In this post, we will discuss the definition of a qualified appraiser.

A qualified appraiser is an individual who meets all the following requirements:

1. the individual either:

a. has earned an appraisal designation from a recognized professional appraisal organization for demonstrated competency in valuing the type of property being appraised, or

b. has met certain minimum education and experience requirements. For real property, the appraiser must be licensed or certified for the type of property being appraised in the state in which the property is located. For property other than real property, the appraiser must have successfully completed college or professional-level coursework relevant to the property being valued, must have at least 2 years of experience in the trade or business of buying, selling, or valuing the type of property being valued, and must fully describe in the appraisal his or her qualifying education and experience;

2. the individual regularly prepares appraisals for which he or she is paid;

3. the individual demonstrates verifiable education and experience in valuing the type of property being appraised. To do this, the appraiser can make a declaration in the appraisal that, because of his or her background, experience, education, and membership in professional associations, he or she is qualified to make appraisals of the type of property being valued;

4. the individual has not been prohibited from practicing before the IRS under section 330(c) of title 31 of the United States Code at any time during the 3-year period ending on the date of the appraisal; and

5. the individual is not an excluded individual.

In addition, the appraiser must complete Form 8283, Section B, part III. More than one appraiser may appraise the property, provided that each complies with the requirements, including signing the qualified appraisal and Form 8283, Section B, Part III.

Who is an excluded individual?

The IRS excludes several individuals from being a qualified appraiser that may have a direct or indirect conflict of interest.

Specifically, the following persons cannot be qualified appraisers with respect to particular property:

1. the donor of the property, or the taxpayer who claims the deduction;

2. the donee of the property;

3. a party to the transaction in which the donor acquired the property being appraised, unless the property is donated within 2 months of the date of acquisition and its appraised value is not more than its acquisition price. This applies to the person who sold, exchanged, or gave the property to the donor, or any person who acted as an agent for the transferor or donor in the transaction;

4. any person employed by any of the above persons. For example, if the donor acquired a painting from an art dealer, neither the dealer nor persons employed by the dealer can be qualified appraisers for that painting;

5. any person related under section 267(b) of the Internal Revenue Code to any of the above persons or married to a person related under section 267(b) to any of the above persons (i.e., family members, fiduciaries and beneficiaries of a trust); and

6. an appraiser who appraises regularly for a person in (1), (2) or (3), and who does not perform a majority of his or her appraisals made during his or her tax year for other persons.

In addition, according to the IRS guidance, a person is not a qualified appraiser for a particular donation if the donor had knowledge of facts that would cause a reasonable person to expect the appraiser to falsely overstate the value of the donated property. For example, if the donor and the appraiser make an agreement concerning the amount at which the property will be valued, and the donor knows that amount is more than the fair market value of the property, the appraiser is not a qualified appraiser for the donation.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner:

Original post permalink:

http://banner.thebrennergroup.com/2012/01/30/what-is-a-qualified-appraisal-part-two/

1. What is a Qualified Appraisal?

A qualified appraisal is an appraisal document that:

- is made, signed, and dated by a qualified appraiser in accordance with generally accepted appraisal standards;

- meets the relevant requirements of Regulations section 1.170A-13(c)(3) and Notice 2006-96, 2006-46 I.R.B. 902 (available at www.irs.gov/irb/2006-46_IRB/ar13.html);

- relates to an appraisal made not earlier than 60 days before the date of contribution of the appraised property;

- does not involve a prohibited appraisal fee; and

- includes certain information.

The qualified appraisal must be received before the due date, including extensions, of the return on which a charitable contribution deduction is first claimed for the donated property. If the deduction is first claimed on an amended return, the qualified appraisal must be received before the date on which the amended return is filed.

2. What is a prohibited appraisal fee?

Generally, no part of the fee arrangement for a qualified appraisal can be based on a percentage of the appraised value of the property. If a fee arrangement is based on what is allowed as a deduction after Internal Revenue Service examination or otherwise, it is treated as a fee based on a percentage of appraised value, rendering disqualification of the appraisal.

3. Information included in qualified appraisal:

A qualified appraisal must include the following information:

1. a description of the property in sufficient detail for a person who is not generally familiar with the type of property to determine that the property appraised is the property that was (or will be) contributed;

2. the physical condition of any tangible property;

3. the date (or expected date) of contribution;

4. the terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor that relates to the use, sale, or other disposition of the donated property, including for example, the terms of any agreement or understanding that:

a. temporarily or permanently restricts a donee’ s right to use or dispose of the donated property,

b. earmarks donated property for a particular use, or

c. reserves to, or confers upon, anyone (other than a donee organization or an organization participating with a donee organization in cooperative fundraising) any right to the income from the donated property or to the possession of the property, including the right to vote donated securities, to acquire the property by purchase or otherwise, or to designate the person having the income, possession, or right to acquire the property;

