After the markets closed on September 18th, Chinese technology giant Alibaba priced the shares for its long-awaited IPO at $68 per share, higher than the previously expected range of between $60 and $66 per share. Alibaba raised $21.8 billion, making it the largest U.S. IPO in history and coming in a close second for the world’s largest IPO (for the record, the Agricultural Bank of China’s $22 billion IPO in 2010 still holds the crown). The $68 per share price implies a value of $168 billion for the growing (and now highly liquid) Chinese company.
When measuring the fair value of equity-based compensation granted prior to an IPO, should the expected IPO price range or even the actual IPO price be indicative of the fair value of the shares at the time of the grant? Alibaba’s Form F-1/A dated September 15, 2014 notes that the company issued both options and restricted stock units up through September 5th. According to the company, the fair value of Alibaba’s ordinary shares was $59.00 for the most recent grant.
The AICPA’s accounting and valuation guide Valuation of Privately-Held-Company Equity Securities Issued as Compensation includes a discussion of the effects of an IPO on a company’s value. IPO prices reflect an estimate of the expected valuation of a company’s shares after the offering, taking into account the effects of the IPO itself. These effects may include:
- The cash flow generated by the IPO, which can be used either to reduce the company’s outstanding debt or to finance the company’s continued growth and expansion.
- An increase in liquidity resulting from the company being listed on a public exchange. An increase in the potential pool of buyers and the liquidity offered by a formal market serve to reduce the marketability discount for minority equity securities of a company.
- Removal of restrictions on transfer. Securities registered in a formal stock market are not subject to federal restrictions and company-created restrictions on unregistered securities.
- Reduction of the concentration of ownership.
- Decrease in valuation uncertainty. Securities with active markets have more easily determined prices than securities with few or no stock transfers in recent years.
- Elimination of special rights on senior equity classes or debt securities.
- A decrease in the company’s cost of capital, which is often higher for privately-held companies than for publicly-traded firms. The overall reduction in risk associated with the company may reduce the cost of financing the company’s ongoing activities, increasing the relative value of the company.
Estimates of IPO pricing can also be influenced by the pipeline of other offerings coming to market, institutional demand, and general industry dynamics. It is not uncommon for IPO candidates to revise, even multiple times, their estimates of pricing over the course of the months-long preparation, road-show, and sales process. In addition, the likelihood and timing of an actual IPO can also be uncertain, sometimes even as late as a couple of weeks before the planned/announced date. It is for these reasons that estimated IPO pricing may not provide reasonable estimates of the fair value of a company’s shares for pre-IPO equity transactions. Should they be ignored in the course of the fair value analysis? Absolutely not. Best practices suggest that a valuation specialist should consider all facts and circumstances when valuing the shares of a privately-held corporation in the periods preceding an IPO. But blind reliance on an estimated IPO pricing range should be avoided when estimating fair value. Mercer Capital is experienced in working with pre-IPO companies in the measurement of the fair value of equity-based compensation. Give us a call to discuss your needs in confidence.
- Service: Equity-Based Compensation Valuation
- Article: Why Quality Matters in Valuation for Equity Compensation Grants
- Presentation: ASC 718 – Equity Compensation
- Guidance: Valuation of Privately-Held-Company Equity Securities Issued as Compensation (Chapter 10) *requires purchase