Behind the numbers: What a 409A valuation says about your business

This deserves a deeper conversation, but I’ll highlight a couple areas for consideration. First, there’s the financial analysis that drives the valuation opinion. There’s been a recent movement away from valuing companies based on market sentiment versus actual performance. Therefore, maintaining accurate financial statements and having strong financial controls gives valuation providers a clearer view of the company’s development and forecasted growth. Keep in mind that any inconsistencies or gaps in a company’s financial data can carry over into future 409A valuations and transactions. This is why our Valuation Services team places a lot of emphasis on helping companies maintain a transaction-ready valuation strategy between major corporate actions.

Additionally, any completed secondaries or tender offers need to be accounted for in the 409A valuation. However, the impact of that activity on the 409A valuation depends on a variety of factors, including how the transaction was structured, the timing and frequency of trading, and who participated in the transaction. A valuation provider can help companies quantify the impact of prior secondaries and anticipate the impact of future transactions.

Most importantly, private companies should understand that valuations become increasingly complex as a business grows. Later-stage companies may require more frequent valuation opinions outside of the 12-month safe harbor period, and it can be beneficial for them to have an ongoing conversation with their 409A valuation provider as they make changes to their equity, liquidity, or exit plans.

In recent years, market volatility has continued to have a significant impact on private company 409A valuations. Many companies may have seen their valuations recalibrate due to material changes in financial performance, sector-specific market dynamics, or forecasted growth projections. As a result, some companies have decided to reprice their stock options or issue additional equity to preserve the upside value of their equity plans. 

409A valuations have also been impacted by the current fundraising environment. Increasingly, private companies have had to raise money at lower valuations (down rounds) or with more onerous terms, creating a downstream impact and future allocations of equity. Lastly, as IPO markets have remained quiet, we’ve also seen an uptick in private company secondary activity, which can often have an impact on valuations.

One key component of a private company’s equity, fundraising, and exit strategy are 409A valuations. Beyond helping companies stay compliant when issuing equity-based compensation, 409A valuations also carry a message to employees, investors, and the market about the fair market value including the growth potential of a business. As companies re-evaluate their equity and liquidity needs amid ongoing market uncertainty, having an up-to-date and accurate 409A valuation will allow them to make more informed decisions and stay transaction ready.

As private companies mature and start to think about how they will operate after going public, 409A valuations tend to focus less on investor sentiment and more on year-over-year financial performance and exit planning. As part of this evolution, demonstrating consistency and transparency within their valuations is a key component. Remember, a 409A valuation is a reasonable, independent estimate of a company’s stock price; it needs to strike a balance between what’s aspirational and the actual performance of the company. Therefore, the responsibility of the 409A valuation provider is to provide an analysis that matches the narrative of the private company and creates a coherent valuation history.

For companies thinking about going public in the near future, consider that 409A valuations and secondary transactions within three years of an IPO are subject to public disclosure and scrutiny by the Securities and Exchange Commission. Given the impact that market volatility has had on private market valuations, companies may want to have a conversation with their valuation provider on how to navigate any potential challenges that may arise.

The fundraising environment remains challenging, especially for late-stage companies. With down rounds happening across the market, investors have greater leverage to dictate the terms of funding. As companies raise capital in this climate, they should pay attention not only to their post-money valuation but also to the terms of their equity financing, as they can have a cascading impact on equity allocation across the capitalization table.

Furthermore, while we’ve likely moved past the peak of stock option repricing that we saw last year, it likely remains a consideration for many companies. At Morgan Stanley at Work, we’ve been helping companies evaluate the short- and long-term impact of a repricing, along with the message it sends to employees about their equity compensation.