Valuation Glossary

409A Valuation, Fair Market Value definition, Enterprise Value vs Equity Value, DLOM, etc. Everything you need to know about valuations.

Our clients tend to be brilliant founders and executives who are experts in their industries. However, they aren’t always experts in the arcane mechanics of finance and valuation. We hope this easy-to-reference glossary will help clarify any unfamiliar terms.


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409A (or IRC 409A)

Section 409A of the Internal Revenue Code (or referred to as IRC 409A) is the portion of the tax code that regulates nonqualified deferred compensation paid by a "service recipient" to a "service provider."

409A Penalty

Generally a 20% excise tax when certain design or operational rules contained in the section are violated.

409A Valuation

A valuation performed by qualified, independent appraiser (like Preferred Return) to assess the Fair Market Value of stock granted to a service recipient (like an employee) in order to provide the service provider certain Safe Harbors in complying with IRC 409A

8283 (or Form 8283)

Form 8283 is a tax form distributed by the Internal Revenue Service, IRS, and used by filers who wish to deduct noncash contributions made to a qualifying charitable organization. Deductions for noncash contributions are reported as itemized deductions, and an example of this may be stock in a private company (for which, the donor will have to receive a Fair Market Value assessment).


A

Acquisition premium

In a merger or an acquisition, the difference between the purchase price and pre acquisition value of the target firm.

Active market

A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.

Anti Dilution right

A right that provides one or more classes of equity with protection against dilution in the event of subsequent down rounds of financing. These rights result in an automatic adjustment of the original conversion ratio of preferred stock to common stock in the event that an enterprise subsequently issues stock at a price per share below the original issue price of the existing preferred stock.

Asset accumulation method

A method commonly under the asset approach under which the value of the enterprise is determined to be the net of the fair value of the enterprise’s individual assets and liabilities. The asset accumulation method is also commonly referred to as the adjusted net asset value method or the adjusted book value method.

Asset Approach

A general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value of the assets net of liabilities (as defined by International Glossary of Business Valuation Terms “IGBVT”). Also known as asset-based approach.


B

Backsolve method

A method within the market approach wherein the equity value for a privately held company is derived from a recent transaction in the company’s own securities. Effectively, given the rights and preferences of a recent transaction, “backing into” the value of the overall company.

Basis of valuation

The basis of valuation reflects the types of premiums or discounts that should be considered for the subject interest, given the premise of value. In traditional valuation practice, valuations may be considered on a controlling or minority basis and on a marketable or non marketable basis. In valuing a minority interest in an enterprise, the basis of valuation for the enterprise should be consistent with the required rate of return for the investors who in aggregate have control over the business. Additional premiums or discounts may be applied to the extent that the required rate of return for the minority investors would differ from that for the investors who in aggregate have control over the business.

Board Composition Rights

Rights that provide preferred stockholders the ability to control the board composition in a manner that is disproportionate to their share ownership.
Burn Rate. For an enterprise with negative cash flow, the rate of that negative cash flow, typicallyper month.


C

Capital Asset Pricing Model (“CAPM”)

A model in which the cost of capital for any stock or portfolio of stocks equals a risk-free rate plus a risk premium that is proportionate to the systematic risk of the stock or portfolio. (IGBVT)

Contemporaneous Valuation

A valuation that is performed concurrent with, or a short time after, the as-of date of the valuation; see also retrospective valuation.

Control

The power to direct the management and policies of a business enterprise. (IGBVT)

Control Premium

An amount or a percentage by which the pro rata value of a controlling interest exceeds the pro rata value of a noncontrolling interest in a business enterprise to reflect the power of control. (IGBVT)

Conversion Right

A feature on some bonds and preferred stock issues allowing the holder to convert the securities into common stock.

Cost Approach

A valuation technique that reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost). (as noted by the Financial Accounting Standard Board (“FASB”) Accounting Standard Codification (“ASC”) master glossary) A general way of determining a value indication of an individual asset by quantifying the amount of money required to replace the future service capability of that asset. (IGBVT)

Cost of Capital

The expected rate of return that the market requires in order to attract funds to a particular investment. (IGBVT)


D

Discount For Lack of Marketability (“DLOM”)

See marketability discount.

