We recently reported that option models—including the commonly used Black Scholes method—may become more common as the courts, the IRS, and the SEC increase emphasis on empirical evidence and the prevalence of fair value accounting standards (see, “Are option models the future of discounts and valuation?” in BVWire #85-2).
But, a new analysis from SVB Analytics challenges the widespread application of the Black Sholes option pricing model, at least to the valuation of early-stage, VC-backed companies.“We decided to take a harder look at the data, as it relates to venture capital-backed technology and life science companies," say James Walling and Cindy Moore of “Does Black Scholes Overvalue Early Stage Allocations?” in the current (Jan. 2010) Business Valuation Update™.

What the data shows: “The reality for early-stage companies differs materially from the model that the industry relies upon to allocate the value of companies, particularly to the common shares,” Walling says. Because many valuation practitioners and auditors apply Black Scholes as the default model, “we are concerned that the common equity of many early-stage firms has been mis-valued over time.”

We’ve posted the full article as a new free download from BVResources; pushback from the auditing and appraisal community is expected. Email your comments (anonymous or attributed) to the ‘Wire, and we’ll feature them in a future issue.