409A valuation and mark-to-market reconciliation

409A valuation, as we know by now, is supposed to be a legally sound valuation, though some offshore companies would never get this concept due to the poor legal environments in their own countries. But what about the FAS 156/157 US GAAP mark-to-market accounting that venture capitalists and other institutional investors are supposed to maintain? Currently, the 409A valuation study and US GAAP mark-to-market valuation study are two different projects. We are not sure how this can be the case. In a 409A valuation, not only is the minority common stock valued, but the pre-discount(if any discounts are allowed at all for institutional stock) values of institutional investor held preferred stock is also valued. Shouldn't this preferred stock value reconcile with the mark-to-market accounting of preferred stocks in a portfolio held by VCs? I believe the jury is out on this one and there is no clear cut direction from the FASB or the audit firms. One line of thinking is that companies are private for a reason, and should not be subject to such reconciliations. But if the fair market value definitions of both 409A and US GAAP mark-to-market accounting are the same, I am unable to see why there should be two different valuations. 409A valuations, for the most part, mark down the valuation offered by VC firms during a term sheet financing, as a VC financing valuation cannot be fully supported as the only method of valuation. Therefore, there is a conflict right away in that VCs have to mark down their portfolio values.I see this as an area of conflict in the future and currently we are unable to determine which way the tide will turn.

Private equity/VC valuation and 409A

At Accuserve, we serve both the venture capital/private equity companies (when we mark to market their portfolios) as well as portfolio companies when they issue stock options, acquire intangible assets and so on. One of the recent observations has been as to whether only one set of valuation is required for both mark-to-market purposes for the VC/PE firms as well as the underlying common stock valuation for the portfolio companies. After all, during the minority common stock valuations for the portfolio companies, the preferred price of the VC/PE holdings is calculated as well. Currently, our observation is that not all VC/PE firms may be using the preferred price calculated during the 409A valuations for their FAS 156/157 mark-to-market purposes. Neither have we come across discussions with the accounting and audit community that such a conformity is required. Note that by virtue of following the AICPA guidelines for 409A valuations, we conform to the letter and spirit, the FASB 156/157 guidelines as well. There may be minor deviations but the fair value definitions of both 409A and FASB 156/157 are virtually identical.

SEC and private company valuations

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In response to a few requests from clients on what the SEC though about how private companies should be fairly valued, I talked to an official at the SEC about this specific question. The reply was on expected lines: "use your judgment and make sure that observations are justified". Though, we at Accuserve, believed that SEC may not comment that much on private company valuations as these firms were outside their jurisdiction, we wanted to assure some of our clients who wanted to know if the valuations conformed to SEC norms. One of our question was if the SEC had any specific inputs on what approaches are better for private company valuations and, if multiple approaches were used, whether they have any observations on the weightings to be used to get at a single value. The SEC official, again, did not have a comment on any specific approaches or the weight splits to be used across the different approaches. In about 30 minutes of conversation I had with the official, one thing that stood out was the need to take into consideration all circumstances of the company in determining the proper valuation - a well established concept in private company valuations, in any case. So, we at Accuserve, are of the firm view that supportable valuations are those that can be well defended and there is no one single template to valuation.