A Layperson’s Guide to the Option Pricing Model, a popular whitepaper by Travis W. Harms, CFA, CPA/ABV, Senior Vice President of Mercer Capital, was recently referenced in a PitchBook article on the overvaluation of unicorn companies.
The article, “Why unicorns are overvalued (and the industry knows it),” discusses a recent academic study (referenced by Travis in a blog post early this fall) that explored how unicorns are overvalued at 50% of their fair value, which could ultimately create valuation issues for future transactions as well as compensation issues for lower-level employees of different share classes.
Industry professionals seem well versed in the valuation distinctions. Mercer Capital, for instance, recently published a white paper on using the option pricing model to “reliably estimate the value of different economic rights in complex capital structures.”
They admit, however, that this strategy cannot account for certain riders such as “differential voting rights, price protection or ratchet provisions, drag-along and tag-along rights, pre-emptive rights,” as well as “complex anti-dilution provisions, including guaranteed minimum returns in the event of an IPO that go beyond the protections offered by traditional price ratchets.”
All that sounds hard
And it is. Mercer Capital recommends making a “discrete adjustment” to valuation estimates when these rights are present; 409A tax valuations also tend to offer a truer picture of actual value, but they’re done with the idea of lowering tax burdens.
Travis W. Harms leads Mercer Capital’s Financial Reporting Valuation Group. Travis’s practice focuses on providing public and private clients with fair value opinions and related assistance pertaining to goodwill and other intangible assets, stock-based compensation, and illiquid financial assets. He also contributes regularly to Mercer Capital’s Financial Reporting Blog.
Mercer Capital provides independent valuation of stock options, restricted stock units, stock appreciation rights, and other equity-based compensation awarded to employees. For more specific information related to financial reporting valuation and consulting services, feel free to reach out.