Why is Coverage Ratio important?
Challenging private market conditions over the past 18 months have resulted in many private company valuations falling significantly below the last round valuation, and in some cases so low that common equity holders would receive nothing if the company were to be acquired at the current market cap.
On top of this, many late stage companies (particularly those raising funding at a discount to previous rounds) are forced to grant preferred shareholders very generous preferences that reduce returns for common shareholders in a M&A exit.
These market trends are difficult for all common shareholders, but in particular for employees who may have a significant portion of compensation in the form of common equity, and must make consequential decisions about exercising their common stock options if they leave the company.
To help employees address these challenges, Notice has developed new data and tools that can help them understand the ability of a company to return capital to its common shareholders in certain liquidity scenarios.
How is Coverage Ratio determined?
Coverage Ratio is a measure of a company's current ability to return capital to common shareholders at the current market capitalization in an exit scenario where all share classes did not convert to common stock (eg. M&A exit)
Coverage Ratio "X" = Current Real-Time Market Cap / Total Capital Raised
Coverage Ratio < 1: Company is currently worth less than total capital raised, and is therefore at high risk of being unable return capital to common shareholders in the event of a M&A exit at the current market cap.
Coverage Ratio > 1: Company is worth more than total capital raised, and is therefore likely able to return some capital to common shareholders in the event a M&A exit at the current market cap. Note that the farther Coverage Ratio rises above 1, the more likely the company is to be able to return capital to common shareholders in an M&A exit at the current market cap. Coverage Ratio just over 1 suggests more risk for common equity holders than a Coverage Ratio far above 1.
Notes
Coverage Ratio does not consider company debt, cap structure or specific investor preferences, and is therefore a "best case" estimate of a company's ability to return capital to common shareholders under an M&A exit scenario at current market cap.
Coverage Ratio does not factor in the likelihood, timing or structure of a future exit event, eg. IPO or M&A. It is just a snapshot of the present situation.
Coverage Ratio is based on Notice Price. Notice Price accuracy increases with private market activity, therefore Coverage Ratio will be most accurate for companies with high private market consensus.
How is Coverage Ratio used?
Coverage Ratio can be an important data point when researching companies and diligencing investments/equity grants.
Two examples:
You are deciding whether to exercise common stock options granted by your previous employer. Along with the exercise price and current common share price, you can consider Coverage Ratio to gauge the company's ability to return capital to common shareholders in the event of an M&A exit at the current market cap.
You are considering private companies from a specific industry category for potential investment. You consider which of the company stocks (all common class) can be purchased at the largest discount to previous round, and you also consider which companies have the the highest coverage Coverage Ratio, suggesting they are more able to return capital to common shareholders in the event of an M&A exit at the current market cap.
How does Coverage Ratio inform Riskiest Common Stock rankings?
We use the Coverage Ratio metric to rank companies on the Riskiest Common Stock rankings. Companies ranked high on this list (especially those with Coverage Ratio near or below 1) should be evaluated carefully due to increased high of the company not being able to return capital to common shareholders in an M&A exit at the current market cap.
