In many ways, company valuation is the backbone of your company. It tells you and the outside world how much your company is worth. In this blog post, we’ll explore why valuation matters for implementing and managing your ESOP, how to come up with the magic valuation number and how to work with valuation(s) in our ESOP management platform.
How is your company valuation relevant for ESOP?
In simple terms, valuation represents the economic value of your company and the value of its shares. That’s why it’s also essential for ESOP setup and management because it:
determines ESOP asset value: Company valuation fixes ESOP asset value at any moment in the ESOP lifecycle. It drives the value at grant (the so-called exercise price for options-based plans or initial value for other plans), during the ESOP’s existence and at payout. At payout, it’s especially crucial for calculating the tax burden.
helps with communication with your team: Employees want to know the value of their ESOP portfolio at any moment in time. The only way to do this well is through asset value based on company valuation. This helps you communicate both the current and future (projected) value of assets.
streamlines ESOP processes: There are many events that happen during the ESOP lifecycle. The company can buy shares back from the ESOP holders or you can enable ESOP holders to swap part of their cash compensation for equity. To do this well and fast, it’s instrumental to have an up-to-date valuation at all times.
How do you fix company valuation?
The general rule here is that you want to use a valuation that represents the true fair market value of your company.
In practice, you can use:
investor valuation: this number results from negotiations with your investor(s) during a financing round. The upside of this approach is that it’s fairly defensible towards tax authorities. On the downside, investor valuation cannot be used for an extended period of time without an update.
External valuation: this is an official valuation produced by an expert valuator. It’s definitely the most defensible approach to fixing valuation. On the flip side, it needs to be updated at least on an annual basis. You’ll need an external valuation if you go for an EMI plan or a US stock options plan. It’s also highly recommended for a STAK plan and a phantom plan if you consider switching to an asset-based plan in the future.
Internal valuation: here, valuation is designed by the company itself based on available financial data and market trends. It’s definitely the most low-touch option in terms of costs but it can’t be used for regulated ESOP plans (an EMI plan or a US stock options plan) and requires strong internal know-how to minimize tax risk. It’s typically used for phantom plans.
How do you work with valuations in the Eldison platform?
The Eldison platform lets you set up one or more valuation scenarios. Each valuation scenario represents the financial worth of a company at different points in time, reflecting its past, current and projected future values.
We recommend following these best practices:
Use valuation projection: This way, employees have a sense of how the value of their assets evolves over time. Great for keeping motivation up.
Work with conservative and ambitious valuations: Besides your primary valuation, show your team projected asset value based on conservative as well as ambitious growth scenarios. This will help people have a more realistic view of their portfolio value and boost trust in the program.
Update your valuation regularly: it’s never a good thing if the valuation chart stagnates for too long. This sends a message to your employees that the company doesn’t grow. You should go for an update frequency that mirrors your financial planning (i.e. if you plan on a monthly basis, work with monthly updates). We typically see companies working with monthly or quarterly updates.
Do you want to learn more about working with valuations in the Eldison platform? Check out our Intercom guide here.
Do you prefer to talk to our experts? Schedule a call here.