Many financial advisors strongly advise business owners to never conduct their own business valuation. “It’s like asking a mother how talented her child is,” explains one. But when a company valuation is necessary within a prospective IPO process, having this process done accurately and correctly may be the make or break for an IPO listing. And like any sales effort, a successful IPO hinges on the demand for the product you are selling – a strong demand for the company will lead to a higher stock price.
Overpricing stock value is as bad as undervaluing stock value – Investors can get overly excited over a hot new company and push the share price higher than the stock’s actual book value. But that doesn’t bode well for the business when the reality starts to present itself, and stock price fluctuations appear more severe than what they should have been – ending in more loss than what is necessary.
Although there are numerous reasons why IPO valuations miss the mark, some of the more common reasons include:
- Diversity of IPO Valuation Methods: Financial experts use a variety of valuation methods to determine the IPO valuation of a business offering that aims to list publicly. Although very different, most of the models used have dependencies on available data and on underlying assumptions. And for businesses with complex group structures and acquisition history, this can sometimes pose all sorts of challenges – which have a direct impact on the value of proposed stock. Different results are often observed from different models used for same stock valuation. No method fits perfectly and variety of opinion exists for pricing as various market participants (other than the underwriting bank) value the IPO differently.
- Ambiguity in Business Perception: Today’s business world is evolving quicker than what many of us actually realise. And so too are the ways in which we value stock, bottom line, and IP. Innovations are emerging with a mix-n-match approach especially for tech companies who are finding interesting business prospects in overlapping domains. While these types of developments do open doors to new business opportunities, it makes the business valuations difficult. One such example was Zynga (ZNGA) – the developers of the social media game Farmville. At first, it started as a social network gaming services company, but has evolved into an entertainment, network-based company built on a tech platform. So, which category does it really fit into, and therefore, when it comes to comparative valuation – which box does one tick? Quite often, in more complex business examples like Zynga, attempts to value a stock on sector categorisation and peer comparison leads to imperfect valuations – creating issues further down the line.
- Use of Raised Capital: As part of the valuation process, an organisation needs to be able to explain how the raised capital will be used post-IPO, and it’s in this description that values are set, and stock interest is raised. But very often, once the IPO has been successfully awarded, and the capital is in the account, the original intentional use of the capital then starts to deviate. The IPO price may be determined based on the stated future expansion plans using IPO proceeds. But due to interim developments, a company may use the funds to repay the existing debt. These types of developments affect the price valuation significantly – and almost always leads to price changes.
The Bottom Line
It is a skill to be able to accurately, and effectively, assign a value to a stock option, within the IPO process. With many potential risks lying waiting, ensuring that your business, and it’s potential, is being valued with growth in mind – it’s critical that you have the right team helping you along the process.
CFPro have been involved in the IPO process for many years – helping many businesses list publicly, and see strong growth post IPO. We have worked as part of a greater IPO team, and we have lead teams ourselves – so whatever your need, you need to know that when it comes to share option valuation, you need skill, know-how and experience. Don’t risk this critical part of the process by just going with what you know. Talk to us today about how we can help you to get it right, first time.