5. the name, address, and taxpayer identification number of the qualified appraiser and, if the appraiser is a partner, an employee, or an independent contractor engaged by a person other than the donor, the name, address, and taxpayer identification number of the partnership or the person who employs or engages the appraiser;

6. the qualifications of the qualified appraiser who signs the appraisal, including the appraiser’s background, experience, education, and any membership in professional appraisal associations;

7. a statement that the appraisal was prepared for income tax purposes;

8. the date (or dates) on which the property was valued;

9. the appraised fair market value on the date (or expected date) of contribution;

10. the method of valuation used to determine fair market value, such as the income approach, the comparable sales or market data approach, or the replacement cost less depreciation approach; and

11. the specific basis for the valuation, such as any specific comparable sales transaction.

The Pension Protection Act also adds the notion of a qualified appraiser. We will discuss the necessary qualifications in the next blog post.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2011/12/20/what-is-a-qualified-appraisal-part-one//

As the name implies, inside rounds are rounds of investment by existing investors, versus outside rounds that are led by new investors.

In our valuation practice, we are often confronted with clients having gone through inside rounds, and we need to make a determination if the pricing of those investments provides an indication of value of the equity of a company (regardless of which class of shares; but usually invested as preferred equity). Each case is different, but often such an investment is not a good indicator of value as it lacks arm’s length characteristics.

Although Broughman and Fried only cover a very limited geography (Silicon Valley), a very limited time frame (companies that were sold in 2003 and 2004), and had very specific exit circumstances (M&A), it provides a welcome quantitative analysis of such inside rounds.

The study tries to answer two questions:

1. Are inside rounds (ab-)used by venture investors in order to dilute founders?

Broughman and Fried’s analysis suggests otherwise: inside rounds were mostly used when outside financing was not available. Inside rounds were often flat or down rounds, outside rounds were often up-rounds. Companies using inside financing were less likely to return a profit to their investors. In those cases, the valuation would really not have mattered to the founders, given that any proceeds were first and foremost used to satisfy the liquidation preferences embedded in venture investor’s preferred stock. This analysis seems to be confirmed by the founders’ assessment: in all cases, the inside round was used as a backstop when outside financing was not available.

2. Are inside rounds overpriced or underpriced?

The authors analyze the valuations used in the inside as well as outside financings in their sample and compare those with the ultimate sales price of the target company. Not a perfect measure by any means, but the results are striking: the last inside round valuation was up to six times higher than the ultimate sales price for companies receiving inside rounds, with a median of about two times. Companies with the last round being an outside round had pre-exit financing round valuations of up to two times higher than the ultimate sales price, with a median closer to one times. We’ve summarized this in the following table:

And why would inside rounds be overvalued?

The authors propose several reasons why inside rounds may be overvalued:

1. Litigation risk: VCs can avoid litigation from disgruntled and diluted founders by overvaluing their follow-on round

2. Signaling: An inside flat round looks much better to the limited partners of a VC than an outside cram-down round. And after additional development milestones are met, it is much easier for the company to fundraise, even if the last was from existing investors.

3. Reduce down-round cost: Staying with a flat inside round avoids triggering anti-dilution provisions, and may eliminate the need for topping off the management option pool, which would lead to additional dilution.

4. Over-optimism: VCs need to be optimists by nature in order to invest in fledgling start-ups. They might as well be optimistic when it comes to pricing their current investments and dismiss an outside investment that comes in “too low”, i.e., carries too much dilution for them.

The study has a number of limitations, foremost its small sample size. Yet it provides some genuine evidence that not all investment rounds are created equal, and that inside rounds may indeed come with a valuation bias of being overpriced.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Master’s Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2011/10/4/insider-trading-are-vcs-dealing-themselves/

• Zillow, Inc. provides online real estate information. Its IPO occurred on July 20, 2011 at a price of $20.00 per share. The price about one week later was $32.37. Holders of stock options granted in the 18 month period preceding the IPO received positive bumps relative to its issue price. Stock options granted March through May 2010 had exercise prices of $3.25 per share (16% of the issue price). Options granted in March 2011 had exercise prices of $3.89 per share (less than 20% of the issue price). Options granted in May 2011 (two months prior to the IPO) had exercise prices of $6.33 per share (32% of the issue price).

• SkullCandy, Inc. manufactures and distributes headphones. Its IPO occurred on 7/20/2011at a price of $20.00. The price about one week later was $19.70. Holders of stock options granted in May 2010 had an exercise price of $10.32 per share (52% of the issue price). Holders of stock options granted in November 2010 had an exercise price of $12.00 per share (60% of the issue price). Holders of stock options granted in the first quarter of 2011 had an exercise price of $16.42 per share (82% of the issue price).

