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Many Silicon Valley companies lack a ‘share price strategy,’ survey reveals

RoseRyan and Assay Investor Perspectives just released their Share Price Survey Results after meeting individually with more than 20 senior finance leaders and directors and surveying others online. We intended to gain an understanding of what private and public companies are doing to actively manage their valuation and share price over time.

It turns out they are making some efforts but lack the expertise and long-term strategy to pull it off well. After the clever pre-IPO road show presentations and after all the investment bankers have gone home, there’s little thought put into creating a comprehensive “share price strategy.”

It’s a hot topic. Share price and valuation always get attention whenever RoseRyan provides thought leadership papers or events on this topic. That’s not so surprising since we are in Silicon Valley after all, surrounded by all the hoopla that accompanies the latest IPO, merger or acquisition – and all the valuations that go along with them.

The excitement is even greater these days as we are in the midst of a busy IPO market. In 2013, FireEye, Portola Pharmaceuticals, Twitter, Rocket Fuel, Veracyte, Marketo and others kicked it off. And the trend is continuing, with anticipation that Box, KineMed, Dropbox, Asterias Biotherapeutics, Square, Spotify, Airbnb and others will soon file as well.

It is amazing how much effort goes into preparing for an IPO. What comes next involves hard work as well. Companies that let the inevitable “post-IPO hangover” take too much of an effect miss out on critical opportunities. Those hot-shot companies will need to take their singular focus off getting to the IPO bell and spend a little time considering how they will maintain their share price and valuation. But most likely they will not. Too often, newly public companies don’t come up with a strategy for how they are going to not only maintain their lofty valuation but also increase it over time.

What to Do Next
Executives usually have two choices to increase their valuation – grow their income or increase their multiple. What the survey results and our discussions show is that companies really don’t understand what the buy-side analysts are looking for. The buy-side analysts’ focus is usually on the multiple and the levers that will move the multiple directly. Most companies focus on increasing net income, which is what most buy-side analysts don’t focus on.

Why is there such a big disconnect? It is centered on the nature of the people doing the work. Most investor relations representatives have either a communications or a sell-side background, and most buy-side analysts have advanced degrees or PhDs in mathematics. And most company executives have MBAs. These different backgrounds can lead to a mismatch in the way these groups speak to each other and understand each other. Basically, they are speaking different languages.

The results of our executive conversations show that this disconnect is causing issues in long-term valuations. Companies’ lack of a solid understanding of buy-side analysts and what really drives share price can expose them to undervaluation. A depressed (from where it should be) valuation impacts recruiting, brand, motivation and culture.

Senior leaders can reverse this trend by deploying strategies that really drive the multiple and having a focused strategy on communicating those strategies to analysts. This does not preclude companies’ need for focusing on increasing income; it just means if they want to supercharge their valuation, they need to have clear strategies that increase their multiple. Read our report, Share Price Survey Results 2013, for the details.

Chris Vane is a director at RoseRyan, where he leads the development of the finance and accounting firm’s cleantech and high tech practices. He is open to discussing ways to positively impact your company’s share price/valuation. Contact Chris at [email protected] or call him at 510.456.3056 x169.

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3 quick tips for streamlining your stock-based pay plans

Keep your employees motivated with stock-based compensation, the thinking goes, and you will be rewarded with high productivity and gains in your company’s growth track. What managers often fail to consider is that if they make mistakes along the way—and we’ve seen many when it comes to equity-based compensation plans—they could actually end up with low employee morale, putting a crimp in the pace of the performance-aligned goals they have set up.

Whenever a company has to amend awards previously made or restate their financial statements because of adjustments in equity-based comp, employees will naturally have concerns—even when the change has little, if any, financial impact on them.

The risk of dents in morale is just one of many consequences RoseRyan has observed while helping clients with issues in their equity-based pay strategies. You’d be amazed at the range of problems we have seen—many of them due to honest mistakes. In our experience, 9 out of 10 companies have had some issue with their underlying stock data that affects their stock-based compensation expense.

To prevent such problems at your company, consider these three tips the next time you evaluate your stock-based compensation strategy (we’ll get into more detail about this topic at our February 26 luncheon called Compensation for Private Companies: The Ins and Outs of Equity, which will be held at BayBio with Kyle Holm, associate partner at compensation consulting firm Radford).

