- Two key things to consider when seeking a professional valuation of your business for 409A purposes
- Why “material events” should be on every founder’s radar during the COVID-19 pandemic
- The specific ways COVID-19 could impact a company’s valuation and therefore significantly influence its 409A
The business world is going through unprecedented upheaval. The COVID-19 pandemic has disrupted demand, deal flow, and every form of transaction that can’t happen through Zoom or DoorDash.
Private companies recognize that this disruption has affected their team, their customers, their partners and lenders. And, if that’s true, it will undoubtedly affect the value of their business.
As valuation experts, we’ve fielded a steady stream of inbound inquiries related to COVID-19. Of all the topics being discussed on valuation webinars, the simple, direct ones are the most common. The two we’ve encountered the most are as follows:
- Should my company update its 409A due to the COVID-19 pandemic?
- How will the COVID-19 pandemic affect my company’s value?
We thought we’d break down our thoughts on each so you can consider how it applies to your clients or company.
1. Should my company update its 409A valuation due to the COVID-19 pandemic?
If a company has previously obtained a 409A valuation as required to issue stock options, then the IRS requires the company to regularly update its valuation. The IRS’s guidance sets forth a time-based requirement and an event-specific requirement as follows:
- Time-based: One year has passed since the prior date of valuation
- Event-based: The company has experienced a “material event”
The time-based requirement is simple: If a company is nearing 12 months since its last 409A valuation, it needs to formally update the value to stay compliant and ensure it doesn’t get dinged for a “cheap stock issuance” involving equity grants to its hard-working employees. (Now, more than ever, employees’ sacrifices need to be recognized. Stock options are a cash-light way to compensate your hardworking team.)
If a company is less than a year out from its prior valuation, it still needs to evaluate whether a “material event” has occurred. This is the board of directors’ responsibility, and it’s a critical one. What, then, constitutes a “material event?”
In our experience, financing transactions are the most common material events that result in existing or prospective clients giving us a call. COVID-19 has tilted the balance, however. Companies are going through significant transitions, “pivots,” transactions, and changes in workforce that fall under the umbrella as an impactful material event.
Business disruptions are widespread. The question needs to be asked: How has this affected my business, whether directly or indirectly?
Here are more specific questions to consider in deciding whether a “material event” has occurred at your company (Note: This is not an exhaustive list but a few examples of things to consider).
- Has your company lost (or gained) significant business as a result of COVID-19?
Example: One of our media clients said that production delays are inevitable as actors cannot convene and in-person meetings have stalled. On the other hand, a regional grass-fed meat company we’ve worked with said demand for direct-to-consumer products has soared as traditional supply chains get disrupted.
- Has your company experienced greater than normal turnover of employees or the loss of a production facility because of COVID-19?
- Has your company raised debt or equity to augment cash because of the business disruption?
All of these examples are material to the underlying business, would impact value, and would warrant an updated valuation based on the occurrence of a material event. There are, of course, many other fact patterns to consider and Redwood is happy to discuss how COVID-19 has impacted your company and whether the impacts would be considered material.
2. How will the COVID-19 pandemic affect my company’s value?
A proper valuation takes into account a wide variety of factors that influence the concluded value. A handful of those are noted below, though this is not an exhaustive list:
|Valuation Input||What Part of Valuation is Impacted|
What other factors could influence a specific company’s valuation? To what extent will these factors ultimately increase or decrease a 409A valuation?
The answers to those questions will largely depend on the company’s unique situation. This is where an experienced appraiser can evaluate your business, consider the impact on your valuation, and make the 409A update process as smooth and stress-free as possible.
Our team at Redwood Valuation is happy to hop on a call to get a better understanding of your needs. Schedule a free 30-minute consultation with our valuation experts by sending us an email at firstname.lastname@example.org.
About the Author: Isaac Pino, CPA has more than 10 years working in financial consulting with companies ranging from early-stage ventures to Fortune 500 clients. He is a Consultant with Redwood Valuation, a boutique business valuation firm with a focus on serving venture capital and private equity clients nationally. More information is available at www.redwoodvaluation.com.