ALLOCATION OF ENTERPRISE VALUE USING THE OPTION-PRICING METHOD: TREATMENT OF DERIVATIVES ON COMMON STOCK
by Neil J. Beaton and James K. Herr
The following article was published in the BV Update Newsletter in October 2007. It addresses the inclusion of in-the-money and out-of-the-money stock options in the option-allocation model as referenced in Chapter 4.
Abstract: The AICPA practice aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation was issued in April 2004 following two years of collaborative effort by members of the Big 4 and other top accounting firms, business valuation experts, academics, and legal and venture capital practitioners. This work was supported by the AICPA, the FASB, and the SEC. Although considered comprehensive and cutting edge at publication, in hindsight, it only provides a rudimentary examination of the various allocation methods for purposes of enterprise value allocation. Based on over three years of subsequent experience and additional research, coupled with the opportunity to have reviewed numerous reports prepared by a wide variety of valuation firms from the sole practitioner to the Big 4, this article sets forth an appropriate methodology for including outstanding options and warrants on common equity when one uses the option-pricing model for allocating enterprise value1 among different classes of stock.
With the introduction of the American Institute of Certified Public Accountants’ (AICPA) practice ...