How do you determine the value of virtual shares?

Valuing a company is not an exact science. Many factors determine the value, and they differ per company and per moment. Yet for participants in a virtual share plan the value is essential: it determines what their grant is worth.

In practice, companies rarely struggle with the valuation itself. They struggle with the next step: how the company value translates into the value of one virtual share, and into what a participant eventually receives.

In short: you choose how you value the company at grant and in between, ideally with a simple formula your team understands. Divide that value by the total number of shares or equivalent units to get the value per virtual share. What participants actually receive is set by the plan terms, usually the price a buyer pays at an exit.

Basics

The value of your company is not the value of a virtual share

A virtual share, sometimes called a virtual share unit (VSU), is a copy of a real share. Its value follows the value of the company, divided over the total number of shares or equivalent units. So you always need two numbers: the company value and the number of units.

With Share Appreciation Rights, participants share only in the growth above a starting price per virtual share. That starting price is set when the grant is made. The difference between the current price and the starting price is the value growth a participant shares in.

Freedom

Who decides the value?

By default, the company decides how it values itself at the moment of grant and when someone leaves. It is not obliged to follow a specific valuation method, or to use one at all. Nor does it have to hand participants an official valuation report.

That is worth knowing if you have been putting off a plan because it seems to need a full valuation exercise first. It does not: no shares change hands at grant, so there is no purchase price that has to be defended to the last euro. A sober, well-reasoned starting value is enough to begin. An external valuation can always come later, for example after a funding round or if a leaver disputes the value.

The starting price of a grant is usually related to the (expected) fair market value of the company at that moment, but it does not have to be. Put simply, it is the starting level of someone's incentive to create value.

You have roughly three options to make the valuation clear:

• A formula in the plan. For example EBITDA times a multiple published by a named institute.
• A third party. You agree that a named valuer or valuation software sets the value.
• A board decision. The board sets the value, ideally explained with the figures it is based on.

The advantage of a formula is transparency: participants can see how the value of their grant is determined.

Method

Choose a method your team can follow

Common starting points are a multiple of EBITDA, a multiple of revenue, or the price per share in the most recent funding round. Which one fits depends on your company: a profitable company often uses EBITDA, a fast-growing company that is not yet profitable often uses revenue or the last round.

Simple beats perfect

We regularly see companies that want to copy a complex valuation method, for example from their shareholders' agreement. Our advice is usually to keep it simpler. A virtual share only motivates if people understand it. A formula based on a few clear figures, such as profit or revenue, works better than a model only the CFO can follow.

Whatever you choose: apply it consistently. A method that changes every year makes the value hard to trust.

Calculation

From company value to value per virtual share

The calculation itself is simple. Divide the company value by the total number of shares or equivalent units. Subtract the starting price of the grant. Multiply the result by the number of vested virtual shares. Try it with your own figures:

Why vested virtual shares can be worth €0

A question we hear often: "My virtual shares have vested, so why are they worth nothing?" Vesting means a participant has earned the grant. It says nothing about value growth. If the current price per virtual share is at or below the starting price, there is no growth to share in yet. Set the starting price above the current price in the calculator and you will see it happen.

Growth

Funding rounds and dilution

A higher company valuation does not automatically mean a higher value per virtual share. When new shares are issued, for example in a funding round or when a convertible loan converts, the total number of shares grows. The value is then divided over more units.

Investors with preferred shares may also be paid first at an exit, which affects what is left for ordinary shares and therefore for virtual shares. That is why the plan should state which number of shares or units you divide by, and how new rounds are handled.

Updates

How often should you update the value?

There is no obligation to revalue every year. When the plan administrator communicates a new company value, it can be based on an official valuation, but it does not have to be. It is mainly a way to show progress that is realistic to expect.

Moments when an update makes sense:

• Once a year, after the annual accounts, so participants see progress.
• After a funding round, when an outside party has put a price on the company.
• When someone leaves, if the plan caps the value of their grant.
• For new grants, to set a fair starting price.

One nuance: freedom is not arbitrariness. Once you have made agreements, you cannot choose a random value afterwards. The plan terms and reasonableness still apply.

Payout

Exit, leavers and the actual payout

An interim value is not a payout. It is worth separating three things: the indicative value you show participants, the value your accountant may need for the annual accounts, and the amount a participant actually receives under the plan terms.

At an exit

What counts most for participants is the exit price: the price agreed between the selling shareholders and the buyer. That price is largely the result of negotiation, not of a formula. The higher it is, the higher the payout.

It is possible to agree that the exit value is calculated with the same formula as at grant. Be careful: that can result in a (much) higher value than the buyer pays, so participants receive a higher price than the shareholders, who end up with less.

When someone leaves

A participant who leaves before an exit no longer contributes to further growth. That is why many plans cap the exit price for a leaver at the fair value on the day they leave. Include a short formula in the plan to set that maximum. It does not have to be extensive, as long as both sides know where they stand. If there is still disagreement, the company can commission an official valuation report, paid for by the company, the participant or both.

This article is general information, not legal, tax or financial advice. The examples are illustrative. Check the exact rules for your situation with your own adviser.

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