Valuing Securities Using the Option Pricing Method

Frank Kiepura, CPA/ABV

The option pricing model (OPM) is a popular and commonly used model to allocate equity value to securities in the complex capital structures of privately held companies. Given the absence of active markets for privately issued securities, one of the challenges that valuation specialists face is determining how to allocate value to each specific security in the capital structure. Although the OPM is one of the more common methods, choosing it as the optimal allocation technique is dependent on certain characteristics of the company. The OPM is most appropriate for companies with longer liquidity event timelines and access to a variety of exit options; the model also works well in valuing option-like payoffs (e.g., common stock options and warrants). Using an example of a complex privately held company, the author constructed a hypothetical capital structure that incorporates the characteristics associated with choosing the OPM. The results are analyzed with respect to the Black-Scholes option pricing model and how changes to its parameters can affect allocations of value.