Will the IRS Accept Carta 409A Valuations Amid Quality Concerns?

It’s no secret that Carta has been the elephant in the room for 409As over the last five-to-ten-year period. While they have certainly made an impact on the space, we find that their reports may not be as reliable as their presence would let on. Often, we find that Carta reports are missing key details and support that are necessary for a report to adhere to industry standards.

Let’s explore this in more detail starting with the common-sense items that people ask us about Carta’s valuations:

Where is the concluded total equity value / total enterprise value displayed in Carta’s 409A valuation report?

Carta’s newest 409A valuation reports don’t typically include total equity value or total enterprise value, which points to their valuation outcomes potentially being unsupportable. The lack of transparency regarding total equity value makes those Carta valuation reports one-dimensional and difficult for you or your auditors to sanity test the total value outcome for reasonability.

Additionally, some clients like to leverage 409A valuations for QSBS purposes, and Carta reports without the total equity value make that impossible.

At Redwood Valuation, we include either total equity value or total enterprise value (or both) in our 409A valuation reports as this is an essential component of all our reports.

Are Carta’s appraisers listed on the report and is there a signature?

Listing all the valuation professionals that worked on an analysis is crucial to the quality and defensibility of your 409A valuation report. We’ve noticed Carta no longer lists its team members on their reports, thus making their reports non-compliant with USPAP and valuation industry best practices. This could leave you exposed in the event of an IRS, SEC, or financial statement audit.

Additionally, we typically expect a signature on the report whether it is on behalf of the firm signature or individual appraiser. Carta does not sign its current reports, which is problematic for compliance with industry standards and is a glaring red flag given the inexperience of most of Carta’s valuation team.

Is it true that most Carta valuation analysts are recent college grads with less than 2 years’ experience?  

According to Carta’s valuation report, Carta’s valuation team has approximately 60 people with about 200 years’ experience, which is an average of 3.3 years of experience per person and a likely median of less than 2 years of experience per person. Based on our understanding of valuation industry structuring and the LinkedIn profiles of key Carta team members, we estimate that the most senior 5 or 10 people probably make up for half the total valuation experience. As a result, there are potentially 50+ valuation analysts at Carta who have less than 2-years’ valuation experience.

Important questions to ask yourself are:

1.     Can an associate with a year or two of valuation experience be trusted to defend a valuation in front of the IRS?

2.     Will that individual or that team even be around to defend the valuation? If not, you may end up defending the valuation yourself without access to much of the underlying valuation data given the opaque nature of Carta’s reports.

In contrast, Redwood Valuation has 15 valuation professionals and over 200 years of combined valuation experience, which is more than 13 years average experience per person. Our core team has been intact for nearly a decade, and we will be around to defend your valuations years for years to come. Ongoing valuation support is not only a feature but a crucial differentiator when selecting a qualified appraiser.

Is it true that the IRS won’t accept Carta’s use of its clients’ proprietary internal data in valuation reports? What does this mean exactly?

Carta aggregates value outcomes from its own clients’ valuation reports and uses them as key drivers in many of its valuations. This exercise is not transparent and inherently circular in nature. The problem is that the data Carta generates and relies on is only as good as Carta’s own valuations, which many in the industry consider to be very low quality. Additionally, the fact that Carta’s data isn’t easily auditable for the IRS or for financial statement auditors is problematic. Which brings us to the next question…

Why can’t Carta’s valuations be used for ASC 718 purposes, and why is the disclaimer so prominent on the first page of the report?

Carta’s newest 409A valuation reports state in large red font on the first page that they should not be used for ASC 718 purposes. This is because most of Carta’s 409A valuation reports aren’t robust enough for financial reporting purposes and will not withstand a financial statement audit. It has become apparent in recent years that Carta does not have the time or resources to defend their valuation reports. Audit support does not fit Carta’s business model of tossing in a “free” valuation (of course, you get what you pay for).

Additionally, since Carta is using its opaque, self-fed data set, it will be very difficult for a financial statement auditor to sign off on Carta’s 409A valuation reports. This leads one to legitimately question whether an IRS agent could audit Carta’s valuations, either. 

