With stock option pricing getting a lot of attention in the headlines lately we thought it would be beneficial to our fellow financial professionals to find out more about how overvaluation happens, the many ways in which overvaluation creates problems, and tip-offs in an appraisal that suggest a potential overvaluation.
This webinar was presented by valuation expert Eric Nath ASA (Eric Nath & Associates, LLC).
The slides cover the latest financial theories and pronouncements affecting valuation as they relate to private companies.
Learn more about overvaluation problems with:
Stock options
Analysis of acquisition opportunities
Buyouts
FAS 157 and fair value accounting
Busted IPOs (Facebook)
Estate and gift tax
2. About The FENG
The Financial Executives Network Group is the
largest group of senior financial executives in the
world.
• Serves CFOs, Controllers, Treasurers, Managing
Directors, Vice Presidents of Tax, M&A
professionals, Auditors, and more
• Chapters in nearly every major city in the U.S.
• Job opportunities, career advice, and solid business
connections
4. About Eric Nath& Associates, LLC
• Eric Nath has been a
business appraiser since
1985
• Formed Eric Nath &
Associates, LLC in 1991
• Specializing in private
companies & minority
interest valuations
• See www.EricNath.com
for more
information, links and
resources
5. Is overvaluation a problem for
private companies?
Agenda:
• How overvaluation happens
• The many ways in which overvaluation creates
problems
• Can undervaluation also be a problem?
• Tip-offs in an appraisal that suggest potential
overvaluation
6. Is overvaluation a problem for
private companies?
Overvaluation in:
• Stock options
• Mergers and Acquisitions
• Buyouts
• Fair value measurement & impairment testing
• Busted IPOs (Facebook)
• Estate and gift tax
9. How overvaluation happens
"Reason is the slave to the emotions“
David Hume
Behavioral economics and the bias toward
optimism
10. How overvaluation happens
Behavioral economics
People often make decisions based on
approximate rules of thumb, not strict logic.
People operate based on anecdotes and
stereotypes that make up the mental emotional
filters individuals rely on to understand and
respond to events.
11. How overvaluation happens
Behavioral Finance
Market inefficiencies, mis-pricings, non-rational
decision making, and other market anomalies.
Richard Thaler (“Nudge”) has described specific
market anomalies from a behavioral perspective:
"conventional economics assumes that people are highly-
rational - super-rational - and unemotional. They can
calculate like a computer and have no self-control problems"
12. How overvaluation happens
Behavioral Finance
Extrapolation and overconfidence mean security
market under- and overreactions.
Cognitive biases: in the aggregate if there is social
contagion of ideas and emotions (causing collective
euphoria or fear) leading to phenomena such as
herding and groupthink.
14. How overvaluation happens
• Notional value ("fair market value"), versus
the real world
• FASB pronouncements and rules
• Cost of capital
– myths – capital asset pricing model – control
premium studies – restricted stock studies
17. The many ways in which
overvaluation creates problems
18. The many ways in which
overvaluation creates problems
Facebook IPO
• Trading in the secondary markets pre-IPO
• Valuation and IPOs are not a science, but…
• Was it really a bust?
• Amazon took nearly two months to get back
to it’s IPO price
19. The many ways in which
overvaluation creates problems
Mergers and Acquisitions
• Majority of acquisitions by public companies
destroy shareholder value
• System is designed to encourage overvaluation
• Over optimism about potential synergies
• Things usually takes longer than expected
20. The many ways in which
overvaluation creates problems
Stock option plans and incentive compensation
(409A)
• Unwittingly setting the strike price too high
acts as a disincentive
• Using control premiums and low required
rates of return from history-based models
21. The many ways in which
overvaluation creates problems
Stock option plans and incentive compensation
(409A)
• Unwittingly setting the strike price too high
acts as a disincentive
• Using control premiums and low required
rates of return from history-based models
22.
23. The many ways in which
overvaluation creates problems
Fair Value Measurement
Impairment Testing
• Willingness to apply control premiums is a
problem
• Cost of capital estimation using history-based
models is a problem
• Results in misleading financial statements
24. The many ways in which
overvaluation creates problems
Shareholder buyouts
Role of buy-sell agreements can be critical!
Ambiguity creates disputes and can lead to litigation
Can be many highly adverse unintended consequences of
a poorly drafted buy-sell
25. The many ways in which
overvaluation creates problems
Paying too much estate and gift taxes – why give
the government an unnecessary gift when you
die?
• Control premiums / discounts for lack of
marketability and lack of liquidity
• Court cases
• Appraisers
26. The many ways in which
overvaluation creates problems
Does the form of the entity affect valuation (C
Corp., S Corp., partnership, LLC)?
Theory is that C-Corp., partnership and LLC could be
worth more because there is only one level of tax
instead of two.
28. Can undervaluation also be a
problem?
• Dissenting shareholder lawsuits
• Overly aggressive tax advice
• Fairness issues in buyouts
29. Tip-offs in an appraisal that suggest
potential overvaluation
• History-based cost of capital estimation
• Restricted stock studies
• Control premium studies
• Conflicts of interest/investment banking
• Buy – side analysts
31. Review
• How overvaluation happens
• The many ways in which overvaluation creates
problems
• Can undervaluation also be a problem?
• Tip-offs in an appraisal that suggest potential
overvaluation
32. Review
• Stock options
• Mergers and Acquisitions
• Buyouts
• Fair value measurement & impairment testing
• Busted IPOs (Facebook)
• Estate and gift tax
34. Contact Information
Eric Nath & Associates, LLC
T 415.445.3031
eric@ericnath.com
Website: www.ericnath.com
The National FENG
T 203.227.8965
brucelynn@thefeng.org
Website: www.theFENG.org
AppFolio SecureDocs
50 Castilian Dr.
Goleta, CA 93117
T 866.700.7975
info@SecureDocs.com
Website: www.SecureDocs.com