Valuation of pre-IPO Equity Interests
3rd Semester, Course Code: ΜΕΧΤΕ305
Credits: 7,5
Learning Outcomes
Valuation of pre-IPO equity interests with Various Numerical Methods & Option Pricing Techniques comprises a 13-week course focusing on the applications of modern quantitative valuation advisory financial models in order to deal with the complexities of multi tranche capital structures, mark to market valuation requirements for private equity investments, dynamic asset pricing of plain vanilla awards or more sophisticated awards with exotic option pricing features as well as the implementation of various numerical methods & closed form or open ended option pricing techniques in order to derive fair value considerations that are acceptable for financial reporting or tax requirements. The fundamental goal of this course is to (i) provide an overview of the various types of capital structures/equity securities/management equity awards that are part of complex business transactions that are performed by the biggest institutional investors in the world (ii) provide a deep insight in all the quantitative valuations tools utilized for standard or more dynamic asset pricing (iii) provide thought leadership content in terms of appropriateness/limitations/challenges of the various approaches and a hands on experience in real world capital investment processes, risk evaluation and attribution analysis, optimization assessment, relative value bifurcation analysis and the foundations of optimal investor behavior with practical applications (iv) present case studies with the valuation of complex pre-IPO equity interests and the application of various approaches contemplated within the duration of the course.
General Competences
- Search for, analysis and synthesis of data and information, with the use of the necessary technology
- Decision making
- Working independently
- Team work
- Working in an international environment
- Production of new research ideas
- Production of free, creative and inductive thinking
Course Content
- Section 1: Quantitative Option Pricing Techniques
- Option Pricing Method – Combination of call options calculations based on the relative risk characteristics, contractual economic rights and privileges of the various equity classes as well as certain market participant and company specific assumptions.
- Current Value Method – Assumes an imminent liquidation event and the distribution mechanics follow the contractual economic rights and privileges assuming acceleration of vesting of equity awards upon the satisfaction of predetermined vesting conditions.
- Probability Weighted Expected Return Method – Involves estimating expected future potential liquidation events of a company and weighting them by the probability of each scenario occurring accounting for the uncertainty of the future cash flows of the company. An assessment of different risk profile & return characteristics or waterfall economics is necessary depending on the type of liquidity events.
- Hybrid Methods – Combine multiple valuation techniques that cover the potential spectrum of the exit strategies of companies under consideration and a modeling application of various economic payoffs in order to derive fair value considerations that are consistent with the market participants view as of the measurement date or the date of the consummation of a contemplated transaction.
- Section 2: Discounts for Lack of Marketability/ Lack of Control
- Quantitative Put Option Methods based on the Chaffee, Longstaff, Ghaidarov, Finnerty or Asian Protective Put Option. – Estimate the risk profile of each equity instrument with specific option pricing assumptions and infer a specific discount relative to primary equity securities based on a combination of different parameters.
- Benchmark Studies: Multiple theoretical empirical studies across different time windows and different specifications within specific range estimates depending on the stage of the company, type of transaction etc.
- Other Approaches: Quantitative Marketability Discount Model (QMDM), Nonmarketable Investment Company Evaluation (NICE) etc.
- Section 3: Dynamic Optimization Techniques
- Multi-step Monte Carlo Simulation with various correlated variables: Simulation of various variables in a correlated way and an application of different risk adjustments depending on the risk profile of the underlying metric – application of size adjustments or market participant characteristics for calibration purposes – illustration on antithetic variate techniques and standard error minimization procedures.
- Least Square Monte Carlo Simulation: Dynamic simulation technique to calculation optimal payoffs of embedded derivatives either conditional or mutually exclusive.
- Optimal Foresight Techniques: Dynamic simulation techniques that involve perfect foresight assumptions and valuation of exotic-like option structures or more sophisticated embedded derivatives.
- Section 4: Standard Valuation Practices/Calibration/Backtesting
- Calibration: Case study illustration with calibration of fair value indications to cash considerations or purchase consideration in connection with contemplated transaction
- Mark to Market: Overview of valuation procedures for purposes of marking to market subject equity interests as part of financial reporting requirements for the biggest asset managers, private equity funds.
- Backtest/Roll Forward: Various consideration for adjustments of Income/Market Approaches when initiating fair value measurements or rolling forward valuation models
Student Performance Evaluation
For the overall students’ evaluation there is a final exam (70% of the final grade) which contains numerical problems based on real case studies and a combination of different valuation techniques.
Homework assignments (30% of the final grade)
Bibliography
Suggested Bibliography
- Hull, J. (2014) Options, Futures and Other Derivatives. 9th Edition, Prentice Hall, Upper Saddle River
- Pietro Veronesi. Fixed Income Securities: Valuation, Risk, and Risk Management
- Principles of Corporate Finance, 11th edition, Allen, Myers, and Brealey, 2013
- Applied Corporate Finance, 4th Edition, Aswath Demodaran
- Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Shannon P. Pratt, ASA Educational Foundation (McGraw Hill), 2022
- Principals of Private Firm Valuation, 1st Edition, Stanley J. Feldman
- Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies – Accounting and Valuation Guide, American Institute of CPAs
- Benninga, S. And Mofkadi, T. (2022). Financial modeling, 5th Edition, MIT press
- Ang. James S. (1992) On the Theory of Finance for Privately Held Firms. Journal of Small Business Finance, 1 (3), 185-203
- Jenkinson Tim, Miguel Sousa, & Rudiger Stucke. ”How fair are the valuations of private equity funds?.” Available at SSRN 2229547 (2013)
- PE/VC Task Force (2018). Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies, AICPA Accounting and Valuation Guide
- Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economy, 81(3), 637-654
- Robert Merton. (1973) The Theory of Rational Option Pricing. The Bell Journal of Economics and Management Science, 4 (1), 141-183
- Antoniades H. & Michopoulos I. (2020). A Roadmap for the Valuation of Pre-IPO Equity Interests. Stout Website: https://www.stout.com/en/insights/article/roadmap-for-the-valuation-of-pre-ipo-equity-interests
- James J. Diamond. (1967) Earnings Distribution and Valuation of Shares: Some Recent Evidence. The Journal of Financial and Quantitative Analysis, 2 (1), 15-30
- Antoniades H. & Michopoulos I. (2019). Valuing Equity Interests in Complex Capital Structures. Stout Website: https://www.stout.com/en/insights/article/valuing-equity-interests-common-valuation-approaches & https://www.stout.com/en/insights/article/valuing-equity-interests-case-studies
- John H. Cochrane. (2005) The risk and return of venture capital. Journal of Financial Economics, 75 (1), 3-52
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