Early Stage Valuation

CHAPTER 9Allocation of Enterprise Value

In the preceding chapters, we have examined how valuation models under the income-, market-, and asset-based approaches can be used to estimate of the value of an early stage enterprise (ESE) under the fair value standard. This chapter focuses on how to allocate the enterprise value through the company's capital structure to estimate the value of a partial ownership interest in the company in the form of common or preferred stock. For a company that has a simple capital structure consisting exclusively of common stock with equal ownership rights, the unit value of common stock can be determined by dividing the enterprise value by the number of common shares issued and outstanding as of the measurement date. As the company grows into a more complex entity, with multiple layers of equity interests and debt, a methodology for the allocation of enterprise value to the various stakeholders in the company needs to be developed by taking into account the rights and privileges of the various types of ownership interests.

In this chapter, we distinguish three methods for allocating enterprise value and valuing equity interests in a company:¹

1. The Option Pricing Method (OPM). This method allocates the current equity value of the firm to the various classes of equity using option pricing models. We have discussed the OPM in Chapter 5 of this book as a method that can be used both to estimate equity value and to allocate equity value to individual ...