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Correct, the 409a is only going to show you the maximum possible value. Realistically, investors get their money back first, so 50% (picking an arbiter number)

Correct, the 409a is only going to show you the maximum possible value. Realistically, investors get their money back first, so 50% (picking an arbiter number) of that valuation value won’t ever been seen by employees. Then it gets even worse with multipliers and preferences.

FreakLegion 1y ago
It's the preference and its multiplier that gives investors their money back first. These aren't different things, they're one thing, and generally only matter if the company exits for less than the valuation the investors invested at. The exception to this is if any investors have a liquidation preference > 1x (you should avoid companies where this is the case). Preferences also don't stack with the rest of a liquidity event. E.g. say an investor puts in $100m at a post-money of $1b with a 1x liquidation preference. If the shares go for $900m, the investor gets back their $100m, and that's all. They don't lose money, but they don't make money either. If the shares go at a $1.1b valuation, the investor converts their preferred shares to common shares like everyone else has. The investor doesn't get their money back first and sell more shares on top of that. It's either/or.
- deleted 1y ago
  [deleted]
- t0mas88 1y ago
  Whether it's and vs either/or is the difference between a liquidation preference or a participating liquidation preference. And indeed the more than 1x cases are also problematic for common stock holders. But I do assume the 409A for the fair marker value of the common stock takes these into account? Not a US tax expert :-)
  - FreakLegion 1y ago
    You can construct any arbitrary deal terms you like, of course, but in the Silicon Valley ecosystem nobody you'd want to raise money from does this. Deal terms are broadly standardized and the desirable investors only do clean term sheets. Quoting myself from another thread a couple years ago: VCs make their money from outlier companies, so the competent ones don't optimize for worst-case outcomes. You'll never see a dirty term sheet (e.g. liquidation preference > 1x) from Sequoia, for example, because they don't return 8x on a fund by squeezing pennies out of failed startups. To answer your question, yes, doling out company value to different share classes is part of the 409A calculation. I've used Carta and Pulley for this, but it looks like neither has their docs posted publicly. Here's Pulley's overview page from our last 409A, though: Valuation Analysis To determine the fair market value of the Subject Interest in our analysis, the following steps were taken: Step 1 - Determine the value of the Company using an appropriate methodology(ies) Step 2 - Allocate the value of the Company to the various share classes taking into account share classes economic rights and preferences Step 3 - Apply a discount for lack of marketability (“DLOM”) to the resulting per share value of common Step 4 - Analyze any secondary transactions that have incurred in the past and determine to what extent they should be considered relevant in determining the value of the Subject Interest in the analysis The system is built to handle non-standard liquidation preferences, but anything more esoteric (e.g. your participating preferred shares) probably needs a bespoke valuation. You won't see this stuff from successful VCs, though. It would be a bit like investing in SpaceX, but having one of the terms be an increase in Earth's gravity.
    - TuringNYC 1y ago
      >>> VCs make their money from outlier companies, so the competent ones don't optimize for worst-case outcomes. You'll never see a dirty term sheet (e.g. liquidation preference > 1x) from Sequoia, for example, because they don't return 8x on a fund by squeezing pennies out of failed startups. Serious question -- if you are right, then why hide the cap tables?! Typically cap tables are even hidden from employees who have millions of theoretical dollars riding on the company. Transparency is usually an indicator of above-board terms, and opaque things are usually opaque for a reason.
      - FreakLegion 1y ago
        The cap table is just a spreadsheet of who owns what. Employees don't need to see that level of detail to understand their shares, so there's no particular reason to pass it around, and plenty of reasons not to. Many startups are happy to give relevant details, though, like the percentage of fully diluted shares you own, the last preferred share price, whether any investors got non-standard terms, etc. Rather than asking to see the cap table, ask the questions you want the cap table to answer. If they won't tell you, maybe pass on working there.
CPLX 1y ago
> the 409a is only going to show you the maximum possible value While the points about uncertainty of options are quite accurate, this detail isn’t really true. For the most part a 409a is the lowest reasonable valuation the company could talk the auditors into accepting. The lower it is the less tax paid and everyone knows that.
- bcyn 1y ago
  You're correct about valuation, but the parent post was meant to address "how much liquid dollars should you expect to receive vs. 409a." You are likely to receive less in most cases (read: unless there are wildly successful public liquidity events) due to liquidation preferences.
  - x0xrx 1y ago
    Plenty of (non-VC backed) startups raise some money and then sell privately; it’s often the case that preference does not cause the common stock value to drop below the most recent 409a in these cases. (In my experience, the 409a is on the order of 20% of the most recent raise, and preference is not more than 50%, in my area. And obviously you hope to sell for more than the last raise!).
  - CPLX 1y ago
    Any reasonable 409a will be fully aware of those preference terms and will have factored them in.
TuringNYC 1y ago
>> Then it gets even worse with multipliers and preferences. Yeah, and most companies wont share the cap table with you, so you do not know the multipliers and preferences. Its like you get $(409a/X) in value, but you dont know what X is and they wont tell you -- but you still have to buy in or lose everything (you typically have to exercise all options upon departure, or lose it!) Then, once you exercise, you wait for 5yrs to 10yrs for a liquidity event, if the company even survives that long. My annual discount rate would be like 10% or higher.

