Illiquid Startup Equity as a Feature

With the continued volatility in the public markets, which are now on a strong upswing, it’s tempting to look at the stock prices and investments on a regular basis. Great, the market is up 2% today, how’s my portfolio? Bummer, the market is down 1% today, how’s my portfolio? Of course, it’s outside our control and should be ignored, save for a periodic annual or quarterly review. But, the fact that it’s there, at our finger tips, makes it distracting and compete for our attention.

In the startup world, we have a few measures of the value of our equity. The most common, and often misunderstood, is the valuation from the latest funding round. Let’s say a venture firm invested $5M at a $20M pre-money valuation, such that the company is worth $25M. Well, that’s for preferred stock which often has a number of special features that make it more valuable than common stock (features like dividends and anti-dilution). The next type of valuation that’s well known is the 409A. The 409A is an independent appraisal of the fair market value of the common stock that’s accepted by the IRS so that employees will get long-term capital gains. Put another way, it’s an independent valuation so that employees can be granted stock options at a lower valuation and save on their taxes if everything goes well. As a ballpark, the 409A valuation is 40-50% of the last round’s valuation.

Even with these valuations, there’s often no way to sell stock. (Read more...)