• Pandora Media, Inc. is a personalized radio service on the Internet. Its IPO occurred on 6/15/2011at a price of $20.00. The price about five weeks later was $15.02. Holders of stock options granted in the fiscal year ending January 2011 had an average exercise price of $2.16 per share (11% of the issue price). Holders of stock options granted in the quarter ending April 30, 2011 had an exercise price of $5.67 per share (28% of the issue price).

• Solazyme, Inc. provides plant based petroleum products. Its IPO occurred on 5/27/2011at a price of $18.00. The price about eight weeks later was $22.07. Holders of stock options granted in the calendar year 2010 had an average exercise price of $4.09 per share (23% of the issue price). Holders of stock options granted in the quarter ending April 30, 2011 had an exercise price of $8.62 per share (48% of the issue price).

IPO Bumps are not necessarily a guarantee of instantaneous riches. Most stock options are subject to vesting limitations over several years (usually four years), so any grants in the period preceding an IPO do not lead to an immediate windfall for the option holder at IPO. The employee will only receive the incremental value if the company itself is able to grow in value in the years after the IPO. Yet the evidence suggests that stock options continue to be an important element of compensation, providing the potential for strong ultimate payouts to the lucky (or hardworking) few who successfully steer their companies towards an IPO exit.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2011/08/18/the-latest-IPO-bumps/

IRC 409A requires the company to estimate the fair market value of its stock at the time of an option grant. As a venture capital backed company grows successfully and starts aiming for an IPO exit, the fair market value of the stock should grow as well, in theory. If the company had perfect foresight, the discount relative to the IPO price should decrease the closer the company gets to an IPO.

One comment first: most stock options are subject to vesting limitations over several years (usually four years), so any grants in the period preceding an IPO do not lead necessarily to an immediate windfall at IPO. The employee will only receive the incremental value if the company itself is able to grow in value in the years after the IPO.

Based on several recent IPOs, experience indicates the IPO Bump appears to be alive and well. I looked at SEC filings by LinkedIn, ZipCar, Boingo Wireless, and Freescale Semiconductor, as well as their traded prices as of June 7th:

• LinkedIn Corporation operates an online professional network designed to help members find jobs, connect with other professionals, and locate business opportunities. This company’s IPO occurred on May 24, 2011 at a price of $45.00 per share. The price two weeks after the IPO was $77.82. In addition to the increase in value since its debut, holders of stock options granted in the two years preceding the IPO received impressive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $2.32 per share (5% of the issue price). Options granted one year before the IPO had exercise prices of $6.20 per share (14% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $9.63 per share (44% of the issue price). [The Brenner Group has provided valuation services for LinkedIn.]

• Zipcar, Inc. operates a car sharing network that provides self-service vehicles that are located in reserved parking spaces throughout the neighborhoods where its customers live and work. This company’s IPO occurred on April 19, 2011 at a price of $18.00 per share. The price seven weeks later was $21.54. Holders of stock options granted in the two years preceding the IPO received positive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $5.10 per share (28% of the issue price). Options granted one year before the IPO had exercise prices of $8.74 per share (49% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $11.90 per share (66% of the issue price).

• Boingo Wireless, Inc. provides mobile Internet access service through wireless fidelity (Wi-Fi) networks. This company’s IPO occurred on May 9, 2011 at a price of $13.50 per share. The price five weeks later had declined to $8.87. Holders of stock options granted in the two years preceding the IPO received positive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $1.40 per share (10% of the issue price). Options granted one year before the IPO had exercise prices of $2.85 per share (21% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $8.50 per share (63% of the issue price).

• Freescale Semiconductor Inc. provides semiconductors, microprocessors, and similar electronic devices for automotive and telecommunications products. This company’s IPO occurred on June 1 2011 at a price of $18.00 per share. The price one week later was $18.12. Holders of stock options granted in the first quarter of 2011 received a positive bump relative to its issue price: stock options granted three to five months before the IPO had an average exercise prices of $12.69 per share (71% of the issue price).

Stock options continue to be an important element of compensation. However, as demonstrated in the discussion above, not all IPOs result in an IPO bump for all option grants. It should not be assumed that every IPO provides a guaranteed bump in value to the employees that receive options in the period before the IPO. The recent IPOs discussed in this blog would suggest the IPO Bump is still with us, although the magnitude of the benefit can vary significantly from IPO to IPO.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2011/07/05/recent-IPOs-and-the-IPO-bump/

An interesting speech during the annual AICPA National Conference on Current SEC and PCAOB Developments in December 2010 picks up on some of the issues surrounding derivative accounting for ASC 815 (aka FASB 133). For a good summary of the conference, see KPMG’s Issues In-Depth or Grant Thornton’s New Development Summary.

Amongst other tidbits, the SEC commented on the analysis and valuation of embedded conversion options and freestanding warrants. Similar comments can be observed at this SEC presentation dated November 2010.

