Share Price

We are a privately held, $250-million cyclical manufacturing company. We work to value our company annually for purposes of charitable donations of our stock, for executive compensation (strike price of options), and for the suggested price for small-share buyback transactions.

Currently, we use a discounted, weighted three-year average multiple of trailing earnings to establish a share price. I would like to know what practices other private companies have adopted to establish a share price, and how they use this measure.

Rick Danning (Rick.Danning@metaltek.com )

Response:

We are an $80-million, privately held company that is employee-owned (Sub S with 35 shareholders and no ESOP). Currently the two largest shareholders own 60 percent of the company stock, but their plan is to sell their shares back to the company for distribution to employees in conjunction with our various employee stock ownership/bonus programs. In our case, stock value per share is very important, since it has a direct bearing on most employees’ W-2 compensation and so on.

Our company has used an outside company, Chartwell Financial Advisory, LLC, to do our annual valuations for a number of years now. They use three methods: discounted cash flow, guideline public company, and merger and acquisition to arrive at their final opinion of fair market value.

The "independent third party" element of the end product, plus the fact that it was prepared by professionals who have received special training to do this work, gives the CFO (me) and the employee shareholders of the company significant comfort.

Chartwell has done a nice job for us, and I would recommend them or another similar firm to do your annual share price valuation.

Russ Carlson (rcarlson20@msn.com )

Response:

Our management program is a combination of purchased shares and granted options. For the purchased shares, the price is calculated quarterly. We use an EBITDA multiple value, plus cash, minus debt. The value is an average of the previous four quarters and the forward-looking four quarters.

Option grants are valued the same way. For the sale of shares or exercise of options, we calculate the value as of the effective date, and pay out one-third of the value in the first installment. The remaining two-thirds is paid out over two years, and is subject to an adjustment for the forward-looking four-quarter period actuals, versus the estimates used in the initial calculation. The reason for the forward-looking adjustment is twofold:

1. It prevents management from benefiting by selling before a downturn in earnings, and
2. It prevents using inflated figures for the forward four quarters, since the final payout is adjusted for actual performance.

Ed Ashton (eashton@maclean-fogg.com )

Response:

We provide valuations of privately held companies and their stock for financial reporting and other purposes. This is often to conform to IRC section 409a. There is an AICPA guideline for the valuation of such securities that discusses methodology and has become the accepted, de facto standard. This is the “Valuation of Privately-Held-Company Equity Securities Issued as Compensation” of the AICPA Audit and Accounting Practice Series.

This methodology – which typically involves weighted combinations of discounted cash flow, market comparables, and market transactions – has withstood external auditor and IRS review. The discounted cash-flow component is often a blend of ongoing concern value, and an earlier sale/merger/exit value.

This weighted value is the enterprise value, with the equity value derived by subtracting the fair market value of debt.

The equity value is apportioned among preferred and common stock (as well as options and warrants), utilizing the option pricing method. The option pricing methodology treats preferred and common as call options on the total equity of the company, with common having value only if funds exceed the liquidation preference(s) of preferred. Black-Scholes is still the most common model to price these.

Ray Weisner (rweisner@valuationresearch.com)

Response:

As regards valuation for purposes of executive compensation, we are recommending that our clients use a third-party valuation service to take advantage of Section 409A's safe harbor. Section III.D.4.c.i of the final 409A regulations allows a company to do an internal valuation based on "reasonable application of a reasonable valuation method". However, Section III.D.4.c.ii establishes a safe harbor stating that where a valuation is "based upon an independent appraisal", such a valuation can be rebutted only by showing it to be "grossly unreasonable." Thus, while an internal valuation may survive an audit, an independent valuation generally will not be subject to an audit in the first place.

I hope this feedback is helpful. I have a marked-up PDF copy of the final regulations, so let me know if you'd like me to forward them to you.

Achaessa James (Achaessa.James@corefino.com )

Having just returned from the AICPA's business valuation conference, I can confirm that the IRS is looking closely at valuations performed by non-accredited analysts. The liability is increased with ESOP valuations because the Department of Labor also gets involved. I encourage any CFO needing a valuation to use a CPA-ABV (Accredited in Business Valuation) or a member of the American Society of Appraisers. If an FEI member has questions, he or she is welcome to contact me.