Convertible securities come in many forms—convertible notes, convertible bonds, and convertible preferred shares, to name a few. Generally, they are interest-bearing, fixed-income debt securities that may also be converted into a predetermined number of common stock or equity shares, meaning they combine features of debt and equity. When a company is looking for alternative means of financing, convertible securities hold numerous advantages over common and preferred stock. Convertible securities can also be a compelling option for investors, but both parties should ensure that they are well-informed of the risks.
Companies offer convertible bonds at lower coupon rates, and because corporations only need to share operating income with the newly converted shareholders when performance is good, they benefit by holding onto more of their cash. In addition, bond interest is a deductible expense for the issuing company, meaning that the federal government will pay for a percentage of the interest charges on the debt.
Selling convertible bonds is also an advantage for organizations that do not want to lose voting control of the business. However, since bonds do convert to stocks eventually and stockholders are entitled to vote for directors, the benefit is usually temporary. Companies with weak credit ratings may also sell convertible securities to lower the yield necessary to sell their debt securities.
Companies should also be aware of the risks. Financing with convertible securities may dilute the earnings per share (EPS) of the issuer’s common stock. And, while convertible securities stave off yielding control of the company to others for a time, if a large part of the issue is purchased by an investment banker or insurance company, a conversion could shift voting control away from owners. Other disadvantages mirror those of utilizing straight debt, although convertible bonds do entail a greater risk of bankruptcy than preferred or common stocks, and the shorter the maturity, the greater the risk. If it does not convert, for example, the company may be forced to repay the money within a very tight timeframe.
Investors are drawn to convertible securities because they could yield the high returns associated with stocks, combined with the lower risk of bonds. By investing in debt, and essentially lending money to a company, investors are given more protections since they are technically considered creditors rather than owners and, if the company goes out of business, creditors are always paid before shareholders. These transactions also cost less than stock sales, making them a relatively safe and cost-effective way to invest.
Yet, investors are typically providing funds to unproven companies whose values are not yet known. Credit-worthy companies often issue convertibles to reduce the cost of obtaining capital. Sometimes, however, companies with poor credit ratings will issue them without the intention of ever converting the issues. Some corporations with weak credit ratings still have a high potential for growth, but investors must study the company’s performance and industry standing to make an informed decision about its likelihood for future success. The rate of return must be high enough to reward the risk.
Convertible debt has become a common financing tool, especially for entrepreneurs trying to fund start-ups, and it is a great way for investors to engage with this landscape with some built-in safety features. These transactions are quick, relatively easy, and beneficial for all involved, as long as everyone has done their homework.
Employee Stock Purchase Plans (ESPPs) are an excellent way to maximize employee compensation at a modest cost, but the benefits go well beyond remuneration. A well-structured ESPP also engages employees by helping to create an ownership culture. Employees will do what is best for shareholders because they are shareholders. Considerable benefits also exist for the issuing companies, which can better compete in tight labor markets, attract and retain high-quality talent, and even improve productivity and profits.
An ESPP allows employees to purchase shares of the company’s common stock at a discount, usually through after-tax payroll deductions. Typical plans offer a 10 percent purchase price discount, meaning that the moment employees purchase their shares, they are netting an immediate gain. Plans that include a lookback provision allow employees to purchase shares at the offering-date price or the purchase-date price, whichever is lower, yielding even higher gains. In cases where the purchase date stock price is lower than the offering date price, the employee is insulated from the decline by having the ability to purchase shares at the lower discounted price. Purchase discounts and lookback features are just two of the many options that employers can build into ESPPs to ensure that they are a valuable employee incentive.
ESPPs incentivize employees to work harder in the company’s best interests. By handing over a portion of their salary to an ESPP, employees have a higher stake in the company’s performance, and are willing to go above and beyond to ensure its share price appreciation. It has been proven that employees that participate in ESPPs work longer hours, are absent less frequently, and express greater job satisfaction.