The reality is that financial statement auditors ask a lot of questions to understand the assumptions and methods used by the appraiser and point out potential flaws in the valuation analysis – that’s their job.  Responding to these queries is often very difficult for inexperienced valuation professionals to handle and can take a great deal of thought to adequately respond to.  This is where Redwood Valuation excels and what sets us apart from many of our competitors.

Certainly, there are differences between fair market value per the IRS (IRC 409A) and fair value per GAAP (ASC 718), but a conversation with an experienced valuation professional should occur early on to discuss the implications of the two values diverging, if they do, and what that might mean for future audits. Redwood Valuation has a consultative approach that addresses these complex issues head on, which directly contrasts with Carta’s more hands-off approach.  

We prefer to have upfront discussions about the potential costs and challenges of having separate 409A valuation and ASC 718 valuations to ensure we are on the same page as our clients. At Redwood Valuation, customer experience isn’t an afterthought, it is what puts us ahead of the pack.

Do Carta’s 409A valuations make sense?   

A common complaint from our clients that switch over from Carta is, “The concluded value provided doesn’t make any sense given our company’s stage of development”. We often hear new clients say the outcome of the previous Carta valuation is too high, too low, or just plain nonsensical given the fact pattern. When they reach out to discuss their opinions with Carta’s team, it is typical that they either can’t reach anyone or are given the runaround (multiple calls with multiple reps, and multiple iterations with minimal confidence in the valuation team).

A recent 409A Valuation report we received from a Carta client had a negative concluded equity value. In valuation theory, this is technically impossible and practically nonsensical because a company that has negative value would typically enter bankruptcy and/or be forced to close its doors from investors (particularly given the industry of the company being valued). Oddly, Carta arbitrarily decided that even though the equity value of the company was negative, the value of one share of common stock was positive. The report was not only indefensible, but it was fundamentally flawed and very hard to follow such that most clients would not be able to identify the problematic outcome in the first place.

Are Carta’s 409A valuations accurate and consistent?

In a recent Carta valuation report that we received, Carta had conflicting data on back-to-back pages. They selected a probability of failure of 58.87% from their own internal research but chose a 66.17% chance of failure on the slider on the next page when determining the concluded value, without any support for either figure. Putting aside the fact that the probability of failure calculation they used was not properly supported by external data in the first place (a common Carta issue), to show two completely different probabilities for the same estimate on back-to-back pages is a prime example of the sloppy valuation analyses from Carta that we have reviewed repeatedly.

Trying to catch all the errors that Carta might make can be an undue burden on the client, and when the errors are so obvious (contradicting data on back-to-back pages) it may leave the client exposed in the event of an IRS audit. These errors are particularly problematic given the supposed “automation” in Carta’s system, which means the errors might be repeating for numerous clients. 

Does Carta really let you change the value in the report if you aren’t happy with the outcome?

Not quite, but the language in the report suggests that if you aren’t happy with the outcome, you can just change it by contacting Carta. The language says, “Not representative of your company?” and then provides a blueprint in the report that tells the client how to manipulate the value (“If the calculated xxx does not align with Company’s current expectations, please let us know” with a hyperlink). While it is certainly is acceptable for a client to provide input on certain key assumptions in the report, the way Carta approaches it risks a lack of independence on the part of the appraiser which could result in serious IRS scrutiny. 

Conclusion
In conclusion, a closer look at Carta's 409A valuation reports reveals significant shortcomings that you should carefully consider. From the absence of critical details such as total equity value or total enterprise value to the lack of transparency in listing appraisers and obtaining their signatures, Carta's reports do not align with industry standards and could leave businesses exposed in audits. Moreover, the disclaimer on Carta's reports cautioning against ASC 718 purposes underscores the challenges in relying on their valuations for financial reporting. In contrast, Redwood Valuation distinguishes itself through a robust team with extensive experience, commitment to transparency, and a consultative approach. Ultimately, the decision to choose a valuation provider like Redwood Valuation extends beyond mere numbers; it speaks to the integrity, defensibility, and long-term support essential for sound financial decision-making.