Squashing Small Business Reviewed by Momizat on . Why VCs and Private Equity Pros are Sensitive to IRC 409A Valuations Rand Curtiss weighs in on why IRC 409A option-related valuations for small businesses do no Why VCs and Private Equity Pros are Sensitive to IRC 409A Valuations Rand Curtiss weighs in on why IRC 409A option-related valuations for small businesses do no Rating: 0
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Squashing Small Business

Why VCs and Private Equity Pros are Sensitive to IRC 409A Valuations

Rand Curtiss weighs in on why IRC 409A option-related valuations for small businesses do not solve real business problems for them. They set minimum exercise prices, asserts Curtiss—but that’s all they do.

Squashing Small Business

Squashing Small Business

If you Google “Squashing Small Business,” you will find links to a post by venture capitalist Bill Frezza. Read it. You, like me, probably will find his tone more than somewhat disagreeable, but he makes three points with which I agree:

1. IRC 409A option-related valuations for small businesses—particularly development stage   enterprises—do not solve real business problems for them. Yes, they set minimum exercise prices to avoid adverse tax consequences for issuers and grantees, but that just complies with the regulation. That is all they do. They provide no guidance to company  boards as to how to use the options to attract, retain, and motivate recipients, which is a real business problem. 

2. The valuations are “fanciful” (far too high) in many cases. What Frezza did not say, however, was that the venture capitalists (like him) negotiate those fanciful valuations and put real money—that of their funds—behind them! We appraisers, of course, must consider them in our analyses. We do so based on actual capital raises or more   hypothetical (and possibly fanciful, indeed) exit prices.

3. There is increasing sensitivity to 409A fees on the part of private equity and venture capital managers; the market is wising up. Frezza’s post came to me after a long chain of forwards through a huge chain of private equity managers; I infer that it is being widely circulated. 409A fees are being viewed as “taxes on entrepreneurship.”  

“Fairness opinions can serve as evidence that officers and directors have conducted a process that helped them fulfill their fiduciary obligations.”

I can only speculate that the government will exempt small businesses from 409A compliance; I would wholeheartedly support that. In the meantime, I am looking for profitable and safe ways to furnish such valuations at lower, more acceptable fees to smaller businesses.

My guess is that the 409A market will divide into high- and low-fee segments; the high fees will derive from work for established companies (with higher longevity, more valuation issues, and higher audit risk) and the low fees will derive from work for early-stage and small businesses that have none of those characteristics.

Rand M. Curtiss, MCBA, FIBA, ASA, ASA is president of Loveman-Curtiss, a business appraisal firm located in Shaker Heights, OH.   This piece was originally published in Business Appraisal Practice (BAP).  Visit http://www.go-iba.org/ for more info. 

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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