Does the pre-money valuation of recent round of financing give a reasonable estimate of fair value of an investment in start-up companies from accounting point of view?
Answers
I suppose the answer is "it depends".
The only "
For tax reasons, you have to look to the source and methodology of the valuation to see if it is sufficient to establish FMV for tax reporting purposes, so it depends if it meets the standards required by tax code.
For investment reasons, it also depends on the source and methodology to determine if outside investors would give any credence to the valuation so it also depends-mostly on the qualification and reputation of whomever prepares the valuation.
There would be no need for a valuation from a financial reporting standpoint because you don't "write up" the value of a business based on market value for reporting purposes.
It also depends on the non-monetary terms of the investment and what else the investor expects to bring to the startup. It also depends on how much the company shopped the investment and how the valuation was negotiated. So, pre-money valuation may be a useful reference point (i.e., a willing buyer). Post financing valuation is better, as it accounts for any option pools, etc., required to make the deal make sense.
A couple questions to better understand what you're asking: what is the reason for wanting to know the fair value of equity (e.g. financial report - FAS123R, or taxes - stock options), and was the price per share for the recent investment established by existing investors or new investors?
The post money valuation would be a better measure since this reflects the value contributed by the amount of the investment in the recent round. Generally, a investment is a good and simple way of establishing a fair value estimate for the Company, but bear in mind that if the recent round was small, or only returning inside investors, this may not be reperesentative of fair market value.... much better if the recent round valuation was determined by a new investor, and for a significant amount!
Is a pre-money valuation simply a guess at what what the market will bear before an investment has actually been raised - a founder's pre-money valuation may be one number and a potential investor's quite another?
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Yes, pre-money valuation is the combination of a guess, and the result of some math that investors do to get them the ownership % they want. For example, many firms simply won't invest if they can't have, say, 20% of the company, post money. Thus, an early stage company which absolutely no one knows a good valuation for would take a typical road of $4M pre-$ valuation, plus $1M from the investor which equals $5M post-$, of which the investor now owns 20% (see, their $1M equals 20% of the $5M that the company is worth immediately post investment). So this is all a wonderful dance of completely made up numbers which then have to fit into an investment model that the investor has based on their modus operandi as an institutional investor. Fun!
I agree with Simon, using the post money valuation and to calculate against diluted shares, once all the particulars for the round are closed is the way to go (e.g. preferred share liquidation preferences, conversion premiums, option plan bump ups, anti-dilution adjustments, etc.). If the round was material and has occurred within the last year, it most likely is a close enough proxy to your company's valuation, especially if there are outside investors involved. If it has been more than a year since your last round, I suggest initially going about it with a basket of valuation factors, culled from your industry and applied against your financial results. This can form an internal basis, but ultimately you will need to revert to new negotiated investor terms - what the market dictates.
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