advanced valuation analytics. authority for valuing options statement of financial standards no....
TRANSCRIPT
Advanced Valuation Analytics
Equity-based Compensation For S Corporations
Barry GoodmanCFA, ASA, CPA/ABV, CBA, CFP
Advanced Valuation Analytics, Ltd.
Advanced Valuation Analytics
Authority For Valuing Options• Statement of financial standards no. 123.• Issued in October, 1995.• Assume fair value for accounting purposes.
Advanced Valuation Analytics
Two Methods Used To Value Stock Options
• Black - Scholes model• Binomial model
Advanced Valuation Analytics
General Factors Used To Value Options
• Price of the underlying stock• Adjustment for dividends• Exercise price• Risk-free rate of return• Expected life of the options• Volatility of the underlying stock
Advanced Valuation Analytics
Price of the Stock
•What about the esop stock price?•Adjustment for marketability.
Advanced Valuation Analytics
Adjustment for Dividends• Dividends not received until options exercised.• Generally considered to be the present value of the
dividends to be paid through the expected life of the dividend.
• Can be hard to estimate.
Advanced Valuation Analytics
Risk-free Rate of Return• FAS 13, paragraph 19:
• “For options that a U.S. entity grants on its own stock, the risk-free interest rate used shall be the rate currently available on zero-coupon U.S. government issues with a remaining term equal to the expected life of the options.”
Advanced Valuation Analytics
Expected Life of the Options• This is very subjective. FAS 13 includes the following
factors to consider:• The vesting period of the grant. The expected life must at least include the
vesting period. In addition, if all other factors are equal, the length of time employees hold options after they first become exercisable may vary inversely with the length of the vesting period. For example, employees may be more likely to exercise options shortly after the options vest if the vesting period is four years than if the vesting period is only two years.
• The average length of time similar grants have remained outstanding in the past.
• Expected volatility of the underlying stock. On average, employees may tend to exercise options on highly volatile stocks earlier than on stocks with low volatility.
Advanced Valuation Analytics
Volatility• In general, high volatility will result in a higher value of an
option.• For non-public companies, no volatility factor is used.
Advanced Valuation Analytics
Effect of Plans on Value of Stock
• Based upon FAS 123, an expense is measured pursuant to the stock-based compensation.
• An expense reduces operating income, ebit, and ebitda.• An expense does not always reduce operating cash flow
unless the estimation of cash flow is based on ebitda.
Advanced Valuation Analytics
Stock Options-Dilution• When the option is granted, assuming that the exercise
price is equal to the stock price, there should be no dilution.• Additional shares that could be issued are considered, but:
• The value should be increased by the capital contribution to be received by the company upon the exercise of the options.
• There is potential dilution if and when stock price increases from the date of the grant.
Advanced Valuation Analytics
Stock Option Expense• Does not directly affect cash flow.• Does threaten dilution in the future.• What adjustment might be made to ebitda and/or
operating cash flow for valuation purposes?• Is the expense level in any one year considered to be
non-recurring or unusual in amount?
Advanced Valuation Analytics
Phantom Stock and SARs
• Both are cash-based compensation that will ultimately result in a reduction of operating cash flow.
• Unless the amounts are judged by the appraiser to be non-recurring and/or unusual, EBITDA and cash flow will be reduced for valuation purposes.
Advanced Valuation Analytics
Restricted Stock
• Does not directly affect cash flow.• It is dilutive and will therefore negatively impact on the
value per share.