When employees are more engaged due to an ownership culture, top talent begins to think and act as business owners. And why not? They actually are! When employees are taking advantage of a successful ESPP, it does not take them long to realize that each dollar they invest multiplies their wealth. This knowledge cultivates ownership, which in turn improves corporate performance.
The issuing company benefits by enhanced productivity, as well as lower turnover and greater efficiencies. There are, however, a number of harder financial benefits to be had. Regular payroll deductions provide a steady cash flow to the company. ESPPs also cost less than other equity compensation, and can substitute for more expensive benefits. Additionally, when companies offer discounted ESPP purchases, the company can take advantage of substantial tax deductions. According to the National Association of Stock Plan Professionals (NASPP), 52 percent of U.S. companies offer an ESPP. That figure might seem high, but given the benefits reaped by employees and employers alike, it should be higher.
ESPPs are a cost-effective tool for cultivating an ownership mindset among employees at all levels of an organization and can prove a powerful tool for hiring, retention, and productivity. Those organizations that have not yet considered developing one should do so, and those that have experienced lackluster results from an existing program should seek to restructure and revitalize it to its full potential.
Global demand for solar power is on the rise and rightfully so: it is an efficient form of green energy and a renewable solution toward lowering greenhouse emissions and addressing climate change. Government incentives, tax rebates, and lower prices have fueled increased consumer use, as well as broadened solar’s applications for both power generation and real estate development. The market is strong. However, solar companies’ profitability continues to lag behind this impressive growth. Companies can generate more value going forward by improving capital and operational efficiencies.
The global solar energy industry is expected to reach $422 billion by 2022, up from $84 billion in 2015, meaning that the market is growing at a CAGR of 24.2 percent. The United States installed 2.7 gigawatts (GW) of solar PV capacity in the first quarter of 2019, reaching 67 GW of total installed capacity. That is enough to power 12.7 million American homes and represents a 10 percent year-over-year increase. The U.S.’s total installed PV capacity is expected to more than double over the next five years, reaching over 15 GW of capacity installed annually by 2024.
Despite substantial growth, solar are continuing to struggle. Some developers and builders of solar power plants have seen their valuations drop, undergone restructurings, or even weathered bankruptcies. Factors like low oil and gas prices and increasing interest rates will continue to challenge the industry, but can be counterbalanced by better project margins, as well as improving capital flows and balance sheets.
Solar companies need to drive down the costs of building plants faster than the industry average. This can be accomplished by building systems that leverage more prefabricated components and are useful across a wider range of sites, rather than complete customization for each new project. Automation and aerial site assessments can also speed prototyping and, for large utility-scale projects, better assessments minimize rework for pile driving or trenching. The most straightforward path to profitability and, by extension, higher valuations, is to ensure that projects are finished on time and within budget. Delays and cost overruns reliably erode profitability and prevent solar players from generating more value.
Capital Flows and Strong Balance Sheets
Solar companies should look for new ways to attract long-term capital from institutional investors in order to improve capital efficiency and enable growth. Institutional investors are seeking high yields and low risk, and solar developers need dependable ways to liquidate higher-cost equity capital to reinvest in the next project. One solution is to create the next generation of YieldCo that houses long-term capital and also provides flexibility for project developers, as well as pure-play DevCos focused on equity without high debt levels. The industry is also testing PoolCos that invest on an asset-by-asset basis. Companies should also improve capital efficiency by ensuring that capital does not get locked up into long-term, low-margin uses. When capital is being put to use wisely and balance sheets are strong, it is possible to scale up without getting into financial trouble.
Falling costs, improved technology, and greater regulatory support will continue to fuel the industry’s growth, and developers that successfully lower the cost of their installed systems, manage the cost of capital, and improve their operations will increase their financial returns and generate more value.
Employee Stock Ownership Plans (ESOPs) have become commonplace in the United States, with 6,669 plans covering 14.4 million people. ESOPs are a fantastic option for private companies that want to reward and motivate employees by providing them with equity, but how and when share prices are valued is somewhat complex. Typical stocks are valued on a public stock exchange, meaning that the valuation and how it is attained is transparent and updated daily. ESOPs work differently. The Department of Labor mandates that an ESOP value its shares at least annually, which may seem extreme, but given how these share prices are determined, regular valuations are in everyone’s best interest.