The SEC admits that it is indeed a complicated path to determine the appropriate accounting for such instruments. It makes several observations:

1. They continue to encounter registrants who fail to appropriately apply the guidance relating to derivative accounting. This may not be surprising given the complexity of the subject matter, but this failure may lead to comment letters from the SEC and embarrassing re-statements of financial information.

2. More specifically, the SEC remarks cite a failure to consider all the different settlement provisions and features contained in such instruments and their impact on the accounting treatment (i.e., “down-round protection” – a rather common feature that has been explicitly mentioned in FASB’s EITF 07-5, making the instrument “not indexed to an entity’s own stock” and hence should be presented as a derivative liability at fair value with changes in fair value periodically flowing through the income statement.)

3. Often, such instruments are erroneously valued using the Black Scholes formula. The Black Scholes formula is not designed to accurately value the embedded features of the derivative, such as down-round protection or performance provisions etc. More appropriate valuation methods would be a lattice model or a Monte Carlo simulation.

The Black Scholes model is known as a “close form” model, providing a deterministic outcome for a limited number of inputs. All inputs are observable, explaining the popularity that the Black Scholes model enjoys with the audit community. It is relatively easy to implement, in turn explaining its popularity with financial statement preparers. However, the Black Scholes model is limited to valuing “plain vanilla” options or warrants: options with no additional features. There are closed-form solutions for some of the more “exotic” options, such as barrier options or Asian options, but the features embedded in warrants seldom map to any of these.

A lattice model or Monte Carlo simulation by itself does not necessarily value these embedded features. Rather, these “open form” models allow the user to insert conditions and varying assumptions depending on stock price movements or other, additional inputs. They will need to be tailored to the specific embedded features of the derivative, and hence are more complex to set up. Most issuers shy away from implementing these models in favor of valuation firms with specialized expertise.

The Brenner Group regularly values companies with complex capital structures, including multiple levels of preferred shares, convertible debt, and warrants. We have seen a considerable increase in the need to provide support for the valuation of warrants and embedded features for ASC 815, especially after the latest guidance of EITF 07-5, and more specifically the stated preference of the SEC for issuers to use the proper valuation method to value complex features.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink: http://banner.thebrennergroup.com/2011/04/25/when-black-scholes-falls-short/

A search for “cloud computing bubble” on Google returns an amazing 1,350,000 results, leaving our other contenders in the dust. The Google News search returns an increase to 83 results in 2010 from 31 in 2009. Cloud computing now may be more of a pervasive paradigm shift in IT infrastructure than a subsector like social gaming, and a multitude of companies are involved, or like to be thought of as being involved, in delivering a cloud computing solution. In that respect, cloud computing may be more about bubbly IT marketers rallying behind a common term to increase sales than a genuine business sector bubble.

In Gartner’s hype cycle of August 2010, Cloud Computing and Cloud/Web Platforms just surpassed the “peak of inflated expectations” and are slated for the deep dive into the “trough of disillusionment”. With an expected time to mainstream adoption of 2 to 5 years, such trough could of course be crossed relatively quickly.

Valuations for companies with some ties to anything cloud are still (or again) very substantial. VMWare is trading at a healthy 14 times revenue, Citrix is at 7 times revenue.

This leaves social gaming company valuations looking rather tame.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2011/04/11/bubblewatch-part-three/

A search for “social gaming bubble” on Google returns a whopping 266,000 results. Move over, cleantech! The search in the news section shows an increase from 22 hits in 2009 to 87 in 2010. Getting closer.

The social gaming industry has seen some inspiring transactions: Disney bought Playdom for more than $750 million, Electronic Arts bought Playfish for $400 million, and Google bought Slide for $182 million. Zynga gobbles up one game company after the other, making use of its war chest of more than half a billion dollars that it raised from online media stalwarts like Google, Softbank, and Digital Sky Technology.

Usage numbers are certainly impressive. According to market research company The NPD Group, 20 percent of the US population ages 6 and older reports having played a game on a social network in the past three months. That equates to 56.8 million US consumers. And anything that 20 percent of the US population does, must have some value. About 35% of social network gamers are new to gaming, and at last the interactive entertainment industry seems to have reached the elusive female audience: the majority of social gamers are indeed female.

