A Layperson’s Guide to the Option Pricing Model

The option pricing model is often used to value ownership interests in early-stage companies.

  • Developed in response to the need to reliably estimate the value of different economic rights in complex capital structures, the OPM models the various capital structure components as a series of call options on underlying total equity value.
  • Through a detailed example, we explain key concepts including breakpoints and tranches in a straightforward and non-technical way, taking the mystery out of OPM terms such as “breakpoint” and “tranche”.
  • Relative to the probability-weighted expected return method, the principal strengths of the OPM include the small number of required assumptions and auditability. The PWERM, in contrast, offers greater flexibility and transparency.

The whitepaper closes with some thought on reconciling OPM results with the market participant perspective.