Complex Securities Valuation: Navigating Turbulent Waters

Complex securities valuation can be a challenging field. Developing an understanding of baseline fundamentals, gaining repetitions, mastering the development and vetting of sound valuation models, technical writing, developing the efficiencies necessary to meet challenging delivery timelines and avoid unnecessary cost overruns, supporting and defending valuations, ensuring smooth audit review processes — no matter the task, there is no shortage of possible pitfalls. Often, complex securities valuation needs are identified with limited timelines for delivery and involve little margin for error. Further, these instruments and their valuation methodologies and mechanics can range from confusing to overwhelming for the uninitiated, and the uninitiated often includes the intended users of the valuations (typically, C-suites and controllers). Lastly, since each financial instrument is unique and involves professional judgment, it is unusual to find clear and prescriptive guidance on valuation methods, and it can be challenging to ensure alignment between valuation specialists.

At the outset, it is critical to ensure an aligned understanding of the engagement’s use case and timeline, the instrument’s key features, the fact pattern leading up to the instrument’s issuance, and the intended methodology and key simplifying assumptions for the valuation. A failure to understand the contextual background regarding the subject instrument’s issuance, negotiation, and execution can easily lead to a failure to identify and consider key elements of the instrument’s value. These may include contingent payoffs or outcomes, embedded options (call, put, convert, exchange, etc), and other hidden drivers of value. Engaging in discussions with our clients and their advisors to ensure an understanding of the instrument, as well as the primary and plausible outcomes, is key to a sound valuation process.

During the production and review phases of the project, it is valuable to bring deep experience and expertise to bear. Often, the value of complex financial instruments is not observable, and there is no price discovery (particularly, if they were not transacted recently and at arm’s-length). The valuations are typically quite sensitive to multiple unobservable inputs requiring professional judgment. This is where experience is valuable. While each financial instrument is unique, we do identify patterns and similarities in many cases. Often, we are able to break down a complex instrument into simpler parts, leveraging our experiences and past successes with valuing similar instruments and/or components. Ultimately, it is critical to apply such experience to ensure reasonableness of the methods, inputs, and conclusions of the valuation, and to be able to clearly and effectively communicate the same to our clients and their auditors.

CFGI’s complex securities valuation team’s mission is to serve and assist our clients to the maximum possible extent with achieving their goals and objectives. In most cases, our clients’ goals and objectives include completion of their financial statement audit and the receipt of their audited financial statements, in a timely and cost-effective manner. These objectives may vary, however, and include tax, management planning, gift and estate, litigation, or transaction-related goals. While there are certain exceptions, the primary avenue by which we assist our clients with achieving their goals and objectives is through valuation deliverables (reports and/or exhibits).

We strive to provide deliverables which are:

  • Accurate and reasonable: We aim to employ a reasonable methodology, which contemplates (i) all salient contractual terms, conditions, and economics, (ii) all reasonably possible outcomes, and (iii) considers all salient risk factors. These methodologies may include Monte Carlo simulations, probability-weighted expected return (“PWERM”) or scenario-based methods (“SBM”), binomial lattice models, variations of Black-Scholes models, discounted cash flows, and code-based solutions. We proactively search for and resolve inappropriate assumptions and mechanics, calculation errors, and other potential barriers to the delivery of accurate and supportable valuations. We aim to ensure upfront alignment with our clients’ auditors regarding the proposed approach and methodologies to minimize the risks of late filings, restatements, delays, and cost overruns.
  • Comprehensive and informative: We aim to provide valuation deliverables that include all salient information necessary for both informed and uninformed readers to understand (i) the instrument and key background information regarding its negotiation and issuance, (ii) the methodology being employed and rationale for the same, (iii) the mechanics being employed in the model and our rationale for the same, and any key deviations from standard practices, and (iv) the key input assumptions being employed in the model and our rationale for the same.
  • Clean: We aim to provide valuation deliverables that are neat, visually appealing, and consistent with CFGI marketing materials, free of typos and grammatical errors, and easy to follow for both informed and uninformed readers. While more information is nearly always preferred over less information, we want to minimize clutter and ensure the reader’s ability to follow the salient points, support, and conclusions.
  • Timely: We aim to execute our valuations in a workmanlike manner and to deliver our valuations on schedules that (to the best of our ability) empower our clients to meet their financial reporting, tax, or other deadlines. We have a deep bench of talented and experienced professionals who specialize in complex securities valuations to ensure the ability to get projects started and completed quickly.

Feel free to reach out to us with your complex securities valuation needs, which may include but are not limited to:

  • Equity Instruments and Classification
    • Complex Capital Structures
    • Non-controlling Interests and rollover interests
    • MIUs, Profits Interests, Phantom Stock, TSR awards, etc
    • Options/warrants with ratchet and other unique provisions
  • Liability Instruments and Classification
    • Tranche obligations to purchase additional preferred shares
    • Options/warrants with ratchet and other unique provisions
    • Convertible debt valuation (embedded derivatives, extinguishment/modification)
    • Earnouts and contingent consideration (including claw-back and holdbacks)
    • SPAC private warrants, founder shares and Forward Purchase Agreements (FPAs)
    • SPAC Royalty Agreements
    • Put/Call arrangements
  • Miscellaneous
    • Carried Interest vehicles
    • OTC Derivatives including Interest Rate Swaps with Credit Value Adjustments (CVAs), Futures, Forward Rate Agreements (FRAs), Swaptions, Energy Derivatives & Contracts
    • Hedge Effectiveness Testing (ASC 815)
    • Fixed Income including floating-rate debt, callable/puttable bonds, etc.
    • Structured Products including ABS, MBS, CDO, CLO, CMBS, etc.
    • Incremental Borrowing Rates (ASC 842)
    • Loan Guarantees and Loan Portfolios
    • Simple Agreement for Future Equity (SAFE)
    • Internal Rate of Return support for litigation purposes
    • Consumer receivables portfolios (unsecured, retail / point-of-sale, auto, cell phone, and other financing vehicles)
    • Ad-hoc requests including appropriate discount rate conclusions, volatility analysis
    • Model validation projects

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