July 18, 2023
As an employee at a unicorn or other pre-IPO, it’s common to receive equity in that company as part of your total compensation.
This begs the question - up until the point where the company goes public or is sold, what are your shares in a private company actually worth?
Unlike in the stock market, where company shares are publicly listed and have a value that is quoted daily, it’s far less clear to startup employees what their shares are currently worth. In this article, we want to shed some light on methods used by investors and companies themselves to determine the value of private company shares.
Method 1: valuing private companies by analysing comparable public companies
One of the most common methods investors use to value private companies is by comparing them to similar publicly-traded companies using financial ratios or multiples based on variables such as revenue, growth, and profitability. For example, if an investor wanted to purchase shares of Stripe, they would analyze similar payment software companies in the public stock market like PayPal, Block (former known as Square), or Toast. If public companies similar to Stripe are trading at a certain multiple of their current revenues, investors may apply a similar multiple to value Stripe shares. This is similar to how a new home on the market may be valued at a certain price per square foot if similar homes have sold at that price recently.
While this is a commonly used method, there are limitations. Even if companies are similar, they are not identical, and several factors can affect a company's valuation, such as market share, growth, and profitability. For example, while it may be helpful for investors to know where Lyft and Uber’s shares are trading in the public market to evaluate a new ride-sharing startup, Uber and Lyft are market leaders, while the new company is unproven. Similarly, the new company may be experiencing exponential growth from a small revenue base, while incumbents' growth may be slower as they mature. Adjusting for these differences is challenging when using this approach to value private companies.
Method 2: looking at 409A valuations
Employees of startups often refer to the company’s 409A valuation as the current “fair market value” of a company’s shares, but this is also an imperfect approach.
Private companies obtain 409A valuations to value the equity that they grant to employees as a form of compensation. Startups typically hire a qualified, independent appraiser like Carta or Scalar to arrive at a 409A valuation. These appraisers develop a detailed report, concluding with the company’s shares valuation. The report takes into account a variety of factors, including the company's financials, the value of any assets or liabilities, the company's growth potential, and current market conditions. Typically private companies must update their 409A valuation annually or with material changes in the business, such as new financing or acquisition, as required by the IRS.
The major drawback of 409A valuations is that they are not based on an actual transaction - i.e. what someone has actually paid for the stock. For this reason, the 409A valuation is open to manipulation and human error and is not a reliable predictor of what someone would pay for the stock today.
Method 3: the valuation of the company’s last capital raise
It’s often said that something is only worth what someone else is willing to pay for it. This is why many view the valuation of a venture-backed company's most recent funding round as a great indicator of its worth. The pricing of the funding round, set by new investors who are impartial to the company and its current shareholders, also ensures an unbiased valuation.
However, the ‘last round value’ suffers from two potential drawbacks. First, it’s established at a specific point in time and may not accurately reflect the current value of a private company’s shares in a rapidly changing market environment, like the one we find ourselves in today. Second, the newest investors usually receive preferred shares that come with a range of special rights that are not attached to the vast majority of the other shares, such as the common shares typically held by employees. For these reasons, the last round value may deviate from the stock’s true, fair market value.
Method 4: real-time trading data
By far, the most accurate indicator of a private company's value is the current trading price of its shares in the secondary market because this is the value at which the shares could be sold today.
At Hiive, we’ve built a marketplace for trading private company shares that enables you to observe the market price for your stock in real time. By signing up, you will join thousands of employees from private companies, as well as institutional and accredited investors. You can monitor real-time buying and selling activity for shares of your company and other pre-IPO companies, such as shares of SpaceX, Reddit, Discord, and OpenAI stock. If you’re interested in knowing what your shares are worth, you can sign-up here or feel free to contact [email protected] for more information.
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