Discount Rate

A rate of return used to convert a future monetary sum into present value. (IGBVT)

Discount Rate Adjustment Technique

A present value technique that uses a risk-adjusted discount rate and contractual, promised, or most likely cash flows. (FASB ASC master glossary)

Discounted Cash Flow (DCF) method

A method within the income approach whereby the present value of future expected net cash flows is calculated using a discount rate. (IGBVT)

Down Round

A round of financing in which investors purchase stock from an enterprise at a lower price than the previous round.

Drag-along Rights

Rights that allow one class of shareholder to compel the holders of one or more other classes of shares to vote their shares as directed in matters relating to sale of the enterprise.


E

EBIT

Earnings before interest and taxes.

EBITDA

Earnings before interest, taxes, depreciation, and amortization.

EITF

Emerging Issues Task Force of FASB.

Enterprise Value

For purposes of accounting for, valuation of, and disclosures related to, privately held company equity securities issued as compensation, enterprise value is defined as the value of equity and interest-bearing debt. In broader valuation practice, the term enterprise value is sometimes used to refer to the value of equity and interest-bearing debt, less all cash and equivalents; however, for this guide, the task force considers enterprise value to include cash and cash equivalents. Enterprise value may also be referred to as invested capital, market value of invested capital (MVIC), or total enterprise value.

Equity Value

For purposes of accounting for, valuation of, and disclosures related to, privately held company equity securities issued as compensation, equity value is defined as the enterprise value, less the fair value of debt, measured considering the required rate of return for the investors who in aggregate have control over the business.

Expected Cash Flow.

The probability-weighted average (that is, mean of the distribution) of possible future cash flows. (FASB ASC master glossary)

Expected Present Value Technique

A technique that uses as a starting point a set of cash flows that represents the probability-weighted average of all possible future cash flows (that is, the expected cash flows). The resulting estimate is identical to expected value, which, in statistical terms, is the weighted average of a discrete random variable’s possible values with the respective probabilities as the weights. Because all possible cash flows are probability-weighted, the resulting expected cash flow is not conditional upon the occurrence of any specified event (unlike the cash flows used in the discount rate adjustment technique).


F

FASB.

Financial Accounting Standards Board.

Fair Market Value

The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. (IGBVT)

Fair Value

The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale. (FASB ASC 718 and FASB ASC 505-50)

Fair Value

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (FASB ASC 820)

Fairness Opinion

An opinion as to whether or not the consideration in a transaction is fair from a financial point of view. (IGBVT)

First Refusal Rights

Contractual rights frequently granted to venture capitalists to purchase shares of common stock held by other shareholders (typically, founders and key management) before such shares may be sold to a third party.

Full Ratchet

An anti-dilution provision that uses the lowest sales price for any shares of common stock sold by an enterprise after the issuance of an option (or convertible security) as the adjusted option price or conversion price for existing shareholders.


G

Guideline Company Transactions Method (or M&A Comparables)

A method within the market approach whereby market multiples are derived from the sales of entire companies engaged in the same or similar lines of business. (Appendix C, "Glossary of Additional Terms," of SSVS No. 1)

Guideline Public Company Method (or Public Comparables)

A method within the market approach whereby market multiples are derived from market prices of stocks of companies that are engaged in the same or similar lines of business and that are actively traded on a free and open market. (IGBVT)


H

Hybrid Method.

The hybrid method is a hybrid between the probability-weighted expected return method and option pricing method (OPM), estimating the probability weighted value across multiple scenarios but using OPM to estimate the allocation of value within one or more of those scenarios.


I

IPO.

Initial public offering

Income Approach

Valuation techniques that convert future amounts (for example, cash flows or income and expenses) to a single current (that is, discounted) amount. The fair value measurement is determined on the basis of the value indicated by current market expectations about those future amounts. (FASB ASC master glossary) A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount (IGBVT). Also known as income-based approach.

Information Rights

Contractual rights of access to pre specified information, such as monthly or audited financial statements or the annual operating plan, within a specified time period after that information is available to management.


J

Junior Security

A security that ranks lower than other securities in regard to the owner’s claims on assets and income in the event of the enterprise becoming insolvent. Sometimes, the term is used interchangeably with junior equity security.


L

Lead Investor

Usually a private equity or venture capital firm that takes the lead in negotiating the terms of the deal or makes the initial investment in the company.

