Complex Securities: Technology

Challenge: 

A private equity sponsored cloud based provider of manager content, enterprise lending services (including product eligibility and pricing, secondary marketing, consumer engagement, data and analytics and compliance services) granted certain management incentive units to participating executives, as compensation to incentivize management performance. As a result of the grant, the capital structure of the provider consists of growth debt obligations (1st and 2nd liens) and equity infusions (Class A, Class B, Class C, Class D, Class E and Class E options). Each class of stock has its own specific terms, preferences, and rights. In order to comply with the financial reporting requirements of ASC 718, the provider engaged VRC to determine the fair value of the issued units (Class D stock and Class E options).

Solution: 

Our analysis involved first establishing the aggregate equity value of the provider by employing the backsolve method on the recent equity investment (assumed to be reasonable indication of the aggregate equity value). The backsolve method utilizes the rights and preferences of each security and their ability to participate in the distribution cash flow at the time of an exit or other liquidity event.

Given the complexity of the capital structure (different tranches of debt and various classes of stock), a Monte Carlo Simulation analysis was applied to allocate the concluded aggregate equity value to all the units in the capital structure. The resulting allocated values represent the fair value of the units.

VRC’s Monte Carlo Simulation analysis considers the specific rights and preferences of the various securities, and at what price / value the respective security would participate in the overall value of the provider.