How do you value your own stock when using it to buy a company?

What does it mean to value your own stock?

Two numbers matter, and they are rarely the same. The market price is what a share trades for today. Your estimate of value is what you think the earnings and cash flow behind the share are worth. The seller sees the first. You should act on the second.

When you pay with stock, you are selling a slice of your whole business. Berkshire's Berkshire Hathaway 1994 shareholder letter states the rule: issue shares only when you receive as much value as you give. That means you must know what a share is worth.

How do you estimate what a share is worth?

1. Start with earnings power. Use the cash the businesses earn in a normal year, after the cost of keeping them running. Do not use a peak year or a forecast.
2. Apply a multiple you could defend. Pick the multiple at which you would buy the whole company yourself. Use a range, not one point.
3. Divide by shares outstanding, including options and warrants. Count what can become shares.
4. Adjust for how the shares trade. A thin float, a small market value and sales limits all affect what a seller will pay for the shares. See how sellers get liquidity.
5. Compare to the market price. If the price is above your value, shares are a good currency. If it is below, they are a costly one.

There is no single standard discount for thin trading, so this guide gives none. Negotiate it.

What does a worked example look like?

Assumptions. A holding company has 12,000,000 shares and a market price of $4.00, so its market value is 12,000,000 x 4 = $48,000,000. Normal-year owner earnings are $4,200,000. You judge the company to be worth 14 times those earnings.

• Your estimate of value: 4,200,000 x 14 = $58,800,000, or 58,800,000 / 12,000,000 = $4.90 a share.
• The market price is below your estimate, so the shares are cheap currency.
• A seller wants $6,000,000 in shares. At the $4.00 market price you issue 6,000,000 / 4 = 1,500,000 shares.
• At your $4.90 estimate those shares are worth 1,500,000 x 4.90 = $7,350,000. The real cost is 7.35 / 6 = 1.225 times the price, or 22.5 percent more.

You can still decide the deal is worth it. You should make that decision knowing the real cost.

Fixed shares or fixed value: which should the contract use?

Your share price will move between signing and closing. The contract decides who carries that move.

• Fixed number of shares. The seller gets 1,500,000 shares whatever the price. At a closing price of $3.00 the seller receives 1,500,000 x 3 = $4,500,000. At $5.00 the seller receives $7,500,000.
• Fixed value. The seller gets $6,000,000 of shares. At $3.00 you issue 6,000,000 / 3 = 2,000,000 shares. At $5.00 you issue 1,200,000.
• Collar. The two methods are combined inside a price band, so neither side bears the full move.

Dilution shows the difference. At $3.00 under a fixed value, the seller owns 2,000,000 / 14,000,000 = 14.3 percent of the enlarged company. Under fixed shares the seller owns 1,500,000 / 13,500,000 = 11.1 percent.

What rules and accounting affect the value you give?

• Accounting. Under ASC 805, shares issued as consideration are measured at fair value on the acquisition date, the date the buyer obtains control, per Deloitte DART, ASC 805 consideration transferred. The share price on that date, not the price when you signed, sets the recorded cost.
• Approval cap. A Nasdaq-listed company generally needs shareholder approval to issue 20 percent or more of its shares or voting power in an acquisition (Nasdaq Rule 5635(a)). Insider interests can trigger a lower test.
• Resale limits. Shares issued to a seller are usually restricted and subject to the holding periods in 17 CFR 230.144 (Cornell LII copy). See how to register shares issued to sellers.

Where these numbers come from: The principle is from the Berkshire Hathaway 1994 shareholder letter. Accounting measurement is from Deloitte DART, ASC 805 consideration transferred. The approval test is from Nasdaq Rule 5635(a). Resale rules are from 17 CFR 230.144 (Cornell LII copy). The share counts, prices, earnings and 14x multiple are assumptions. Confirm with your accountant and securities lawyer.

Related questions

Should I use the market price or my own estimate when setting the exchange ratio?

Negotiate on the market price, because it is what the seller can observe. Decide whether to do the deal on your own estimate of value.

Does a thinly traded stock still work as currency?

It can, but sellers will weigh the limits on selling. Offer registration rights, a shorter lock-up or part cash to close the gap.

Who values my stock if there is no active market?

Usually you and the seller, with an outside valuation firm if the stakes are high. Agree on the method in the contract.

What comes next

Next, see when the math flips: what share price or P/E makes stock a sensible currency.

Related articles

• What share price or P/E makes stock a sensible currency?
• When does paying with stock beat paying with cash?
• How do you avoid dilution in a public roll-up?
• How do lockups and Rule 144 affect sellers who take holdco stock?
• How do you pay a seller with stock instead of cash?

Meraki Dealmakers is a service of Meraki Partners, LLC, an advisory firm. It is not a broker-dealer, investment adviser, business broker, law firm or accounting firm. This article is general information, not legal, tax or investment advice.