Is Zynga, at an estimated market value of over $5 billion, a tad frothy? Maybe; but for a three year old company with 320 million registered users and estimated revenues above $500 million, such a growth rate has to account for something.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2011/04/07/bubblewatch-part-two/

So here goes our list of contenders for 2011 bubbles:

Cleantech

A search for “cleantech bubble” on Google returns 87,300 results. Not bad for an aspiring bubble. A search in Google News returns 74 results, up from 26 results for 2009. A Google search may not be scientific evidence of a bubble, but it can serve as a helpful proxy in our hunt for bubbles. The Cleantech Group researched that Q3 2010 venture investment in cleantech was down to $1.53 billion; 30 percent less than the previous quarter, and 11 percent less than the same period a year ago. Investments for the first three quarters in 2010 were still slightly ahead of the same period in 2009, thanks to a strong first half of 2010. Public markets are still somewhat supportive of anything green; Li-Ion Battery maker A123 systems, which went public in 2009 may be down from its high of $25.77, but even around $9.50 it is trading at about 10 times trailing revenue. Electric car maker Tesla trades at over 25 times trailing revenue, which leaves ample room for future revenues to catch up with the current valuation.

In general, it seems that the public market has not yet caught up to the more modest outlook of venture investors.

For a more bullish view on cleantech, Claremont Creek’s Nat Goldhaber looks at a rebounding IPO market to stoke the public interest in all things green in 2011.

Of course timing is everything in bubble land: one man’s short term investment gain is another’s man’s loss when the bubble pops: And, as the example of the Li-Ion battery market shows, those bubbles may take a while to pop: strategy consulting firm Roland Berger expects the shakeout in the Li-Ion battery market to decimate the number of companies from around 60 to 6. But consolidation is not expected to start until 2014. That leaves plenty of time for bets before the bubble pops!

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2011/04/07/bubblewatch-part-one/

The debate has been carried out rather openly, and the borders of straight-talk, self-promotion, and honest reflection have become somewhat blurred.

The basic question is whether it’s better to take a limited amount of money from Super Angels – say between $100 thousand and $1.0 million, or shoot for the moon and go to Sand Hill Road where a self-respecting Series A starts with $5.0 million. Super Angels are loosely defined as business angels with more money making a lot more investments.

I give Dave McClure credit for kicking off the fight in his signature R-rated rant (and coming-out piece as a Micro-VC) asking traditional VCs to HURRY UP & DIE ALREADY.

Representatives from both sides finally square off in the informative and entertaining ”Super Angel/VC Smackdown” on TechCrunch TV.

The arguments of the Super Angels boil down to the following:

- Start-ups need less capital, get to revenue faster, and get to an exit faster. No need for the big pockets of a VC. The discussion almost exclusively centers on consumer-focused internet and mobile startups. Life-science, clean tech, and semiconductor may very well be very different.

- Traditional VCs invest too late, once market traction is already established, and hence overpay. The right way of early-stage investing is to invest BEFORE market traction, and double down if the company takes off.

- Exits are smaller: there aren’t those billion dollar IPOs out there, anymore. For the return metrics to work, those smaller exits need smaller investments. (We talked about this in this past post.)

The VCs counter back:

- Super Angel thinking is small-scale thinking: entrepreneurs will be trained to think small, try to flip a company in a couple of years if not months for a couple of million dollars, and won’t be building the next Google or Facebook: big thinking needs big money.

- Super Angels are merely hedging their bets, investing in a LOT of start-ups, and there is no way they can add value to the hundreds of companies that they invest in. It is better to focus on a select few and make them successful.

But the dollars aren’t always greener on the other side, and it seems to me that the whole discussion is focused on the wrong premise.

1. Investment adequacy

Some start-ups will need little money, other will need a lot. Some start-ups will drive towards a smaller exit, others won’t. There are plenty of start-ups that will do just fine by taking little money and having a fast, reasonable exit that makes all stakeholders happy. Matching the right start-up with the right financing strategy is difficult. Too much money will spoil a company’s strategy and an investor’s returns; too little money will constrain and jeopardize the business plan. But there should be ample room for plain old Business Angels, Super Angels, and VCs. A lot of these arguments resurface in the recent discussion about fat and slim start-ups.

2. Value added investing

Early-stage investing should always be about more than money: open doors, help find strategic partners, and find the next investors. VCs may have been complacent in this respect, but the danger of offering “just money” and waiting for the start-up to develop is especially present with Super Angels who stretch their investment dollars among too many companies to be effective mentors to each one of them. Super Angels right now ride the wave of “we understand consumer internet investing”. Early stage investing is a numbers game, and a lot of the early investments will blow up. That’s not good for the reputation, especially if the perception switches from SuperAngels being able to pick winners and make them successful to spreading money indiscriminately and waiting to see who survives.

Venture Capital investing has been around for a while. It has shown that it can be very successful. In the last ten years, it has also shown that it can be quite unsuccessful. Super Angel investing hasn’t been around that long. Given the time frame and ups and downs in this industry, it yet has to prove itself right (or wrong). But in the big picture, more investor competition is usually a good thing; giving entrepreneurs choice and requiring investors to focus and differentiate from each other.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:

http://banner.thebrennergroup.com/2010/12/17/super-angel-versus-venture-man/

So what’s the rush?

