CFOs need to think carefully about whether, and how, to get a 409A valuation done on their share price given the tight labor market and the mixed messages being sent by special purpose acquisition companies (SPACs), a valuation specialist says.
Companies need to get their shares valued generally once a year or if they have a liquidity event coming up — a capital raise, IPO or SPAC merger, but you want to avoid getting one done if the liquidity event is just an idea and not a firm plan.
If you get one done and decide not to raise money, or if a planned SPAC merger falls through, you can over-price your shares and hurt the stock options you rely on to attract talent.
“What incentive is that for employees if your deal falls through and the strike price is way over market?” says Maryellen Galuchie, a member of the business valuation committee at the American Institute of CPAs.
409A valuations stem from the 2002 Sarbanes-Oxley law as a way to ensure stock-based and other types of deferred compensation are valued based on a set of principles rather than, as they had been done in the past, on softer, more negotiable criteria. As long as you follow one of the paths included in IRS guidelines for preparing the valuations, you can get a safe harbor that puts the onus on the IRS to show your valuation isn't accurate.
The term 409A refers to the U.S. tax code provision that requires them, but auditors and the Securities and Exchange Commission (SEC) look at them, too, in part to ensure they line up with other valuations a company has done, such as for goodwill impairment.
“I don’t usually see the IRS going after the valuations for tax purposes,” Galuchie told CFO Dive. “I see it more from a financial reporting side.”
The challenge is twofold for CFOs, whose job is to ensure the valuations are done when they’re needed and are accurate. They must protect employees receiving stock-based compensation by ensuring valuations are accurate and not so high that it’s too expensive for employees to exercise their options. They must also ensure valuations are as high as possible in order to meet investor expectations.
“It’s a real balancing act,” said Galuchie, managing director of the forensic advisory services at Grant Thornton.
Especially today, given tight labor markets, particularly among cash-strapped tech companies that are using stock options to attract engineers in lieu of big salaries, getting a high valuation can hurt in the talent market.
“You’re looking at it from the employees’ standpoint, because you don’t want to over-price the stock,” she said.
That concern is one reason timing can be crucial and you don’t want to order a valuation in preparation for a capital raise or other liquidity event unless you’re certain you’re going to do it, something that’s easier to manage in the case of a private equity raise.
“With all the facts and circumstances, maybe you don’t need to do anything right now,” said Galuchie.
Timing can get tricky if you’re being asked to respond to, say, a SPAC merger proposal. The risk is that you’ll get a valuation done and, because it builds in the value of the proposed merger, the amount comes in higher than your last valuation, even if it was done just a few months ago. Then, if the deal doesn’t go through, you're stuck with a high valuation.
Even if the SPAC provides a letter of intent (LOI), there always remains a possibility that the deal won’t move forward, something Galuchie has seen a number of times and, with the SEC taking a hard look at these types of mergers, the uncertainty creates a fertile environment for fickleness by SPACs.
Galuchie worked with a company that had two SPACs interested in it. In both cases, she said, the SPACs gave the company LOIs, with proposed pricing, and in both cases the deals never happened. In one case, the SPAC rescinded its offer and, in the other, it simply stopped being responsive.
Fortunately for the company, she said, the CFO and general counsel chose not to get a valuation done; had they not made that choice and had a valuation done, it would have likely priced company shares significantly higher than what they had been priced at previously.
“Thank goodness they took the time and really thought it through,” she said. “They got other advisors around them — their accounting firm, their valuation firm. The CFO was in sync with the general counsel. Everybody was on board and we ended up saying, ‘We don’t think you need a valuation, because you just had one done three months ago. It really hasn’t changed.' Just because there were these two LOIs from SPACs doesn’t mean anything.”