Private Company Stock

Until you reach that point, however, it pays to keep things simple for as long as possible. For Tim McCorry, who ran his company for seven years before recently starting to negotiate a multimillion-dollar infusion of capital, that meant initially authorizing and issuing a grand total of 100 shares, all of which went to him. Their par value was based on his initial investment of $30,000. "When our new investment round is completed, the company will be recapitalized with many more shares authorized and a smaller portion of them being issued to me -- but they'll be much more valuable," McCorry says.

Ah yes, increasing value. "Entrepreneurs need to remember that once they pass the initial incorporation stage, stock price is a range concept. There's no single right number that everyone can point their fingers at," notes Tony Morabito, a certified public accountant and accredited senior appraiser at Bonadio & Co., an accounting firm in Pittsford, N.Y. "The reality for private companies is this: at any point in time, there's a high number and there's a low number, and somewhere within that price range is the number that's going to get chosen as a company's stock price, based on why their owners need to know it."

For simplicity's sake, we can lump owners' motivations into two broad categories: government driven (when an owner, say, plans to file an estate- or gift-tax return or set up an employee stock ownership plan) and market driven (when an owner sells stock to outside investors, for instance, or gives it away to a key employee). In cases in which a tax liability will be triggered, it makes sense to price stock as low as possible. (See "When You Want a Low Share Price," below.) When an owner is selling part or all of a company, on the other hand, obtaining the highest possible price is desirable.

To figure out the right price, you'll often need an appraiser, who considers the motivation behind the appraisal before coming up with the magic number. "But there are times when it's the market, not any valuation method, that decides," says Trabert. "You might own 1,000 shares of your company's stock, which an independent appraiser values as being worth $300 apiece. But if a potential strategic partner could recognize all kinds of synergies and is willing to pay $600 per share, then that's what your stock is worth."

Not surprisingly, there are some fledgling efforts to use the Internet to add some structure to, and create demand in, the highly fragmented marketplace for private-company stock. But given how new and untested those efforts are, they're not yet effective. Currently, the main way to get a sense of your stock's fair-market value is -- as it's always been -- by negotiating a deal.

In what might seem to be a perversity of the private markets, it wouldn't help you to manage any better if you knew that your company's shares were worth, say, $120 apiece in 1997 (when you gave a minority stake away to a child's trust fund), $300 in 1998 (when you brought in an angel investor), and $220 in 1999 (when you gave a piece of the company to your chief financial officer). Unlike prices on the New York Stock Exchange on different days -- or even in different years -- private-company share prices just aren't comparable, because they reflect valuations for different purposes. But that's not cause for despair. There's no reason why private companies can't use their stock prices as a performance measure, if they're willing to spend some time and money up front on developing the proper valuation tools. "An entrepreneur could retain an appraiser to develop a stock-price formula that would measure key performance indicators for his or her business and yet be simple enough for company staffers to plug in current results on a yearly basis," says Morabito. "Those numbers would then be comparable from year to year and would be another useful way of evaluating how your company is doing."

Two downsides: The initial cost will probably be in the range of $10,000 to $15,000. And you still will need to hire appraisers to price your stock according to different methods if some type of tax issue arises. True, it's a hassle -- but a small one compared with those you'd face complying with public-stock requirements.

The bottom line when it comes to valuing your company's stock? Stock price is one number that can be understood only within its larger context. So concentrate on the big picture rather than on small swings in value, if you're going to make sense of your company's price.

Jill Andresky Fraser is Inc. 's finance editor.

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