Be obsessive about looking for modifications: Some modifications are obvious (say, repricing a stock option); some modifications are less so (say, allowing a consultant to keep options after you hire that person as an employee). Keep an eye out not only for board decisions but also for management decisions, material transactions, and liquidity events. The rule is, any change to the award or the award holder’s status should trigger consideration of accounting modifications.

Identifying that you have a modification is just the first challenge; the accounting can be tricky as well. How you account for the modification will depend on the type of modification. Variations include measuring the incremental value only, accelerating the expense, or valuing the new award and reversing the value associated with the original award. You also need to be sure you’re entering the modification in your equity system in a way that captures the appropriate modification accounting.

Make sure performance-based awards are on everyone’s radar: Performance-based awards are great tools for both retaining employees and motivating goal-driven behavior. But there is accounting risk here as well. With performance-based awards, companies must assess the probability of achieving the metrics at each reporting date and adjust the expense accordingly. This step often doesn’t happen. Maybe the board minutes lay out the performance goals associated with an award, but the stock administrator gets only a spreadsheet of grants to administer, with no indication that vesting is contingent. Or maybe the stock administrator is aware of the performance targets but doesn’t flag performance-based grants in the equity system, so the accounting team doesn’t know they exist. Such miscommunication can lead to overstated stock-based compensation expense.

Tie your 409A valuations to major grant dates: For private companies, the rule of thumb is to obtain a 409A valuation of your stock at least once a year, and in conjunction with major events such as financings, significant transactions, or material changes to the business. Some companies instead tend to do their 409A at the end of the year, just because they’re doing other valuations and financial decompressions at the same time. But think about this example, from one of our clients that approved a major grant to executives and employees in June 2011, six months after valuing its common stock at $1.25 per share for its annual 409A. By that point, the value of the stock had increased significantly—to $3—based on several design wins and other economic factors. While that’s a nice problem to have, they suddenly faced additional stock-based compensation expense and time-consuming updates to their equity system, among other issues.

It’s easy to think your equity-based compensation is under control; however, we have found time and again that it’s an ever-evolving tool that needs tending to, as your headcount grows, the complexity of your company expands, and situations evolve.

Get in the mode of reevaluating your pay strategy during the RoseRyan February 26 Lunch & Learn seminar about equity in South San Francisco. It will be geared toward private companies. Click here to register. And for more details about these best practices as well as some others to consider, also check out the RoseRyan intelligence report I wrote called Stock options: do you have a problem?.

Kelley Wall leads RoseRyan’s Technical Accounting Group, which provides technical accounting and SEC expertise to public and private companies on complex accounting matters and implementation of new accounting pronouncements. 

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New webinar provides strategies for increasing valuation

Does company valuation feel more like a black art than a science? How do investors look at financial integrity and accountability, and their impact on valuation? RoseRyan CEO Kathy Ryan and Adrian Bray, founding partner of international advisory firm Assay, are joining forces to demystify valuation’s key drivers in a Proformative webinar at 11 am PT/2 pm ET on October 29.

“Best Practices in Understanding and Increasing your Company Valuation” will reveal how you can build value throughout your organization, identify key valuation factors, and describe actions you can take to determine a valuation strategy that goes beyond the benchmark. This webinar’s practical advice will include the importance of an equity strategy and how to deliver best-in-class analyst presentations. The presenters will also cover how basic financial practices can impact valuation and how to avoid common pitfalls.

For more information and to register, go to the Proformative website.

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RoseRyan videos deliver the big picture on IPOs, equity comp, and valuation

We know that making time to attend a seminar is tough in our over-scheduled lives. And reading presentation slides is rarely an ideal way to connect the dots of complex subjects. Maybe you’d like to expand your knowledge while wearing your sweats and eating popcorn? Well, now you can.

We’ve made getting guidance easy—with our videos, you can take in valuable information while propping your feet up on your desk or walking your way to fitness at your mobile workstation, if you insist on multitasking.

Check out videos of our three most recent seminars:

IPO Bound? New Strategies, New Ideas and Tips for Success

IPO ahead? Learn the dos and don’ts at key stages and get legal, finance and auditor perspectives on how to get your house in order, tell your business story, nail your S-1 and hit your runway. (This program provides great business advice, even if an IPO’s not in your future.)