ESOPs must determine what their shares would sell for on the open market without the benefit of actually being traded on one. That means that the trustee of an ESOP typically sets the share price based on a recommendation from an independent, third-party valuation firm. There are several methodologies used for valuations, but all take historical and future projected financials into consideration. Most appraisals utilize an income approach, which relies heavily on financial data. The approach may examine historical results, dividing them by a capitalization rate to determine value. It may also forecast future cash flows, which are then discounted back to the present value. Either way, organizations and their employees benefit most when updated financial information is provided and analyzed annually, so that share prices are never severely outdated, reflecting values that are either considerably higher or lower than is appropriate.
Similarly, other market factors that may change during the course of a year could have a profound effect on share prices. Industry performance plays a role, as does the competitive landscape. When major competitors are bought or sold, or when they experience an event that either leads to exceptional performance or bankruptcy declarations, these factors affect your industry standing and therefore inform value assessments.
ESOP companies grow 2 to 3 percent faster than would be expected without an ESOP, and have lower turnover and 2.5 percent higher productivity. Furthermore, ESOPs that leverage an ownership culture throughout the organization grow 6 to 11 percent faster. In order to reap these benefits long-term, however, ESOPs need to be actively managed. This ensures that employees understand the true value of their compensation packages and can rely upon their future existence. When ESOPs are not frequently monitored, this often leads to the program’s termination.
Over time, shares are allocated and debt is repaid, meaning that repurchase liability can accumulate quickly and consume a growing share of cash flow. If this has not been anticipated, cash that might have otherwise been used to fund growth initiatives is eroded in order to satisfy the company’s repurchase obligation. When the company’s growth is stifled, causing stock prices to drop, this burden becomes too heavy to shoulder. In order to properly manage ESOP obligations and ensure this does not happen, companies must regularly study their future repurchase obligations through the lens of regularly updated future stock price projections.
Valuing ESOP stock prices annually not only fulfills the Department of Labor’s mandate to do so; it also ensures the long-term viability of the company, their program, and the ongoing high performance, productivity, and satisfaction of employees.
Some of the most valuable trademarks are also the most recognizable company names: Google, Microsoft, Walmart, Mercedes, and others. However, trademarks protect more than corporate names. They also safeguard logos, designs, product names, taglines, and more. Furthermore, trademarks are not simply for Fortune 500 companies, either. Smaller organizations rightly rely on them too and, regardless of the nature of your business, you should never underestimate the potential value a trademark holds for your brand and, by extension, your company.
It is now widely believed that trademarks are a substantial portion of intangible value for companies, and intangible assets now account for approximately 80 percent of the value of an average U.S. company. That figure is substantially larger than it was even a few years ago and continues to grow. It is hard to ignore the math. Trademarks have become so valuable because they actually generate revenue.
Trademarks help distinguish your company and its products and services from the competition, making it easier to build trust with customers and, ultimately, attract and retain them. A trademark can function like a promise, becoming synonymous with a level of quality or service customers can expect and count on. It is the reputation of a particular brand. This brand recognition sways purchasing decisions and drives revenue generation, as does the fact that when certain products and services are trademarked, the competition is shut out from offering the same and thus revenues are maximized.
There is no more effective communication tool than an image, brand name, or tagline that succinctly conveys so much information. Trademarks tell a universally understood story about your reputation, your quality, your differentiators, and other intellectual and emotional attributes. Trademarks are valued both on their income history, as well as probable future sales and profits. Essentially, as your business reputation grows, your brand and trademarks become more valuable. And even though they make you money, they require minimal investment. The United States Patent and Trademark Office charges around $275 to obtain a trademark, and they are equally affordable to maintain.
Trademarks can also make it easier to expand your business into other industries or geographies. They can be bought, sold, or licensed, facilitate merger and acquisition activity, attract financing, and enable more effective recruiting. In more ways than one, Intellectual Property (IP) has become a coveted source of revenue.