1. Cheap Cash – Lots of It
Current cash balances of companies in the S&P 500 index equal a record 11.6% of those companies’ market value, about twice the level for the period 1980 to 2007.  With profits up and credit markets more or less up and running at record low interest rates, that stock pile of dry powder is poised to increase.  And a good use of that cash is to lock in future growth by buying targets with existing revenues and a strong market positions.

2. Organic Growth Prospects Limited
However one slices it, the current economic outlook is still rather limited.  The CEO Economic Outlook Index declined in the third quarter 2010 to 86 from 95 one quarter ago.  That doesn’t necessarily mean that we’re headed for a second recession, but it does limit everyone’s enthusiasm to go out and spend their way to fuel more growth.  Organic growth options for companies are limited; so why not buy some revenues and profits.

These arguments may support why a buyer would be interested in buying its way out of sluggish growth, but why is it equally interesting for smaller companies to sell at this point?

3. Survival of the Fittest
In such an environment of limited growth outlook, competition intensifies.  Economies of scale take precedent, and smaller players are feeling the squeeze.  Larger companies can bundle product offerings and cross-subsidize technologies to gain market share.  If you can’t beat’em, join’em.

4. It’s Cheap out there
Companies are still relatively cheap.  Or at least they’re not expensive.  The trailing S&P500 P/E ratio is about 15x, below the long-term average P/E of 16.4x.  Not rock bottom, but certainly not “frothy”.  For technology companies, where development time is money, buy versus build often tips towards “buying” time, revenue, and profits.

5. Reality Sets in
There is always a time in a technology start-up when it becomes clear that it’s the elusive home-run, an “also-ran”, or a flop.  In times of abundant venture funding, a lot of the “also-ran” companies will get the time and money to reach some level of maturity, a better exit environment, or a second chance to “re-invent” themselves.  But lately, funding sentiment has turned, and VCs attitudes feel like they are back to the gloomy days of 2008.  After five quarters on the upswing, the Silicon Valley Venture Capitalist Confidence Index turned negative in the second quarter of 2010, and according to PWC’s MoneyTree report, VC financing in the third quarter was down more than 30% to about $4.8 billion from the second quarter.  It may get better, but it will take a while.  Such a restrictive financing environment makes maintaining the “also-rans” more difficult and VCs will start to take some of their chips off the table.  If the valuation isn’t going anywhere, it’s better to do a deal sooner rather than later.

6. Back to the Core
Boom-time-diversification’s ugly cousin comes to visit during periods of crisis and slow growth.  “Back to the core business” becomes the new company motto, and non-core and underperforming business units are sold.  Of course one company’s side show is another company’s main attraction: a lingering economy fosters the reallocation of assets to their best use.

The current wave of M&A will likely persist.  There are plenty of merger opportunities where a combination of two strong companies makes perfect sense.  There are countless “also-ran” businesses, where the timing of a transaction depends on the patience of the investor.  And until we see the tide change to “diversification acquisitions”, there is an abundance of non-core opportunities to be had.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Original post permalink:
http://banner.thebrennergroup.com/2010/10/27/mergers-and-acquisitions-what-is-the-rush/

Bankruptcy filings rose 20 percent in the 12-month period ending June 30, 2010, according to statistics released by the Administrative Office of the U.S. Courts.

This is generally hailed as bad news; at most the Economist is invoking Schumepeterian creative destruction as necessary evil before new growth can blossom.So what’s the good news?

The speed of the increase in total filings has slowed down significantly: quarterly filings in the second quarter of 2010 were 422 thousand. That’s up 11% from the same quarter a year ago (then 381 thousand), and 9% from the first quarter in 2010 (then 388 thousand).

It’s still getting worse, just not as fast any more.

And the business side of things seems to slowly improve: business bankruptcy filings in the same 12-month period ending June 30, 2010 increased only 8% to about 60 thousand. That’s a much more modest increase compared to the groundswell of an increase of 63% in the same 12-month period in 2009 and 42% in 2008. Quarterly business bankruptcy filings actually peaked in the second quarter of 2009 at 16 thousand and have since receded somewhat to around 15 thousand filings per quarter.

That’s still high, but leveling off.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Original post permalink:

http://banner.thebrennergroup.com/2010/09/17/have-we-hit-bottom/

The occasion of the annual 409A/123R (short for Internal Revenue Code Section 409A and Accounting Standards Code 718/Statement of Financial Accounting Standards 123R, Share-Based Payment) valuation exercise is likely a less coveted experience. Often seen as a necessary evil, it is full of rules and methodologies that were developed with the aspiration of transparency, but are often less approachable for the typical user. Similarly, purchase price allocation studies (i.e. valuations of intangible assets for ASC 805/SFAS141R, Business Combinations) come with a surprising complexity even for small acquisitions.