Equity Compensation: End-to-End Strategies for Private Companies

Whether your plans are for growth or a lucrative exit, don’t let thorny equity compensation design and execution issues ground them. Get legal, HR, accounting and industry perspectives on setting yourself up for success, avoiding common pitfalls and planning for an M&A deal or IPO.

Valuation Metrics and Drivers in Today’s Economy

Whatever your goals, a high valuation is a top priority. Demystify the valuation equation and understand market variables, business model economics, and analyst and investor perspectives; develop a valuation strategy; and avoid mistakes and deal breakers.

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Year-end heads-up: don’t let equity issues take you by surprise at audit time

December 31 is fast approaching. Can audits be far behind? Every year as we help our clients maneuver through the audit process, it seems that one of the areas that can cause significant difficulties is equity. It’s not so much the basics, like recording the issuance of 5 million shares of Series C preferred at $3 a share, or the exercise of a stock option, but the “little” issues that don’t pop up until the financial statements are actually being prepared and the footnote disclosures drafted. Things like stock option modifications (that’s a modification?!), accounting for nonemployee options (what do we remeasure and when?), common stock valuations (we did a 409A valuation in October; why do we need another?) and warrants (what do you mean, the warrants are liabilities?). Let’s take a closer look at these issues.

Stock option modifications

Everyone recognizes that a stock option repricing is an option modification. But a lot of other transactions are also considered modifications—and as such have accounting consequences—including extending the post-termination exercise period; exchanging stock options for other types of awards, such as restricted stock units; and changing the option holder’s status from consultant to employee (or vice versa). Altering the vesting terms of an option or other award can also trigger accounting ramifications. In some cases, only the timing of the expense may be affected. In other cases, including accelerating vesting at termination or changing performance criteria, the value of the option must be remeasured, and additional expense may result.

Accounting for nonemployee options

In general, the measurement date for a nonemployee option is the vest date, not the grant date. So technically, you should remeasure nonemployee options on each vesting date, which can be a rather daunting task if your options vest monthly. Fortunately, most auditors are okay with quarterly remeasurement. However, if you are calculating all remeasurements at year’s end, you may discover unexpected issues related to common stock valuations (see below). Also keep in mind that not all software is created equal when it comes to managing nonemployee stock options. Testing your system by manually recalculating expense for a sample of nonemployee options is always a good practice.

Another thing to remember: once each option tranche has vested, the vested shares are no longer subject to remeasurement. We occasionally see situations in which a company has continued to remeasure all shares until the option is fully vested. This practice misstates expense, frequently overstating it.

Common stock valuations

How often do you really need to have a common stock valuation, also referred to as a 409A valuation, performed? The answer is one of those very definite “it depends.” If your company is relatively stable, an annual valuation may be sufficient for both tax and accounting purposes. But if your company is dynamic and reaching significant milestones, you will likely need 409A valuations more frequently. Let’s say you closed your Series C round in September and had a 409A valuation performed in conjunction with that event. In December, your company achieved a significant milestone, like introducing a new product or receiving a favorable result on its Phase III trial. The December milestone increased your company’s value and likely requires a new 409A valuation. Performing the valuation contemporaneously and proactively is best. Dealing with it when your auditors request it usually adds significant time to the audit and could add to the cost of the valuation if the valuation firm has to expedite its work to meet your timelines.

Warrants

Warrants could easily be the subject of an entire article, but here are a few things to be aware of for now. Companies frequently issue warrants for preferred or common stock in connection with debt agreements (bridge loans, term loans, lease lines, and so on) or equity offerings. In all cases, the proceeds that the company receives must be allocated between the warrants and the base loan or equity offering. If the warrants are for preferred shares and there’s any possibility your company will redeem the underlying preferred shares for cash, the warrants are considered liability instruments and must be revalued at each balance sheet date with the change in value flowing through the statement of operations. In addition, if the base loan is convertible into equity, as is generally the case with bridge loans, the warrant will usually create a beneficial conversion feature because of the allocation of a portion of the proceeds to the warrant. Addressing these situations can be confusing and time consuming. Best practice is to discuss them with your accounting advisors before actually sealing the deal so that any accounting issues can be addressed up front.