With increased digitization, however, trademarks are becoming more difficult to protect. Information is shared online at such a dizzying pace, it is easier than ever before for competitors to embrace your ideas. Without trademarks, there is no recourse for this, meaning that a competing company could easily profit from another’s ideas, in some cases more so than the originator. Although IP disputes are becoming more common, they are much easier to resolve when you can point to trademark protections.
Most of today’s industries are rife with competition and when you create a trademark, you give your company the opportunity to differentiate itself from the pack. A well-executed trademark is specific enough to help you stand out, distinctly identify your business and, hopefully, your values. Most importantly, trademarks help generate more revenue (new and recurring) and protect those profits and your market share from others that are eager to erode it.
Fire, floods, earthquakes, and tornados; theft, vandalism, and negligence. Whether it is mother nature, an untrustworthy employee, or simply an error in judgement, business losses are a reality that cannot be ignored. When business owners suffer an equipment loss (and sometimes also a loss of accompanying records), nothing compounds that stress more than worrying about how to prove the value of those losses to an insurance company. Should you ever find yourself in the throes of the unthinkable, and you did not obtain equipment appraisals ahead of time, a retrospective appraisal could be your best path forward.
Eventually, damaged equipment will need to be either repaired or replaced. Retrospective appraisals comprise a trusted approach to dealing with significantly damaged equipment and involve the careful study of remaining paperwork and equipment to determine a defensible valuation of losses. Appraisers evaluate the equipment (if possible), as well as available records such as original purchase paperwork, maintenance logs, repair receipts, and other documentation that would support the equipment’s prior condition and resultant valuation. Most appraisers would also weigh demand for the equipment and other market conditions.
Sometimes, losses due to widespread disasters cause additional complications because supply and demand are impacted. In these instances, it is not uncommon for supply to dwindle and demand to spike or, conversely, for demand to dry up. Qualified appraisers know how to maneuver these situations and assign value accordingly. Additionally, if a loss was suffered in the distant past, appraisers have the ability to pull data from historic repositories to perform their work for a specific time in history, as well.
Retrospective appraisals enable business owners to secure fair compensation for damaged equipment, whether you are pursuing matters with your insurance company or simply claiming a loss on your tax returns. Owners also seek retrospective appraisals when documenting equipment donations or for litigation.
Performing equipment appraisals after the fact is not an easy undertaking, which is why it is so important to hire a seasoned professional for the task. Independent, third-party valuation experts are without a doubt the best choice to perform this type of work. Machinery and equipment valuations can be complex operations that involve weighing multiple factors within the context of a specific methodology. Damaged or lost equipment and/or records only complicate the process, making it even more critical to seek professional assistance that will hold up to scrutiny in court, and with insurance and tax agencies.
There are several common tax scenarios that require business owners to determine a justifiable dollar value for their companies. Business valuations are critical for gift and estate tax liability purposes, and/or to engage in the sale of your business. In all of these instances, business valuations determine the taxable value of your business interest, and that is not a figure you want to get wrong.
Reporting Gift and Estate Taxes
One of the most common tax purposes to drive a valuation is for federal estate tax planning and/or gift tax reasons. In this case, the fair market value of a company is absolutely necessary to determine your tax liability. The value applied to your business has a direct correlation to the taxes you will owe, whether they be gift taxes on shares you have given away or estate property taxes. If the value determined by the IRS differs from the value you used for your tax calculations, you or your estate could be liable for additional taxes. Valuations for estate tax purposes are especially complex because they are based on a body of laws and regulations that are always in flux, changing with new court decisions or government priorities.
Occasionally, owners choose to give all or part of their interest in a business away to a charity of their choice. Donations are typically made with cash, but corporations may also choose to donate stocks, machinery, real estate, or other assets. Should you find yourself in this situation, the IRS requires a business valuation as documentation to support the deduction for the years in which the gift was given. Assuming the fair market value of the donation is properly assessed, you are generally able to deduct that amount from your taxable income, thereby lowering your taxes and supporting a charitable organization at the same time.