Liquidation Preference

The right to receive a specific value for shares of stock if an enterprise is liquidated. (In this context, a dissolution, merger, sale, change of control, or sale of substantially all assets of an enterprise are collectively referred to as a liquidation.)

Liquidity Event

A change or transfer in ownership of an enterprise (for example, an IPO, merger,sale, change of control, sale of substantially all assets, or dissolution). Note, however, that although an IPO can provide liquidity to the company’s freely traded shares and also, in most cases, leads to the conversion of the preferred stock and, thus, resolves the optionality of the common stock, it seldom provides liquidity for all shareholders.


M

MVIC

Market value of invested capital.

Management Rights

Contractual rights to perform certain specific activities normally afforded only to management, such as rights to inspect in detail an enterprise’s books and accounts as well as rights to visit board meetings.

Mandatory Redemption Rights

Contractual rights to redeem one’s investment for a specific amount.

Market Approach

A valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable (that is, similar) assets, liabilities, or a group of assets and liabilities, such as a business. (FASB ASC master glossary) A general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold (IGBVT). Also known as market-based approach.

Market Participants

Buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all of the following characteristics:

  • They are independent of each other, that is, they are not related parties, although the price in a related-party transaction may be used as an input to a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms.
  • They are knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information, including information that might be obtained through due diligence efforts that are usual and customary.
  • They are able to enter into a transaction for the asset or liability
  • They are willing to enter into a transaction for the asset or liability, that is, they are motivated but not forced or otherwise compelled to do so. (FASB ASC master glossary).

Marketability Discount (discount for lack of marketability)

An amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability. (IGBVT)

Mezzanine Financing

A financing round generally associated with venture capital-backed enterprises occurring after the enterprise has developed its product or service and has commenced operations but before the enterprise is ready for an IPO or to be acquired.

Minority Interest

An ownership interest with less than 50 percent of the voting interest in a business enterprise. (IGBVT)


P

Partial Ratchet

An anti dilution provision that uses some type of weighted average sales price of shares of common stock sold by an enterprise after the issuance of an option (or convertible security) as the adjusted option price or conversion price for existing shareholders.participation rights. Rights that relate to situations when after the holders of preferred stock receive their full liquidation preference, they are then entitled to share with the holders of common stock in the remaining amount being paid for the company.

Post-Money Value

An enterprise’s value immediately following its most recent round of financing;
Premise of Value.An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation; for example, going concern, liquidation. (IGBVT)

Pre-Money Value

An enterprise’s value immediately preceding its most recent round of financing;
Prospective Financial Information (PFI). Any financial information about the future. The information may be presented as complete financial statements or limited to one or more elements, items, or accounts. (AICPA Guide Prospective Financial Information).


Q

Qualified Initial Public Offering

An IPO in which the price per share at which the enterprise’s stock is issued to the public and the aggregate proceeds received by the enterprise from the IPO exceed certain pre specified levels.


R

Registration Rights

Contractual rights of an investor to require an enterprise to register and to sell his or her unregistered stock in the enterprise.

Related Parties
Related parties include:

  • Affiliates of the entity
  • Entities for which investments in their equity securities would be required, absent the election of the fair value option under the "Fair Value Option" subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity
  • Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management
  • Principal owners of the entity and members of their immediate families
  • Management of the entity and members of their immediate families
  • Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests
  • Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests (FASB ASC master glossary)


Reload Features

Provides for automatic grants of additional options whenever an employee exercises previously granted options using the entity’s shares, rather than cash, to satisfy theexercise price. At the time of exercise using shares, the employee is automatically granted a new option, called a reload option, for the shares used to exercise the previous option. (FASB ASC master glossary)

Replacement Cost New

The current cost of a similar new property having the nearest equivalent utility to the property being valued. (IGBVT) Also known as current replacement cost or replacement cost.

Reproduction cost new

The current cost of an identical new property. (IGBVT) Also known as reproduction cost.

Required Rate of Return

The minimum rate of return acceptable by investors before they will commit money to an investment at a given level of risk. (IGBVT)

Retrospective Valuation

A valuation that is performed after the as-of date of the valuation and that is not considered to be a contemporaneous valuation; see also contemporaneous valuation.