In order to shed some light into the world of start-up valuations, The Brenner Group is hosting a seminar for executive management, financial professionals, corporate counsel, and investors to prepare for the valuation process, understand valuation reports, and assess the impact of preferred equity terms on common stock valuation.

Topics Include:

• Taxman v. Auditor:

Commonalities and differences between IRC 409A and SFAS 123R (ASC718), as well as fair market value under IRS regulations and fair value under accounting standards

• How it’s done:

Overview of the valuation process, the common methods for enterprise valuations, and the subsequent allocation between different classes of securities, including the Current Value Method, the Option Pricing Method, and the Probability Weighted Expected Return Method

• What does it mean to me:

Impact of different terms of preferred equity on the valuation of common shares

• Accounting for Acquisitions:

Overview of the assumptions and issues regarding valuation of intangible assets intangible assets in a purchase price allocation for SFAS 141R (ASC 805)

Thursday, July 29, 2010 8:00am Breakfast & Registration 8:30 – 10:00am Session

For in person attendance please register by July 27, 2010 to rsvp@thebrennergroup.com

For webinar register by July 27, 2020 via GoToMeeting for Demystifying Valuations for Venture Backed Companies

For more information: Demystifying Valuations for Venture Backed Companies

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Original post permalink:

http://banner.thebrennergroup.com/2010/07/23/demystifying-valuations-for-venture-backed-companies

The acquisition will provide discussion fodder for months if not years to come, and we will see if HP can turn Palm into a serious competitor for the iPhones, Androids and Blackberries of the world.

In this post, I will stay clear of any strategic speculation, but rather focus on the process of the transaction.

The proxy statement recently sent out to the shareholders provides some interesting turn-by-turn insights into the transaction. A number of lessons can be learned that are equally applicable to smaller transactions.

How events unfolded

The story starts with a meeting of the Palm Board of Directors on February 17, 2010, where they reviewed operational results. Anticipated revenues for the quarter ending 2/26/2010 were 25% below plan. Anticipated revenues for the quarter ending 5/28/2010 were 63% below plan.

That has to hurt.

The Board channeled its pain into an “assessment of strategic alternatives”, also known as “raise money, license the IP, or sell the Company”. Bring in the investment bankers – in this case Goldman Sachs and Frank Quattrone’s Qatalyst Partners.

At this point, the share price hovers around $9.62 – down but not out from its recent high of $17.46 in September 2009.

On February 25 the Company officially revised its revenue guidance downwards for the current quarter and the current fiscal year. The stock closes at $6.53 the following day and erodes further in the coming weeks to $3.85 on April 6, the day before takeover rumors start.

The bankers and management draw up a list of 24 strategic partners. Between the end of February and beginning of April a total of 16 companies are contacted of which 6 sign a nondisclosure agreement to take a look under the hood. Three of them (“Company A”, “Company B”, and the ultimate acquirer, HP) are invited at the end of March to submit preliminary proposals for a transaction. Two more hover about the fringes (“Company C” and “Company D”).

HP submits its first offer at $4.75 per share on April 13, below the public market share price of $5.16.

Company A came in with a cash offer of $600 million which after preferences would have returned little or nothing to the common shareholders; Company B delivered an unspecified, drawn-out stock deal ; while Company C proposed a cash offer in the range of $6.00 – $7.00 per share with the promise of a fast close. But after taking a closer look, Company C later revised its offer down to $5.50 per share.

Bird in hand, Palm’s CEO and advisors communicate on April 24 to HP and its advisors that, “to remain in the process, HP must improve its offer significantly and immediately”, which they promptly did, increasing their offer to $5.70 per share on the same day.

In the end, Company C did not match that offer, but proposed an alternative transaction under which it would acquire certain patents and take a nonexclusive license to Palm webOS in exchange for a one-time cash payment of $800 million. The Board eventually dismissed the licensing agreement as too dilutive to the value of the overall Company.

The deal with HP at $5.70 per share was announced on April 28.  Prior to the announcement, the shares were trading at $4.63.  The $1.2B offer represents a 23% premium over the price on the previous trading day, and a premium of almost 50% over the price before any rumors of a transaction started to circle.

Unfortunately it also represents a discount of 41% from the time the M&A process was initiated and before the devastating results were announced; and a discount of 67% from the last high in September 2009.

Several lessons can be learned from the process:

1. Start your M&A process early

There are a number of reasons to start the process early, especially in a situation where the company is strategically stalled, as in Palm’s case. Usually the runway is limited, and any delay also restricts strategic options. For Palm, the option to license out webOS turned out to be an inadequate non-starter. Once the bad news is out, share prices fall quickly and any transaction is perceived as a “fire-sale”. Missing the revenue target by over 60% one quarter out qualifies as VERY bad news. So bring in the bankers before you run out of options.

