When is Preferred Stock / Convertible Instruments Valuation required?

Preferred Stock / Convertible Instruments is required when a company has complex instruments like CCPS, OCPS etc. The first step in valuing a company with complex capital structure is to value the company itself using a combination of the Income, Market and Asset approaches depending on its Nature and Stage of Business, Business Model, Purpose of Valuation etc.

The second step is to allocate the value of the company among different classes of securities like Equity Shares, CCPS, OCPS etc. (including their different series). It is important to understand terms of each of the series of securities including the conversion option, liquidation preference, participation in profits etc.

Approaches and Methodologies for Preferred Stock / Convertible Instruments Valuation?

The Backsolve OPM is a form of market approach which derives the implied equity value for one type of equity security (Common Stock) from derived value of another form of equity security (Preferred stock).

In this method, each share class only has value if the funds available for distribution to shareholders exceed the value of the liquidation preferences at the time of a liquidity event for each of the prior share classes in a company's cap table.

Break points are created in this model (based on the claim each security has in company) and then each class of security is valued as a call option using Black Scholes OPM. The incremental call option value is then allocated amongst each breakpoint. based on the relative liquidation value and thereafter based on the outstanding no of shares.

OPM Inputs

The OPM relies on following inputs:

• the total equity value of the enterprise
• expected time to exit
• expected risk-free interest rate as of the valuation date
• expected volatility derived from similar publicly traded companies
• expected dividend yield

 

Exercise price of each breakpoint is based on liquidation preferences and conversion value of different securities. Incremental call option at each breakpoint is then allocated based on no of outstanding securities.

 

The Equity value of company is computed (by trial and error) such that the value of recent preferred stock investment equals the price paid for such investment as per the backsolve method

 

According to the AICPA, the backsolve is the most reliable indicator of enterprise value for early-stage customers, provided the following:

 

• transactions in the enterprise's shares have occurred at arm's length
• the most recent transaction occurred within ninety days of the date of valuation date.

Our Preferred Stock / Convertible Instruments Valuation Practice

We have a specialized team which comes in a league of one of the best Convertible Instruments Valuation Consultants and have carried out about 100 convertible instruments Valuations. We assist our clients in allocating the value of company into complex instruments after thorough analysis of the terms and conditions of each instrument and their preferences. We provide well-reasoned and defensive valuation reports for commercial purposes and Valuation certificates for regulatory compliance purposes. Corporate Professionals has the experience and commitment necessary to provide practical and timely services as a Transaction Valuation Advisor in India