Crypto and Your 409A Valuation

January 16, 2019 Betty Ma

Back in 2017 when my mom called me out of the blue to ask about “the Bitcoin trend” after hearing it mentioned on a Chinese talk radio show, I knew just how hot cryptocurrencies had become. Fast forward to today. The late 2017 hype of crypto run up may have cooled off, but investments continue to be poured into crypto assets. According to Coindesk, all-time cumulative ICO (Initial Coin Offering) funding reached $22.5B in October 2018, compared to $5.9B at the beginning of the year. While casual investors may no longer favor crypto, industry-forming VC leaders like A16Z continue to launch dedicated crypto funds that invest in foundational blockchain technology and crypto protocols. In other words, crypto is here to stay. But how does an emerging medium of raising capital impact a company’s 409A valuation, especially those bound by a traditional capital structure?

Crypto tokens versus equity

When a company completes an ICO, it is selling a coin or “token” to the public. In contrast to an IPO, where the company is raising money by selling a share (or ownership) in its capital stock, an ICO does not necessarily grant the token purchaser the same ownership rights that a shareholder is entitled to under federal securities laws.

Today, there are generally two types of token issuances: security tokens and utility tokens. Security tokens are intended to be treated as investment vehicles and must comply with regulatory requirements. Utility tokens, on the other hand, are designed to provide token holders access to the company’s product or services or serve a specific function on the company’s blockchain. In many cases, companies are structured as C-corporations with common and preferred shareholders while having utility tokens trading an open exchange. This introduces a new consideration for startups that have issued utility tokens and how the token value impacts their 409A valuation.

Impact of crypto tokens on your 409A valuation

Not all market-traded tokens are created equally. As part of the valuation process, it’s critical to understand the “tokenomics” and role that tokens serve in the company’s business model. For example, some tokens were designed to increase in value over time as the community or ecosystem expands through a network effect. Members of the community then receive the benefit of value appreciation since they are contributors to the network. Other tokens function solely as a medium of exchange, with the exchange ratio to their native fiat currency pegged to the open market. Fluctuations in token value may follow the general, and, frequently volatile and speculative, crypto market, irrespective of any company-specific factors.

Understanding both the function and value drivers of tokens provides a framework to determine how the remaining token supply held at the company level impacts the common stock value. Other factors to consider include economic rights of token holders, liquidity access, and vesting restrictions. From our experience, it’s clear that there is no one-size-fits-all approach when it comes to token treatment in the 409A valuation.
As both the industry and regulations continue to evolve, the conversation on crypto and your 409A valuation will change. If you have any questions, I’d love to learn more about your business and discuss the latest thinking on this topic.

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About the Author

Betty Ma

Betty Ma is a Managing Director with Shareworks by Morgan Stanley, responsible for managing strategic partnerships and execution of client engagements. Betty was previously with SVB Analytics, where she led the Financial Advisory Services valuation practice and provided advisory services to venture-backed technology companies. Prior to joining SVB, Betty worked at Deloitte Financial Advisory Services LLP, with a focus on intangible assets and impairment valuations. Betty also has audit experience with PwC’s financial services group. Betty is a CFA charter holder and a licensed CPA in the state of California. Betty graduated summa cum laude with both master of accounting and bachelor of science degrees in business administration from the University of Southern California.

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