Common Stock Equivalent

Common Stock Equivalent (CSE) is one of those phrases that most financiers automatically know but can’t always define exactly. So what is Common Stock Equivalent and, more importantly, what should it mean to you? Not a bad idea for a refresher, even if you know the terminology inside and out. At the basic level CSE refers to a view of a current capital structure in which all classes of securities are considered to have equal rights as common stock. It operates under the assumption that no preferred rights or preferences exist, except those given to common stock.

Let’s go a little deeper with it. This means that no share of any class is any different than the other. It assumes all series are to be converted to common stock on the date of measurement. For example, if there was a Series A round that closed with a 1x liquidation preference and an 8% accruing dividend, Series A would no longer have those preferences. Everything is simply common stock.

When Is CSE Appropriate?

CSE can be a very appropriate and accepted method of valuing or analyzing private securities. For example, if the subject company has filed an S-1 and plans on a near-term IPO when all series will convert to common, it is appropriate to look at a CSE method. There are two sides to the CSE to consider:

1) Deriving a Value – CSE can sometimes refer to a post-money calculation wherein all securities are assumed to be valued at the most recent price paid for any security regardless of series. In the situation above that involves a qualified IPO, a post-money valuation may be suitable, and it will involve writing up all outstanding securities to the most recent transaction price.

2) Allocation of Value – CSE may also refer to the method of allocating a value, immaterial of the approach used to get there. In a CSE, equity value of the company (after a pay-off of debt) is allocated to all series assuming full conversion to common at the applicable conversion rates. This particular allocation is simple since every share is worth the same common pro-rata amount. Warrants and options that are out of the money, however, are excluded from the CSE because they do not receive allocation.

Another situation that might be an appropriate way of looking at securities is if the indicated value of the company exceeds all liquidation preferences. A good rule of thumb for you is that if the value of the company exceeds the last breakpoint of the company, all series would effectively convert to common and a CSE may thus be an acceptable form of allocation.

When Is CSE Not Appropriate?

While CSE is an appropriate method in some cases, it can also be misused. There are many instances where CSE is not an acceptable method of evaluating securities and should not be used. Some of those cases are the following:

  • Company is very early stage; exit possibilities tough to predict.
  • Exit is near-term, but terms and conditions will be applicable to the exit.
  • Additional funding needed in the future to sustain operations.
  • Liquidation preferences of the preferred series greater than the current indicated value.
  • There are uncertainties in the future.

This content originally appeared on the ShareholderInsite blog.