Sale of Business/Succession Planning
The value of your business drives the capital gains taxes that result from a sale, so you will need to determine the taxable value of your business interest as accurately as possible. If you underestimate, you will likely overpay on taxes because you will miss out on certain tax-saving strategies. Furthermore, selling a business interest for less than fair market value can cause the IRS to deem the transaction a combination sale and charge you gift tax on the difference between the stated value and the value the IRS determined. Transactions from one family member to another are especially scrutinized by the IRS, but any sale involving a disparity in the fair market value versus the stated value will cause your transaction to be flagged. Unfortunately, by the time the IRS challenges the value, years could have passed, meaning that your additional tax liability will be compounded by accrued interest and penalties.
Similarly, if you overestimate, you could invest more time and money into the process than is necessary. The IRS could also deem an above fair market sale a gift from the buyer to you and charge you the resultant gift taxes. An independent business valuation helps you attain the highest possible fair price for your business, ensuring you profit while avoiding additional taxes and penalties. Valuations are also integral for buy-sell agreements for similar reasons.
Without a valuation from an independent, qualified appraiser, any of these tax scenarios could, unfortunately, implode. While the fair market value of a business is always open to interpretation, the IRS is much less likely to challenge professional appraisals based upon sound assumptions and ample supporting evidence.
Upon close examination, most startups with valuations in excess of $1 billion, known as unicorns, turn out to be pretty horses in disguise. A recent study performed by professors at Stanford University and the University of British Columbia found that without the use of complex stock mechanics, many unicorns would lose their horns. The study shows that, on average, these companies report values about 51 percent above what they are really worth. Unicorns, so named because they were once rare enough to be considered mythical, are becoming commonplace. In the US alone, there are 135 of these venture-backed companies out there, with more on the horizon. Luckily, it is possible to separate the hype from reality.
The study, which examined 116 unicorns founded after 1994, with average valuations of $2.7 billion, found that 11 percent of companies used preferential stock to boost their valuations to more than twice what they would be worth using fair value estimates. In many cases, the disconnect lies in the contractual terms between investors and the companies. In some instances, a company gives stock preferences to a backer in exchange for a high valuation, but the shares include a provision to receive additional equity if an initial public offering is set below a target price. Investors are then able to take advantage of this provision in the instance of a mediocre IPO.
Another investor protection, called a liquidation preference, guarantees minimum payouts in the event of an exit, but can also exaggerate a company’s value by as much as 94 percent. Companies have also been doling out ratchets to shareholders, which can inflate valuations by 56 percent or more.
These provisions are now commonly offered to later stage investors who are paying a higher price for their shares, and would thus experience lower returns. Various option rights improve investors’ returns and shield them from risks that might result in losses.
The overvaluations are a product of the use of “post-money valuation.” Analysts, the media, and often the companies themselves take the price per share realized in the most recent round of funding and revalue older share prices using the higher price of the latest class of shares. So by assuming all of a company’s shares have the same price as the most recently issued shares, overvaluation occurs. Startups continue to chase these overblown valuations because of the fanfare and credibility that follows. Unfortunately, other industry players are not going out of their way to correct the problem, because everyone is essentially benefitting from it.
The benefits of overvaluation are short-lived, and it is always at the expense of early investors and employee shareholders. Plus, if the bubble bursts, employees will suffer most. But overvaluations also impact the companies, as well as the economy as a whole. Independent valuations are a great way to separate the pretty ponies from the truly mythical.
Exit planning is not something that should be undertaken in an afternoon. Ideally, it is a multi-year process. Whether you are gearing up for a sale, or preparing to pass your business along to the next generation, it is imperative to fully understand your business’ value and to do your best to maximize it before a change in ownership. A business valuation is the cornerstone of that process. Without one, you cannot boost your sale profits or arm the company’s future leadership with the insights they need to be successful.
