Meaning
Financial assessment procedures determine the fair market value of shares that carry liquidation preferences and other special rights. A preferred stock valuation is a calculation used to price equity that sits higher in the capital structure than common stock. It governs the price at which investors enter a round and establishes the basis for future dilution.
This measurement ceases to apply once the stock converts to common shares during an exit or a standard liquidity event.
Valuation Input
The calculation incorporates the specific rights attached to the security such as participation or cumulative dividends. When conducting a preferred stock valuation, analysts often use an option pricing model to account for the different payoff scenarios. This complexity accounts for the gap between the headline price of a round and the effective value of each share.
Market Impact
Establishing a high price for these shares can set a difficult benchmark for future fundraising. A preferred stock valuation influences how much of the company a founder must give up to secure a specific amount of cash. High valuations protect existing investors from dilution but can make it harder for the company to achieve a successful up round later.
Common Disparity
The gap between what a venture capitalist pays and what an employee receives in options is often wide. A preferred stock valuation remains the primary tool for reconciling these different interests during an audit.
