Abstract

Valuation engagements for businesses with complex capital structures offer unique challenges to the valuation analyst. Complex capital structures frequently accompany a relatively high level of uncertainty surrounding the prospects of the subject company, and determination of enterprise value will almost certainly require techniques beyond those sufficient for valuing established companies. Moreover, once enterprise value has been determined, valuation of the various components of the capital structure will present additional challenges. The purpose of this article is to demonstrate the strengths (and limitations) of the option-pricing method (used in conformance with the AICPA's “Valuation of Privately-Held-Company Equity Securities Issued as Compensation”) in allocating enterprise value between the various components of a complex capital structure. We demonstrate that binomial lattice models have enormous flexibility and can be tailored to accommodate virtually any feature or attribute typically found in employee stock options, warrants, and convertible securities. We also explain circumstances where the option-pricing method should be combined with simulation modeling in order to impound and value certain features of complex capital structures.