Right to Participate in Future Rounds

Contractual right that allows each preferred stockholder to purchase a portion of any offering of new securities of the enterprise based on the proportion that the number of shares of preferred stock held by such holder (on an as-converted basis) bears to the enterprise’s fully diluted capitalization or total preferred equity. The right to participate in future rounds gives the preferred stockholders the ability to maintain their respective ownership percentages and restricts the ability of common stockholders to diversify the shareholdings of the enterprise.


S

SSVS

Statement on Standards for Valuation Services issued by the AICPA and available in VS section 100.

Secondary Market Transaction

A transaction in which nonpublic debt or equity securities are traded, either directly on a secondary exchange or by the use of the exchange as an intermediary. A secondary market transaction differs from a public market transaction in that the securities transacted are not public; therefore, the buyers in these transactions must be qualified investors, and the issuers of the securities are not subject to public company reporting requirements.

Seed Capital

The initial equity capital used to start a new enterprise, typically provided in order to develop a business concept before the enterprise is started.

Senior Security

A security that has priority over other securities in the event of a claim or bankruptcy liquidation. Sometimes, the term is used interchangeably with senior equity security.

Simple Capital Structure

A capital structure that includes only common stock, plus debt, debt-like preferred securities, or both.

Standard of Value

The identification of the type of value being utilized in a specific engagement; for example, fair market value, fair value, investment value. (IGBVT)

Sunk Costs

Costs already incurred that cannot be recovered, regardless of future events.

Synergy

Used mostly in the context of mergers and acquisitions, the concept that the value and performance of two enterprises combined will be greater than the sum of the separate individual parts. In the context of developing prospective financial information, synergies refer to the difference between the assumptions used to estimate cash flows that are unique to an enterprise and the assumptions that would be used by synergistic buyers. tag-along investors. Investors who typically purchase an interest in a deal negotiated by another party (the lead or other follow-on investor).


T

Tag-along Rights

Contractual rights typically granted by founders and key management shareholders in connection with a venture capital investment. Founders and key management shareholders typically agree that they will not sell any of their common shares in the enterprise without giving the investors the right to participate in the sale with the founder and management sellers pro rata to the investors’ holdings; also referred to as co-sale rights.

Terminal Value

The value as of the end of the discrete projection period in a discounted future earnings model. (IGBVT) In a discounted cash flow model, this represents enterprise value as of the end of the discrete cash flow period when earnings are expected to stabilize. Also known as residual value.

Top-down method

Valuation method that involves first valuing an enterprise and then using that enterprise valuation as a basis for valuing the enterprise’s securities.


U

USPAP

Uniform Standards of Professional Appraisal Practice published by the Appraisal Foundation.

Unobservable Inputs

Inputs for which market data are not available and that are developed using the best information available about the assumptions that market participants would use when pricing the asset or liability. (FASB ASC master glossary)

Unrelated Party

Other than a related party, as defined in the FASB ASC master glossary.

Up Round

A round of financing in which investors purchase stock from an enterprise at a higher price than the previous round.


V

A round of financing in which investors purchase stock from an enterprise at a higher price than the previous round.

Valuation Specialist

An individual recognized as possessing the abilities, skills, and experience to perform valuations.

Voting Rights

Contractual rights to vote as a shareholder for members of the board of directors and other matters of corporate policy on the basis of the number and class of shares held.


W

Weighted Average Cost of Capital (WACC)

The cost of capital (discount rate) determined by the weighted average, at market value, of the cost of all financing sources in the business enterprise’s capital structure. (IGBVT)


Y

Yield Method

The yield method is a type of discounted cash flow analysis that estimates the fair value of a debt security or debt like preferred security based on the expected cash flows (given the contractual interest or dividend rate, any scheduled principal repayments, and the expected maturity), discounted at the market yield for the security given its risk. The expected maturity considers both the contractual maturity, as well as market participant assumptions regarding the expected timing of a liquidity event, and any principal repayments expected in connection with the liquidity event.


Z

Zero Coupon Bond Equivalent

A zero coupon bond is a bond that has a face value that is payable at maturity, with no interim interest or principal payments. The fair value of a zero coupon bond is the face value discounted at the market yield from maturity back to the valuation date. The zero coupon bond equivalent for a debt instrument is the future payoff amount (face amount) for a zero coupon bond that has the same fair value as the debt instrument, considering the interest payment and principal amortization schedule for the debt instrument.

Valuation Glossary