What Black-Scholes-Merton modelling inputs should be considered when valuing early-stage enterprises for financial reporting

BVWire–UKIssue #11-1
February 4, 2020

valuation methods & approaches
early stage companies, black scholes option pricing model

Option price models help analysts project values, particularly when assets have little history or highly volatile future outcomes. BVWire—UK has spoken to an increasing number of business valuers who employ Black-Scholes or other models, particularly for financial reporting purposes (one reader commented that, ‘if I included an OPM analysis in a fiscal valuation, Treasury would just send it back,’ so clearly the practice is not universal).

Valuers who are interested in these approaches will enjoy the article on calibration of valuations, written by Alvarez & Marsal’s Neil Beaton, and Andreas Dal Santo and Antonella Puca, both of the BlueVal Group. The article originally appeared in the March 2019 issue of Business Valuation Update.

Beaton, Dal Santo, and Puca focus primarily on five inputs business valuers could use to assess the value of prerevenue or early-stage assets, and they build a number of examples in their study so that analysts can see the impact of typical estimates:

  1. Volatility of the enterprise value. This can be estimated based on the volatility of guideline companies, with adjustments to account for the risk profile of the enterprise based on an industry/sector analysis.
  2. Exercise price. Multiple exercise prices are determined based on the waterfall embedded in the company’s capital structure, which in turn depends on the contractual rights of the various classes of securities. The authors point out that two classes or more are common.
  3. Time to exit. This input represents the expected timing of an exit event (one case study, for instance, estimates the time to exit at three years from the measurement date).
  4. Risk-free rate. This input is often based on the yield of U.S. Treasury securities with a matching term.
  5. Dividend yield. Equity securities of early-stage enterprises do not typically generate cash dividends, but, when they occur, value can be significantly increased.
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