Wrap up

Before you say good-bye to 2012, do two things. First, review your equity transactions, stock option records, board minutes and other relevant documents to determine whether any of the transactions or situations I’ve described occurred during the year. Then discuss your findings with your accounting advisors, equity service providers or both to ensure that the proper accounting treatment has been applied. You will certainly be better prepared for your audit, and you may save yourself from some significant headaches and maybe even some audit fees.

 

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Evaluating an acquisition target: pay attention to the gray areas

What’s more shocking: HP’s $8.8 billion (yes, billion!) impairment charge recorded in its recently completed fourth quarter, or the fact that it blames the charge on the “accounting improprieties and disclosure failures” of Autonomy, a UK-based company it acquired just last year? Clearly, investors were not pleased, as evinced by the immediate drop in stock price after the announcement was made. What lingers, though, is an aching question that haunts companies contemplating an acquisition: if HP, with its significant M&A experience and multiple Big Four audit teams, failed to see through Autonomy’s misrepresentations, then what hope is there for the rest of us?

Investigations by the Securities and Exchange Commission’s Division of Enforcement and the UK’s Serious Fraud Office are under way to determine whether evidence of fraud exists. I think it’s safe to say that detecting fraud at a target company is not typically engrained in the pre-acquisition due diligence process. However, consider this: what if the “improprieties” weren’t fraud per se, but instead liberal interpretations of principles-based international financial reporting standards?

Drawing focus to areas requiring extensive judgment and assumptions should be an integral part of the due diligence process. Even where the financial statements have already been audited by a reputable firm, focusing on the gray can be exceptionally beneficial: it can highlight areas of financial risk; it can provide greater insights in vetting forecasted financial results; and it can identify areas where the target’s accounting policies differ from your own.

More often than not, the financial due diligence process is focused on quantifying the net assets of the business (aka “scrubbing the balance sheet”) and understanding the assumptions underlying the company’s financial projections. However, attention should also be given to those accounting policies for which judgment and/or material estimates are required. SEC registrants often refer to such policies as “critical accounting estimates” and include required disclosures in the Management Discussion & Analysis section of their periodic filings. Private companies are not required to provide such disclosures, and they may only touch on general accounting policies in the footnotes.

Critical accounting estimates often include areas such as rev rec, asset impairment analysis, contingent liabilities, income taxes and reserve accounting, including warranty provisions, bad debt allowance and reserves for excess and obsolete inventory. Understanding your target’s policies with regard to these areas is critical, not only to assess the judgments applied, but also because certain accounting rules (especially those that are principles based) can provide leniency in interpretation, and different companies arguably have different risk profiles.

So the moral of the story is, no deal is ever black and white. The more time you spend understanding the gray, the better your chances are for understanding and valuing what you’re buying.

For an M&A due diligence checklist, see our report, M&A: Get What You Bargained For.

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New report: scoring a high valuation in any economy

Let’s face it: whatever the climate for M&As and IPOs, positioning your business for a high valuation can be tricky. What if you could assemble a brain trust to give you the insider perspective on ensuring a big payday?

RoseRyan hears you. We pulled together a roundtable of Silicon Valley’s sharpest minds in accounting, investment analysis, business strategy and the law to answer exactly the questions you’d like to ask. We share the highlights in our new report, Boost Your Business’s Value: What to Do—and What Not to Do—When You Want to Be Worth a Fortune.

Our experts—RoseRyan’s Jim Goldhawk, Adrian Bray of Assay, Jim Chapman of Foley & Lardner and Tony Yeh of SVB Analytics—got deep into a conversation that reveals how complex valuation can be. Financial metrics are only part of the story. Qualitative factors—inflows of top talent and even the background of the founding group—can be predictors of competitiveness. But workforce won’t count as much after the close of deal. That’s when what the workforce has created drives value.

The good news is that even in skeptical times, entrepreneurs can bank against uncertainty to boost valuation. Culture, product positioning, customer mix, business infrastructure—all are within a company’s control. Moving away from commoditization, investing in due diligence, and pursuing what one of our thought leaders calls “organic growth” are a few strategies for preparing to pounce when the time is right.

Our last question: if there was one thing you could say to CEOs who are interested in or worried about their valuation, whether or not they have an exit strategy on the horizon, what would you tell them?

Check out our report to find out how our experts responded!

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