How to value private shares

Common stock of private companies is notoriously difficult to value. One approached that is taken by sophisticated large secondary buyers (the like of Elevation and DST), is to apply a discount to the value of the last preferred round. Preferred shares are inhenrently more valuable than common shares, it therefore makes sense to take the latest preferred valuation and apply a discount to it. The preferred round will have been negotiated by sophisticated parties witch access to full company information. It is therefore best to piggy back on that valuation as opposed to try to make a better one yourself.

A discount of 50 to 70% seems fair. Meaning selling common stock at about 50 to 30% of the value of the last preferred round is a good deal.

But what if you don’t know the value of the last preferred round? Well, companies usually base their share options on preferred valuations as well. Usually options represent the right to buy stock at 10% of the preferred round prior to the option grant.

So check out your options, and the price at which they allow you to buy shares. That price should be around 10% of the preferred round at the time. Off course the company will have grown in value since the options were granted… So you should take that into account as well.

Check out the below quote from a very interesting academic article:

Common stock in start-ups is notoriously difficult to
value. But one common method is to price it relative to the latest
preferred stock price. Because common stock does not have all the
bells and whistles of preferred stock, it will be worth less. Indeed,
when granting stock options to employees, start-ups usually take the
position that the stripped-down common stock is worth no more than
ten percent of the latest preferred price (a ninety percent discount).
Conversely, the discounts are far less in direct market transactions.
One interviewee claimed that a five to twenty percent discount from
the latest preferred round is standard. By way of a quantitative data
point, Digital Sky Technologies recently bought both preferred and
common shares of Facebook; it valued the preferred at $10 billion and
the common at $6.5 billion—only a thirty-five percent discount. One
large buyer told me that his firm’s preferred-to-common discount
averages seventy-one percent, higher than others but still less than
standard practice in option pricing.

source: The New Exit in Venture Capital, Darian M. Ibrahim · Jan-31-2012 · 65 VAND. L. REV. 1 (2012)

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