AICPA guide, covering valuation of privately held shares stands out in relation to other valuation literature. It covers certain technical valuation topics as well as softer or business aspects of valuation. The technical content includes application of the option pricing model, related allocation techniques, relations between assets and equity volatility, many helpful examples. Business content includes stages of enterprise development, their impact on fair value estimates, discussing of market participant expectations, evaluating relevance of secondary transaction. The guide is geared toward valuations performed for financial reporting purposes, generally, more complex valuations.

The AICPA guide became probably the single most popular source of reference among valuation professionals. It is no surprise that AICPA prepared the updated version to the initial guide published in 2013.

The guide is hard to read. Mostly due to frequent cross-references, use of more formal language and, at times, difficult-to-reperform numerical examples. We hope readers will find our summary of key updates in the draft guide helpful. The key updates are as follows:

  • expect to see the so-called common-stock equivalent (CSE) allocation method, which ignores contractual liquidation preferences and assumes one per share price across all equity classes where, the per share price is from the most recent share issuance transaction;
  • CSE method is likely to be used in combination with other allocation methods, including option pricing model;
  • use of CSE will generally result in higher valuations of less senior shares, e.g. common stock;
  • expect to see the implied credit spread, representing an internal rate of return on the present value of the liquidation preference less the risk-free rate. Calculated credit spread is compared against market participants expectations as part of valuation reasonableness check.
  • expect to see more reliance on secondary transactions, i.e., trading of existing securities as opposed to a primary transaction in which the issuer itself sells new securities. Higher extent of reliance on secondary transactions should be supported by detailed analysis to determine their applicability in fair value estimates.
  • the updated guide makes an emphasis on using the fair value of debt as opposed to book value or repayment value when determining fair value of equity;
  • the updated guide places more emphasis on calibration and consistency checks applied as part of the valuation process.