Valuing Early Stage and Venture Backed Companies

Appendix B

VOLATILITY IN THE OPTION-PRICING MODEL

By Neil Beaton, Stillian Ghaidarov, and William Brigida

 

 

The following article was published in Valuation Strategies in November 2009. It explores capital structure volatility in the option allocation model as referenced in Chapter 4.

INTRODUCTION

This article explores and expands on the concept of volatility in the option-pricing method (OPM) as applied in the allocation of enterprise value in early stage companies with complex capital structures. The sophistication of the OPM as applied to early stage companies has increased considerably over the past five years since the AICPA’s Practice Aid on the Valuation of Privately-Held-Company Equity Securities Issued as Compensation (Practice Aid) introduced the model to a wide audience. The Practice Aid was primarily a high-level guide in the valuation of early stage companies. Its authors recognized the limitations of that early work and encouraged readers to go beyond the rudimentary principles contained therein. There have been a number of articles published since 2004 that have endeavored to do just that. This article continues in that vein pending the publication of the updated Practice Aid that is expected in late 2009 or early 2010. In addition, this article will be expanded upon in a book that is to be published by John Wiley & Sons, Inc. in late 2009.

The specific focus of this article is to provide a review of the volatility assumption in the OPM, and to highlight several ...