How to calculate the share price of a startup company?

Ray Shan

What is your startup's stock price?

Share prices in the public stock market are easily accessible and understood through trading platforms and stock market indexes. For example, if a trading app shows a share of Apple at $100, it is clear that this is the stock's current value.

Share prices in the private markets are another story. Suppose your lawyer sends you some paperwork that shows shares in your startup company with a par value of $0.00001. Your CFO, meanwhile, gets a 409A valuation that sets the fair market value at 10 cents a share. One of your investors tells you that you should raise more money at $1 a share. Later that day, one of your employees asks you how much her stock is worth. What do you say?

When I think of price, I picture an amount of cash that I pay for something, like that share of Apple stock or a cup of ramen for sale at the local Safeway. But founders and their advisors use a variety of share prices based on who’s asking and why, and they rarely define what they mean.

As someone who works on capital market infrastructure, that confuses me. It also confuses many customers of LTSE Equity, the equity management software we are building at LTSE, judging by the number of founders who ask us for help in untangling share prices.

You may have heard terms like par value, common stock, and preferred stock; they are crucial in understanding and determining how to value a startup’s shares. Let’s break down those basics.

Par value: What it is and what it does

Don’t overthink par value. Sometimes called face value or nominal value, par value is the lowest price your company can issue shares for. All of your stock, common and preferred, can have par values. A long time ago, someone thought it would be a good idea to ink a par value on each share. We still do it today. Each share of Apple, for example, has a par value of $0.00001. But nobody expects to buy a share of Apple at that price. Share price changes over time. Par value lives on as a relic.

Shares in a startup company don’t necessarily have par values. Delaware, for example, lets companies incorporate with no-par stock. You still may want a par value; it might save you some money on tax. Talk to your accountant about what to do here. If your shares do have par values, put it on paper, enter it in your cap table software, and forget about it. Chances are no one will ask you about it again.

How to value common stock and preferred stock?

Common stock

Startups are founded with common stock, which represents all of the company’s assets commonly owned by the shareholders. Unlike par value, your common stock’s value is based on your startup’s value, which, if things go well, this value goes up over time.

Common stock is valuable, and startups are short on cash, so you can pay yourself and your employees with stock. Your stock will be taxed as income, even if you can’t sell it to put food on the table, at least not yet.

So who decides what your stock is worth for tax purposes if there’s no market for it yet? Not you. In the U.S., the government requires you to get an independent appraisal of your stock’s fair market value. (The requirement derives from Section 409A of the Internal Revenue Code.) We built a cap table management tool and provide audit-defensible 409a valuation to help startups assess their common stock’s fair market value.

The so-called 409A fair market value is fair because the experts who appraise it use methods that the government says are fair. But there’s not much “market” in fair market value early on. Buyers and sellers haven’t come together to form a market and agree on what price to pay for your shares. So how does an appraiser decide what stock price an imaginary buyer might pay?

One way is to compare your startup to a public company that has many buyers and sellers for its stock. If you make customer relationship management software, the appraiser compares you with Salesforce. What if you make cookie management software for bakers? No public companies do exactly that. Still, you’re making software, like Salesforce does. Again, the analyst compares your company with Salesforce. Since there’s not much of a market for stock in your startup, the analyst values its stock at a big discount to Salesforce’s share price. Thankfully, you’re not taxed like the Salesforce founders. At least not yet.

In short, the price of your common stock in a 409A valuation is a guesstimate. I always liked that word. The guess says no one’s sure. The estimate is full of science. The guesstimate becomes more accurate over time as your business develops.

Preferred stock

Here, you may be wondering how much funding you can raise with stock that your 409A appraiser has just discounted for tax purposes. That’s where preferred stock comes in. The price you assign your preferred stock will be the price you can persuade an investor to pay for it.

In all likelihood, you’ll paint a picture for investors of what your startup will be worth in the long term. And you’ll offer them a way to get their money back if you don’t do as well as they predicted. That’s preferred stock. It’s preferred because of the stock’s preferential safety net for those who hold it. When your startup makes money, sells itself to another company or goes public, preferred shareholders get their cut before common shareholders. (More on liquidation preferences here.) Selling preferred stock is the main way to fund your startup, so you should focus on its price.

The value of your preferred stock tells you what your startup is really worth. When you sell preferred stock you’ll have closed a priced funding round. This process creates a share price more akin to share prices in the public markets, not a placeholder you put on a piece of paper or a guesstimate for purposes of your tax bill.

However (and whenever) your startup exits, its preferred stock converts to common stock, and everything sells together. Your common share price grows over time to match your preferred share price: your company’s true worth.

How to answer common stock-related questions

It is important to address the questions stakeholders (such as employees and investors) have about their stock worth. Let’s take a look at some of the most common questions:

1. "How are employee options taxed?"

By using the 409A fair market value. If an employee received stock options and exercised them to buy stock, they pay tax on the difference between the exercise share price and the latest 409A share price. They can wait to receive a Form 3921 that includes the 409A price and all the numbers she needs. If she received restricted stock units (RSUs) that vested, she pays tax on the latest 409A share price. The IRS treats RSUs like cash pay. Your company withholds RSU tax for them; the Form W-2 they receive will show the amount withheld.

2. "How much will my stock options be worth?"

There’s no right answer. Your share price changes over time based on how well your startup does. How far you are from either the last or next funding round matters too. You could answer by painting the long-term picture with facts. At the last funding round, for example, your common stock sold for $1 a share. Since then, the team has set new goals. When you achieve them, investors will pay some multiple of $1 at the next funding round. You go on and do well. Your startup exits five to 10 years from now. A similar startup went public at $20 a share and now trades at $40. Another sold to Apple.

3. "How much is my stock worth today?"

If an investor asks what their shares are worth, chances are they’re working out what their stake in your startup is worth now. They want facts and tips. You can brief them on your new preferred share price, common share price, and news, as well as any goals the company has achieved. That will help the investor do the math and brief their shareholders.

Your share price is your secret to tell. You may have given a few investors information rights when they funded you. For everyone else, you get to decide how open you and your company want to be.

Then there’s convenience. To bring transparency to employee and investor relations, you can give folks who should see your startup’s share price access to your LTSE Equity account. That enables employees and investors to get the facts independently, in real time.

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Disclaimer
The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Information about the company is provided by the company, or comes from the companies’ public filings and is not independently verified by LTSE. Neither LTSE nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding LTSE-listed companies are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. Advice from a securities professional is strongly advised.
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