2. The more the merrier

Not all bidders may be the ideal candidate, and any auction in such an environment will inevitably attract bottom-feeders. But a healthy number of participants will keep the auction competitive, make the ideal candidate pay up, and generally force a transaction in a timely manner on the best available terms.

3. Keep key employees motivated

Once a company is on the auction block, employees will consider their options too. It is important to retain  key employees to effectuate a transaction as well as maintain the value of the company. This is especially true for technology companies, where most of the value is intellectual property that is embedded in the workforce. Palm’s Board recognized this early on and approved a Retention Bonus Plan for certain employees on April 1.

4. Cash is king

Somewhat obvious, but in a situation such as Palm’s it is hard for any Board to accept and consider the complexity and value of a stock deal. Not surprisingly, Company B’s proposal was not pursued further, in part because of the ambiguity and uncertainty of a stock deal.

5. Keep the options open

A straight sale is not always the best option, and Palm’s Board considered a range of different strategic options. Although the ultimate transaction was a sale of the whole Company, this open option approach helped to attract more and diverse potential interested parties. In this case, a straight sale was the easiest to evaluate for the seller, and – as indicated above – as the game moved to later innings, the less viable options were retired.

6. Elephants can dance

This one is probably less obvious. The deal was pulled off on a very abbreviated time line. This is exceptional from the seller’s perspective, but even more from the buyer’s. Palm certainly was motivated by a dwindling cash balance, deteriorating fundamentals, and the inability to double-down on its webOS roll-out in light of the weak initial market success. HP had its strategic reasons to buy into the deal, but the speed of execution was forced by the competitive nature of the auction that did not leave much room for delay.

Now, if only HP and Palm do their post-merger integration at the same speed as they did the transaction, we should see some new and exciting products in the marketplace fairly soon.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and is an Accredited Valuation Analyst (NACVA). Gunther is Treasurer and a Member of the Board of Directors of the the German American Business Association (GABA)

Original post permalink:

http://banner.thebrennergroup.com/2010/05/26/hp-extends-palm-life-line/

This is true in general, but can become a prerequisite in connection with securities laws[i].

Many of our clients are venture-backed technology companies. Most of the capital that they raise comes from accredited investors, if not institutional venture capital funds. Some of their money may come from unaccredited investors, and virtually all venture-backed companies issue stock options to employees that are sooner or later exercised. Most of the employees of course are not accredited investors. An annual income of at least $200 thousand or net worth of at least $1.0 million renders you an accredited investor[ii] .

As IPOs continue to be the exception, the exit route of choice for most companies is a sale to another company in an M&A transaction.

And as cash comes at a premium these days, the acquiring company often pays with its own stock – and that’s where some sophistication goes a long way.

Exempt Transactions

Most often, the stock of the acquiring company is not registered with the SEC, either because the acquirer is a public company that uses newly issued shares that are pending registration, or because the acquirer itself is a private company with restricted stock. Thus, such a stock offering would need to use one of the exemptions provided under Regulation D of the 1933 Securities Act – known as “Reg D Offerings [iii].

Usually, the issuance is exempt under Rule 506 of Regulation D, which allows for unlimited amounts of capital raised (Rule 504 limits the sale of securities to $1 million within a 12-month period; Rule 505 limits the raise to $5 million, also within a 12-month period).

Rule 506 also allows the sale to a maximum of 35 non-accredited investors; however, these investors need to be “sophisticated”.

What is “sophisticated”?

In the eyes of the Security Act, “sophisticated” means someone who has “either alone or with his purchaser representative(s) such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment.”

So you can get some help on the way to “sophistication” by retaining a purchaser representative.

What now is a “purchaser representative”?

The purchaser representative is defined in Rule 501 of the Securities Act.

Apart from not being an affiliate of the issuer and being acknowledged by the purchaser, the purchaser representative “has such knowledge and experience in financial and business matters that he is capable of evaluating, alone, or together with other purchaser representatives of the purchaser, or together with the purchaser, the merits and risks of the prospective investment”.

In other words, the purchaser representative is a shortcut to “sophistication” and the path around unaccredited status.

The Brenner Group regularly acts as purchaser representative, enjoying the opportunity to spread “sophistication” and help unaccredited investors to navigate and understand sometimes complex transactions with hundreds of pages of agreements in a multitude of disclosure documents that today’s mergers produce in the interest of compliance …….. and informing investors.

[i] This blog post does not constitute legal or investment advice.

[ii] California provides for some similar provisions regarding a “qualified purchaser”.

[iii] For very small transactions including only buyers (and seller) in the same states, companies may be able to take advantage of some of the state exemptions, such as California Corporations Code Section 25012.

Original post permalink:

http://banner.thebrennergroup.com/2010/05/24/the-purchaser-representative/