Another day, another question to answer that was stuck in my “answer this question on your blog” someday folder in Outlook. 

When I got my new IBM X41 tablet in September, I wrote a glowing review of it.  I recently was asked if I still like it – three months later I’m still loving it.  Laptops usually last me six months, so let’s see how I feel on April 1st.  Ironically, I’m not using it as a tablet much (occasionally when I’m lying on the couch reading while listening to music, I’ll flip it into tablet mode so it (a) takes up less space and (b) I can monitor my email without having to move around each time something arrives in my inbox.  However, as a standard, hardworking laptop, it’s great.

In the spirit of the New Year, I’m trying to blog the questions that I’m getting that I think could have broad interest.  Here’s another one.  Remember – I’m not a lawyer so this isn’t legal advice.

I have a question regarding the valuation of a startup I’m in and when it takes affect.  When I joined the startup in 2004, I was granted options at $.10 each.  In Oct ’05, we received a term sheet as part our financing efforts which valued the shares at a multiple to the $.10.  We ultimately didn’t sign for various reasons.  I have 2 questions related to this.  

a) Does the event of receiving a term sheet automatically trigger a new price for the options based upon the valuation in the term sheet even if it isn’t signed? While a 409A valuation expert might take into consideration an unsigned term sheet as part of their valuation analysis (similar to them taking into consideration an offer to acquire the company at a certain price), this won’t necessarily trigger a new price for common stock (presumably the stock underlying the options – equal to the option strike price.)  It’s likely the the new investment would have been preferred stock with some additional characteristics (liquidation preference, participation, dividends) that would cause the preferred stock to have a higher price than common stock.  As a result, at the minimum, one has to take into consideration the capital structure of the company when determining the price for the stock options.  It’s even conceivable – based on a formal valuation analysis – that the appraised value of the common stock might be less than $0.10 due to the new proposed capital structure, even though the per share price of the preferred stock that was proposed was a multiple to the $0.10.

b) Given there was lots of pre-work to come up with the pre-money valuation, when would this pre-money valuation take effect? Since the proposed investment was never consummated, this pre-money valuation doesn’t really ever take effect.  It’s merely one data point in the determination of value under 409A (and – in my opinion – a relatively weak one since the deal didn’t occur).

For the lawyers and 409A valuation experts out there lurking, I encourage you to comments on / add to posts like these.