FreakLegion 1y ago

It's the preference and its multiplier that gives investors their money back first. These aren't different things, they're one thing, and generally only matter if the company exits for less than the valuation the investors invested at. The exception to this is if any investors have a liquidation preference > 1x (you should avoid companies where this is the case). Preferences also don't stack with the rest of a liquidity event. E.g. say an investor puts in $100m at a post-money of $1b with a 1x liquidation preference. If the shares go for $900m, the investor gets back their $100m, and that's all. They don't lose money, but they don't make money either. If the shares go at a $1.1b valuation, the investor converts their preferred shares to common shares like everyone else has. The investor doesn't get their money back first and sell more shares on top of that. It's either/or.

deleted 1y ago
[deleted]
t0mas88 1y ago
Whether it's and vs either/or is the difference between a liquidation preference or a participating liquidation preference. And indeed the more than 1x cases are also problematic for common stock holders. But I do assume the 409A for the fair marker value of the common stock takes these into account? Not a US tax expert :-)
- FreakLegion 1y ago
  You can construct any arbitrary deal terms you like, of course, but in the Silicon Valley ecosystem nobody you'd want to raise money from does this. Deal terms are broadly standardized and the desirable investors only do clean term sheets. Quoting myself from another thread a couple years ago: VCs make their money from outlier companies, so the competent ones don't optimize for worst-case outcomes. You'll never see a dirty term sheet (e.g. liquidation preference > 1x) from Sequoia, for example, because they don't return 8x on a fund by squeezing pennies out of failed startups. To answer your question, yes, doling out company value to different share classes is part of the 409A calculation. I've used Carta and Pulley for this, but it looks like neither has their docs posted publicly. Here's Pulley's overview page from our last 409A, though: Valuation Analysis To determine the fair market value of the Subject Interest in our analysis, the following steps were taken: Step 1 - Determine the value of the Company using an appropriate methodology(ies) Step 2 - Allocate the value of the Company to the various share classes taking into account share classes economic rights and preferences Step 3 - Apply a discount for lack of marketability (“DLOM”) to the resulting per share value of common Step 4 - Analyze any secondary transactions that have incurred in the past and determine to what extent they should be considered relevant in determining the value of the Subject Interest in the analysis The system is built to handle non-standard liquidation preferences, but anything more esoteric (e.g. your participating preferred shares) probably needs a bespoke valuation. You won't see this stuff from successful VCs, though. It would be a bit like investing in SpaceX, but having one of the terms be an increase in Earth's gravity.
  - TuringNYC 1y ago
    >>> VCs make their money from outlier companies, so the competent ones don't optimize for worst-case outcomes. You'll never see a dirty term sheet (e.g. liquidation preference > 1x) from Sequoia, for example, because they don't return 8x on a fund by squeezing pennies out of failed startups. Serious question -- if you are right, then why hide the cap tables?! Typically cap tables are even hidden from employees who have millions of theoretical dollars riding on the company. Transparency is usually an indicator of above-board terms, and opaque things are usually opaque for a reason.
    - FreakLegion 1y ago
      The cap table is just a spreadsheet of who owns what. Employees don't need to see that level of detail to understand their shares, so there's no particular reason to pass it around, and plenty of reasons not to. Many startups are happy to give relevant details, though, like the percentage of fully diluted shares you own, the last preferred share price, whether any investors got non-standard terms, etc. Rather than asking to see the cap table, ask the questions you want the cap table to answer. If they won't tell you, maybe pass on working there.

CPLX 1y ago

> the 409a is only going to show you the maximum possible value While the points about uncertainty of options are quite accurate, this detail isn’t really true. For the most part a 409a is the lowest reasonable valuation the company could talk the auditors into accepting. The lower it is the less tax paid and everyone knows that.

bcyn 1y ago
You're correct about valuation, but the parent post was meant to address "how much liquid dollars should you expect to receive vs. 409a." You are likely to receive less in most cases (read: unless there are wildly successful public liquidity events) due to liquidation preferences.
- x0xrx 1y ago
  Plenty of (non-VC backed) startups raise some money and then sell privately; it’s often the case that preference does not cause the common stock value to drop below the most recent 409a in these cases. (In my experience, the 409a is on the order of 20% of the most recent raise, and preference is not more than 50%, in my area. And obviously you hope to sell for more than the last raise!).
- CPLX 1y ago
  Any reasonable 409a will be fully aware of those preference terms and will have factored them in.

TuringNYC 1y ago

>> Then it gets even worse with multipliers and preferences. Yeah, and most companies wont share the cap table with you, so you do not know the multipliers and preferences. Its like you get $(409a/X) in value, but you dont know what X is and they wont tell you -- but you still have to buy in or lose everything (you typically have to exercise all options upon departure, or lose it!) Then, once you exercise, you wait for 5yrs to 10yrs for a liquidity event, if the company even survives that long. My annual discount rate would be like 10% or higher.