E Should The Basis For A Pre-Money Valuation Be Disclosed?

The U.S. Securities and Exchange Commission can help investors protect themselves from overpriced stock deals if it requires valuation disclosure in offering documents.”

That’s the opening line from an article I wrote called “The Case for a Valuation Disclosure Requirement.” It argues that the SEC should require companies that sell stock in a private or public offering state the pre-money valuation they set for themselves in their offering document.

If you unsure what a pre-money valuation is, check out my YouTube video Pre-Money Valuation: How to Calculate It. The deck is here.

The article didn’t address a question, “If an issuer is required to disclose the pre-money valuation it gave itself, should it also be required to discuss how it arrived at the figure?” It’s an intriguing one because no one knows how to reliably value a venture-stage company, one whose existence is dependent on new infusions of capital.

I think issuers should be encouraged to discuss the basis for a valuation. But, they should not be required to do so. Why? If management doesn’t want to talk about it, they will say something like this:

The initial public offering price of our common stock was determined through negotiations between us and our underwriters.

That banal statement all that was said about the (undisclosed) pre-money valuation for Alibaba Group (BABA) in its 2014 offering document. It was the largest IPO in history.

If required to explain a valuation, many issuers will say something similar. The world doesn’t need more junk-speak, so I oppose a requirement to explain what determined where a valuation was set.

That said, if issuers must disclose their valuation, some may want to say something about it. That is especially true for a small IPO, such as one based on SEC Rule CF (crowdfunding), which be used to raise $1 million, or Reg. A+, which can be used to raise up to $50 million. Small companies tend to set their pre-money valuation without guidance from intermediaries who assemble investors capable of making a significant investment.