Questions

How do you discount value of common stock?

I want to exit a startup as a founder and to sell my common stock. I understand that it is less valued compared to preferred stock. But how much? Are there any benchmarks?

2answers

Hire an independent valuator. In the case of US companies, a 409A valuation has to occur at every priced financing round, so if you've had one done, that would serve as guide.

But you might not even have the right to sell your shares. Your shares should be subjected to vesting and your voluntary resignation would likely cancel all remaining unvested shares. Even should you have shares to sell, if you have Preferred shareholders, it's likely that there are terms that might make selling your shares to a 3rd party difficult.

Happy to talk in more detail about the specifics of your situation.


Answered 5 years ago

Basic starting point to value any stock is to look at the earnings that stock is likely to generate in future. Boring, mature companies generating fairly predicatable (but not fast-growing) profits might be valued at 10x annual earnings.

A fast-growing business might be valued at 20x annual profits.

Something off-the-scale in terms of growth prospects (or for some other reason, e.g. Facebook buying Instagram to stop it growing into a competitor) could see 100x or more.

If you company is not profitable, you can still do the same sort calculation, but you have to base it on some prediction of future earnings (and then purchaser takes a punt on how likely your prediction is and will adjust multiple accordingly.)

It all comes down to the same kind of calculation you'd make with any investment.

Let's say that if you buy asset X you get $50k per year income.

So you might pay $1m for that asset (=5% return, better than a bank account).

If someone buying your shares confidently expects to get exactly $50k per year, they might pay $1m for them.

If they think that $50k is going to grow a lot, they'll pay more than $1m.

If they think the $50k is actually very uncertain, they'll pay a lot less than $1m.

If your shares are somehow worth more to them than just the income stream (which is often the case) then they'll adjust their valuation accordingly (e.g. another shareholder wants control as he can then do more things; another company can make more out of your company than you can alone; a competitor wants to buy you out to shut you down; etc.)

Regarding preferred stock: Preferred stock is more valuable than common stock because the preferred stock has special rights (which would vary from one company to another, but might include rights to get the first $X from any sale, then whatever is leftover is split amongst all shareholders; or the right to receive $x per year in a special dividend before remaining profits are split amongst all shareholders)

Those special rights will determine how much more valuable the preferred stock is to common stock, but hard to answer any more meaningfully without knowing more details.


Answered 5 years ago

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