One: Dilution
Get the whole story
Total shareholder dilution is not determined by percentage ownership alone. It must also incorporate the combined effect of value dilution created by equity compensation. Dilution in earnings per share is usually not a consideration for privately owned companies.
Two: Option formulas
Don’t forget to change your variables
Modifications are required to standard variables used in option pricing formulas such as the Black Scholes and binomial methods. These changes reflect the special characteristics of options used as equity compensation.
Three: Income adjustments
No double dipping
Costs for equity compensation expense must be adjusted in the income measures used in valuation methods. This applies to valuation methods using multiples such as EBITDA or discount rates.
Four: Tax effects
Remember your Uncle Sam
Don’t forget to factor income tax effects in the valuation. Incorporate the deferral, vesting, and non-cash features and tax benefits generated by certain types of equity compensation.
Five: Capital allocation
Put everything in its place
The total business value is allocated across the capital structure including debt, shareholder interests, and equity compensation. This requires capturing the order of preference and co-dependence of the specific capital interests.
Six: Terms and conditions
It’s the little things that can matter most
Differences in the type, restrictions, vesting requirements, performance conditions, gross up, dividends, and other terms of equity compensation can have a significant effect on value. Be sure they are clearly identified and factored into the analysis.
Seven: Standard of value
Keep your eyes on the road
Select an appropriate regulatory standard of value. It’s either fair market value or fair value. The appropriate standard is decided by the purpose of the valuation.
Eight: Valuation methods
Choose your friends wisely
Select professionally recognized valuation approaches and methods. Use best practices which satisfy regulatory requirements and are appropriate for equity compensation valuation.
Nine: Discounts and premiums
Watch the bottom line
Adjust the value of individual equity compensation interests for applicable control premiums, minority interest discounts, marketability discounts, or other factors.
Ten: Documentation
Be ready to rumble
Have results supported by complete information regarding the data, methods, assumptions, and analysis supporting the valuation. Be fully prepared for any inquiry, review, audit, and questions.
