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The category of early-stage companies includes startup companies, which have an initial concept, design, or business plan but, not an actual product, as well as multibillion-dollar companies with significant revenue and operations that have yet to reach profitability. The valuation of an early-stage enterprise (ESE) is based on a mix of quantitative analysis, people insight, and intuition for the company’s growth prospects. In spite of their diversity, ESEs have unique characteristics as a group that warrant special consideration in valuation. Antonella Puca provides an overview of the valuation of early-stage companies and their equity securities using the Black-Scholes-Merton option pricing model (BSM OPM). We’ll provide examples of how to build and apply a BSM OPM to value preferred stock, common stock, and convertible bonds in an early-stage company based on the price of the latest preferred stock round (backsolve method). We’ll also provide examples of how to best reflect dividend and participation rights in the model and how to conduct a delta partition analysis to estimate the volatility of specific classes/series of equity interests in the company.
Program Agenda
Introduction: Overview of valuation approaches for early-stage companies under the fair value standard (ASC 820/IFRS 13).
Black-Scholes-Merton OPM as it applies to early-stage companies: Key inputs and valuation challenges.
BSM OPM v. binominal OPM v. Monte Carlo simulation: How to choose?
Case Study 1: Sample OPM application to the valuation of preferred stock in a complex capital structure.
Participation and dividend rights in a BSM OPM.
Case Study 2: Valuing convertible bonds under the BSM OPM method.
Case Study 3: Delta partition analysis to estimate common and preferred stock volatility.
Learning Objectives
Develop and interpret an option pricing model under the backsolve method for an ESE with a complex capital structure;
Demonstrate how participation and dividend rights affect the valuation of preferred and common stock in an OPM model;
Apply delta partition analysis to estimate volatility for specific classes/series of equity interests in a complex capital structure; and
Discuss the advantages/limitations of the Black-Scholes Merton OPM model as compared to binomial OPM and Monte Carlo simulation in the valuation of early-stage companies.
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