Financial Reporting Blog: Best of 2015

With the New Year just around the corner, we begin our countdown a little early. Here are this year’s 10 most popular posts from The Financial Reporting Blog.

Happy New Year 2016!

10. Lower Valuations for Private Companies?

The CFA Institute recently released a report about investor apprehensions concerning separate accounting standards for private companies. The report reflects the results of a survey of investment professionals in the CFA Institute. The separate accounting standards include differing accounting rules for SMEs (small or medium sized entities) under IFRS and for private companies under GAAP (as advanced by the Private Company Council). On balance, while investors seem to think the initiative will reduce companies’ compliance costs, they believe the benefits are unlikely to outweigh the costs.

9. Unicorn Valuations: What’s Obvious Isn’t Real, and What’s Real Isn’t Obvious

In the two short years since Aileen Lee introduced the term “unicorn” into the VC parlance, the number of such companies has steadily increased from the 39 identified by Lee’s team at Cowboy Ventures to nearly 150 (and growing weekly) by most current estimates.  Pundits and analysts have offered a variety of explanations for the phenomenon, with some identifying unicorns as the sign that the tech bubble of the late 1990s has returned under a different guise, others attributing the existence of such companies to structural changes in how innovation is funded in the economy, and the most intrepid of the group suggesting that the previously undreamt valuations are fully supported by the underlying fundamentals given the maturity and ubiquity of the internet, smart phones, tablets, and related technologies.

8. Is a Bubble Forming in FinTech?

With analysts and pundits trying to identify those sectors that may be overheating as the market grinds to all-time highs, one sector to keep an eye on is financial technology (“FinTech”). Against a backdrop of optimism and growing investor interest, we thought it might be useful to examine valuation multiples within the FinTech industry over time to see whether public markets are reflecting these trends as well. While key valuation drivers such as profitability, growth prospects and risks vary among each FinTech niche, our graphic illustrates that the public market is indeed telling a similar story and perhaps a FinTech bubble is emerging or at least starting to form as margins are generally down across various FinTech niches while valuation multiples have expanded.

7. Valuation of Contingent Consideration in M&A Transactions

Companies often use contingent consideration when structuring M&A transactions to bridge differing perceptions of value between a buyer and seller, to share risk related to uncertainty of future events, to create an incentive for sellers who will remain active in the business post-acquisition, and other reasons. ASC 805 stipulates that acquiring entities are required to record the fair value of earn-outs and other contingent payments as part of the total purchase price at the acquisition date.

6. Equity-Based Compensation: Are Non-GAAP Earnings Misleading?

During the 1990s debate over the status of stock options as a corporate expense, the big technology companies argued passionately that, since stock option grants to employees don’t ding the corporate checkbook, they should not be recognized as an expense. Despite winning the initial battle (SFAS 123), the tech companies ultimately lost the war (SFAS 123R). Regardless of the ongoing debate about how best to measure earnings, stock-based compensation is a tool used by companies of all sizes and in all industries. In order to deliver the most reliable information to investors, companies need to carefully evaluate the value of such compensation packages when granted.

5. How to Value Venture Capital Portfolio Investments

In this post we describe our process when providing periodic fair value marks for venture capital fund investments in pre-public companies. This process includes examining the most recent financing round economics, adjusting valuation inputs the measurement date, measuring fair value, and reconciling and testing for reasonableness.

4. Pulling the Trigger: Interim Goodwill Impairment Testing

Most financial professionals understand that goodwill impairment testing is typically performed annually. However, ASC 350 also prescribes that interim goodwill tests may be necessary in the case of certain “triggering” events. For public companies, perhaps the most common triggering event is a decline in stock price, but a variety of other factors may constitute a triggering event as described in ASC 350. For reporting units undergoing major changes, interim goodwill impairment testing provides management, auditors, and investors with some assurance that the unit’s balance sheet reflects the current expectations for the unit.

3. Noncompete Agreements for Section 280G Compliance

Golden parachute payments have long been a controversial topic. These payments, typically occurring when a public company undergoes a change-in-control, can result in huge windfalls for senior executives and in some cases draw the ire of political activists and shareholder advisory groups. Golden parachute payments can also lead to significant tax consequences for both the company and the individual. Strategies to mitigate these tax risks include careful design of compensation agreements and consideration of noncompete agreements to reduce the likelihood of additional excise taxes.

2. Valuation Best Practices for Venture Capital Funds

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.

1. Consequences of Calcified Cap Charts: A Few Thoughts on Startup Equity-Based Compensation

In a prior blog post, we noted a plethora of pricing indications observed around Box, Inc.’s (NYSE: BOX) initial public offering and asked the question, “Which price is right?” The prices (and implied valuations) that a business venture can obtain in future funding rounds, and in the public markets, are important considerations from the perspective of VCs and other investors. Unlike most mature public companies, however, startups have a predilection for complex capital structures, which introduces a degree of opacity that makes simple inference from headline numbers (however correct, however precise) difficult. A future funding round or exit event can result in varying outcomes for the multiple classes of securities with dissimilar rights and protections. This blog post will focus on the impact of (relatively steep) pre-public pricing on equity granted as employee compensation, usually the junior-most security in a startup capital stack.