Valuation Updates: When and How

Yesterday we participated in a Fair Value forum with our friends and colleagues at Frank Rimerman, Grant Thornton, Trenwith, Cogent, FSCG and Perisho Tombor.

Among other issues, we discussed the common concerns of our clients relating to 409A/123R valuation practices. Our primary concern was how best to educate our clients and disseminate meaningful information relating to best practices. (Arcstone's humble attempt to solve this issue is the raison d'etre of these self-published articles you are reading now.) I was relieved to hear that the practitioners at the meeting were well aligned on some significant issues.

In general, the following practices seemed to be well accepted among the group:

1. Stock option grants should conform to a schedule. We recognize that sometimes special situations arise where a company cannot conform to a quarterly or semi-annual schedule, but best efforts should be made to keep grants to a regular timeline.


2. Boards should assess the magnitude of change since the last valuation. The rule of thumb that I am comfortable with is this: is the change in company status measurably significant? In other words, hiring a new VP of Sales is certainly significant, but we can't measure its impact quantitatively. However, if the new sales team really starts producing, we should be able to measure that both historically (beating expectations) and prospectively (increasing projections). If company management believes that the change is both significant and quantitatively measurable, perhaps it's time for a new valuation.


3. Regardless of the outcome of the above, carefully note that the discussion was had and a decision was made. If you are asked at a later date why your company got a valuation in 1Q07 and 3Q07, but not 2Q07 or 4Q07, you may want to have the minutes explain the decision making process.


4. When another valuation is required, do not settle for a summary "update". These go by different names -- "updates" or "bundles" -- but the idea is the same, and that is to conduct an analysis using the previous valuation as a basis for the current analysis. It's simply not best practice to do so. Each business appraisal should produce a stand-alone document that adheres to all of the relevant standards. It should not depend on past appraisals for its substance.

As always, if you have any questions about the above thoughts, please do not hesitate to contact us. We are always happy to speak about these issues, and very open to suggestions and comments.