industry that comprehensively classifies a company; instead we often must choose from a database of industries to include in the valuation which is a requirement by IRC 409A. As part of our analysis, we review the expected growth and anticipated economic conditions for each relevant industry, and adjust our analysis in cases where future expected outcomes are either extraordinarily positive or extraordinarily negative. However, in the typical case the quantitative side of the valuation report far outweighs the qualitative industry factors, so in this case a reclassification into a new industry will not cause a material change in the valuation.