Knowledge is power, and nothing is more critical to exit planning than understanding your position in the marketplace; the strengths and weaknesses of your daily operations and balance sheet; and the worth of your tangible and intangible assets (the latter of which comprise the bulk of most businesses’ worth and are notoriously difficult to value). A business valuation will guide you on whether the time is right to proceed with an exit or, more likely, if it makes sense to hold off until you address pressing issues that will serve as red flags and value detractors for potential buyers. Plus, business valuation experts are able to find value in places where accountants typically do not, allowing you to make a credible, independent argument for a higher sale price when the time comes.
First, consider your finances. Any potential buyer will expect to see at least three years’ worth of financial statements. Business valuations comb through your financials, normalizing your paperwork so that one-time expenses and occasional income fluctuations do not negatively impact your negotiations. Valuation experts are also able to provide you with insights on which debts should be paid down, areas of your operations where the cost overhead exceeds industry standards, business processes to streamline, and other issues that can be addressed prior to an exit.
In terms of assets, business valuations assess the worth of intangibles like brand recognition, patents, copyrights, client lists, talent, and other elements that have no book value. Valuations also help to preserve more of the value of tangible assets. The standardized depreciation tables typically used by accountants can rob companies from capitalizing on the value of depreciated assets that are still in use. Valuations include equipment appraisals that ensure you are able to list all of your relevant assets on your balance sheet accurately so that you don’t inadvertently shortchange yourself.
A business valuation also gives you a more concrete sense of where the market is headed, your competitive standing within that market, your competitive differentiators, and your firm’s future trajectory at the present time, as well as an idea of how those factors could change by making certain adjustments. Valuations remove the guesswork from exit planning.
No matter how much time and internal manpower you dedicate to the process, no company can accurately synthesize the information and factors that play into a comprehensive exit strategy as well as a third-party business valuation expert. Business valuations make a successful exit by giving you the opportunity to maximize your business, whether you are exiting in six months or six years.
Entrepreneurs and business owners do themselves a disservice by moving towards a sale too hastily. If you have decided it is time to sell your business, the last thing you should do is actually list it. At least, not if you would like to get the best return on your investment. Business owners who are serious about selling and maximizing profits should take their time, ensuring that the process is well planned, and that they are approaching their exit with the same care and thought used to build the business in the first place.
A great place to start is by seeking a business appraisal from a certified third-party specialist. A business valuation ensures you understand the worth of your tangible assets, like real estate and equipment, as well as your intangible assets, like innovation or other intellectual property. Intangibles are the hardest to pinpoint and often comprise the bulk of a business’ value, so it is very important to attain an independent assessment of these. And, perhaps most importantly, a valuation flags any issues that are detracting value from your business, giving you the opportunity to fix them beforehand. An appraisal will point out areas where your cost overhead is too high, or where you have bad debts or other issues that can be proactively addressed. By cleaning up the bad and protecting or even enhancing the good, you will set yourself up for the best case scenario at the time of sale.
Most businesses opt to do this work, then seek a second valuation. This helps them understand how the changes they made improved their company’s worth. Depending on those findings, owners either decide it is time to sell, or decide to make one more round of improvements before moving forward. Either way, a business valuation helps to maximize your sale price, and serves as a guidepost for you, your investors, and potential buyers during future negotiations.
Ideally, you should attain your first valuation and begin the planning process years before a sale. This gives you ample time to increase your earnings and cash flow, and make other recommended changes per the report findings. You will need to provide the past three years of financial statements to any prospective buyers and, ideally, the business is operating at its best during those years. Most smart entrepreneurs seek their first valuation four to five years prior to sale, giving them ample time to implement necessary changes, as well as three years of improved performance to point to during the sale process.
Selling your business is a huge decision that should not be undertaken lightly. It no doubt took years, if not decades, of meticulous planning and calculated decision-making to grow your business to what it is today. A sale should be approached with the same level of strategic decision-making. Entrepreneurs that fall prey to the temptation of hastily putting up a for-sale and walking away inevitably regret it. Selling should never be an emotional, sudden, or careless undertaking. Instead, choose to focus on better understanding your strengths and weaknesses and addressing them appropriately. Time spent achieving operational efficiencies, cost reductions, and other value enhancers will be well-rewarded down the line.