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 Curtissâ€”but thatâ€™s all they do.
If you Google â€śSquashing Small Business,â€ť 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 businessesâ€”particularly development stageÂ Â enterprisesâ€”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 companyÂ boards as to how to use the options to attract, retain, and motivate recipients, which is a real business problem.Â
2. The valuations are â€śfancifulâ€ť (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 moneyâ€”that of their fundsâ€”behind them! We appraisers, of course, must consider them in our analyses. We do so based on actual capital raises or moreÂ Â 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. Frezzaâ€™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 â€śtaxes on entrepreneurship.â€ť Â
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.Â Â This piece was originally published in Business Appraisal Practice (BAP).Â Visit http://www.go-iba.org/ for more info.Â