The National Venture Capital Association (NVCA) published the 2014 Venture Capital Yearbook in May 2014. This blog post summarizes Appendix I of the 2014 Yearbook, which includes comments on valuation guidelines and best practices for venture capital investments and funds.
A recent article from McKinsey & Company examined investor reaction to news of a goodwill impairment. Through analysis of excess returns in the three days before and after announcement, McKinsey found that investors often respond positively, or neutrally, when companies announce a goodwill write-down. Why wouldn’t investors react more negatively? The authors suggest that when investors already understand that an acquisition has been underperforming, the impairment charge may be perceived as an event that communicates acknowledgment on the part of management as well as an opportunity to charge course. The article goes on to encourage companies to be candid with investors about the nature of the impairment and the company’s plans to address the situation and move forward.
A recent post on the Wall Street Journal’s CFO Journal blog reported recent comments by Andrew Ceresny, head of enforcement at the SEC, signaling that financial reporting issues will be the subject of enhanced scrutiny as actions related to the financial crisis recede. In testimony before Congress this spring, SEC Chair Mary Jo White cited efforts by the newly-formed Financial Reporting and Audit Task Force to “identify areas susceptible to fraudulent financial reporting through an on-going review of financial statement restatements and revisions, analysis of performance trends by industry, and the use of technology-based tools.” Through Operation Broken Gate, the task force is focused on audit failures in addition to issuer fraud. The emphasis on valuation issues is not surprising, since the exercise of judgment is an inherent aspect of valuation.
Elon Musk just opened Tesla Motors’ patents to the public in “the spirit of the open source movement.” Perhaps shrewdly, he appears to have concluded that the cash flows he is giving up today in the form of foregone royalties or potentially lower margins will be more than made up by future cash flows from a more vibrant solar power-based transportation network.
Contingent consideration (otherwise known as earn-outs) has been in the news lately. From the acquirer’s perspective, contingent consideration functions as a hedge against poor future performance and the possibility that cash flow will not grow as much as projected. Additionally, it can serve as incentive for a seller to maintain or improve the performance of the company after a transaction. ASC 805 requires that the fair value of contingent consideration be recorded as a liability at the acquisition date, with the effective result of increasing the amount of goodwill in the transaction. This liability must be revalued annually until the contingency is resolved. The valuation of contingent liabilities is dependent on the probability of reaching various milestones at points in the future and is usually determined by probability-weighted expected future payments. There is no one-size-fits-all approach to contingent consideration valuation and it can be beneficial to have a valuation expert involved in your purchase price allocation process.
