This is an old blog entry, but I thought I’d include it for prosperity sake. Plus, it might do someone, somewhere, some good. A while back, I received some guidance from the Big 4 on the hierarchy of our three valuation approaches (asset, market, and income). Here’s an outline of where they stand, in the context of a valuation for ASC 718, which at that time was still called SFAS 123r.
1) Liquidation Value
a. Inclusion of a liquidation value is only to be applied in cases where we use a PWERM. A report may have a hybrid PWERM element, but the fact that we use the OPM in both IPO and Sale scenarios eliminates the need for a liquidation premise of value. [Big 4]’s position is that the OPM, through Black Scholes, adequately contemplates the probability of failure in the range of outcomes implied by the calculated volatility. Thus, [Big 4] feels that including the liquidation premise of value in our calculation of Equity Value over‐states the probability of failure for a going‐concern and is only necessary in certain cases;
2) Reverse OPM
a. Consideration of a reverse OPM should only be made in cases where the most recent round of financing is proximate in time. [Big 4] did not express any bright line test for determining what’s proximate in time; however, 1 year is too great to continue using the Reverse OPM to solve for equity value. Past this time frame, solving for the implied value of enterprise by determining a value that results in the per-share price of the last round of preferred securities may not be accurate. Under certain circumstances, a dated investment would be relevant; however, the facts and circumstances should be described in the narrative along with supporting research. For example, we could consider the impact of a dated round of financing, if we simultaneously establish factors such as:
i. The Company’s operating performance has not improved since the round in question (actuals short of Forecasts);
ii. The market for IPOs has not changed since the prior round;
iii. The economy and industry remain unchanged since the prior round;
iv. The Company and its comparables show limited signs of volatility (or flat growth) since the prior round;
3) Disparity in Market/Income Approaches
a. The Big 4 does not want to see significant disparity between Market and Income approaches. The Market approach should represent a shorthand method for arriving at the value derived by DCF. In Market approaches, we should not blindly select the median or mean multiples illustrated in our studies, unless the Company’s performance is, in fact, average among its peers. Rather, we should objectively observe the Company’s performance relative to its peers, and select a multiple which captures the Company’s standing relative to its peers. Ultimately, [Big 4] would prefer to see all of the values we calculate to align closely between the various methods, and the weighting we select for each method should not have a significant bearing on the outcome.