For many private equity (PE) and venture capital (VC) investors, an initial public offering (IPO) is a way to monetize their investments in a company and the most ideal exit strategy through direct investment in a subject company. However, the IPO process might be challenging and could take years before it is finally successfully completed. Various factors, such as financial markets, business progress, and the overall economic environment, may change dramatically before an IPO eventually takes place. Pre-IPO valuation of equity interests is highly important to support the progressive path toward an IPO and to withstand scrutiny from investors, auditors, and the Securities and Exchange Commission (SEC). Pre-IPO valuations are also used to document the fair value of equity holdings (preferred stock, common stock, options, warrants, incentive units, etc.) and to set the strike price for new option grants for IRC 409(a) purposes.
As IPO valuation has been a hot discussion area in the past few months, including certain cases in which IPO valuations have back-fired, it is important to outline the key valuation considerations and complexities that need to be acknowledged and addressed as a company prepares to go down the path of a potential IPO. The purpose of this guide is to shed light on those areas of consideration and to present a more concrete roadmap for selecting the appropriate valuation methodologies and assumptions to ensure proper guidance along the pre-IPO valuation journey. This report summarizes the main guidance offered by the American Institute of CPAs in their latest published Accounting and Valuation Guide, Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies, which presents a relevant case study as an illustrational example and provides certain items for consideration based on our valuation experience.
Stout Associate Yadi Niu contributed to the development of this article.
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