Option pricing modeling more challenging in certain arenas

BVWireIssue #99-4
December 22, 2010

During last week’s webinar "The Use and Application of Option Pricing Modeling" James Walling (Grant Thornton) and Scott Beauchene (Strategic Value Group) advised listeners on the current state of option pricing models and their appropriateness and applicability to certain valuation scenarios.  “When using OPM, not only do you need to know and understand the model you are using, but you need to think about the industry. Does the model fit?” asks Walling. “You also have to consider the stage of the company and how that stage will impact the outcome.” Certain industries, stage companies and capital structures make using the OPM methodology more challenging:

  • Biopharma
    • Very long investment cycles
    • Binary nature of outcomes
    • High event risk makes price evolution very "jumpy"
  • Cleantech
    • Same reasons a Biopharma
  • Early stage companies (Series A or earlier)
    • High common ownership relative to preferred liquidation preference
    • Similarity of risk profiles
  • Common "friendly" capital structures
    • 1x liquidation preferences
    • Preferred is non-participating

Beauchene emphasized that appraisers need to understand the inputs they use in their models. “If we want to add more value to our clients, we need to step up the analysis of our inputs and assumptions and what they are doing to the models, rather than just relying on the results,” he believes.

Please let us know if you have any comments about this article or enhancements you would like to see.