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PWERM & hybrid methods

The allocation of equity value using the Option Pricing Method to multiple stock classes in businesses with complex capital structures was covered in our newsletter article, “Allocation of Value to Multiple Classes of Equity Shares in a Company.”
Although the option pricing method is more scientifically sound than other approaches, it is a complex and time-consuming process. In some instances, the costs associated with the OPM allocation exercise may outweigh its advantages. Experts have also pointed up some fundamental weaknesses in the OPM.
The OPM’s assumption that the future equity values of the company will be lognormally distributed is one of its significant drawbacks. This presumption might not hold for early-stage businesses, which have a high chance of failing.
As a result, the OPM may exaggerate the value of the equity of early-stage enterprises. The need for alternative allocation procedures results from this.
The International Valuation Standards Council’s (“IVSC”)”) International Valuation Standard 200 (“IVS”) and 200 Alternative Methodologies for Allocation Exercise are covered in this newsletter. They can be summarized into the following:
Probability weighted expected return method (“PWERM”)
Current value method (“CVM”)
Hybrid methods
Every technique covered in the newsletter series has advantages and disadvantages. One method cannot be singled out and declared superior to the others. The OPM and PWERM are frequently used in everyday life, sometimes in tandem (hybrid). The case’s facts and the intricacy of the related structures must be considered while choosing a methodology.