Management is responsible for appropriately valuing complex securities for audit, general reporting and tax purposes. Proper fair value estimates require selecting the most appropriate valuation model—a topic that has received increased scrutiny from regulators and investors in recent years.
VRC’s Complex Instruments Group is a team of seasoned professionals who help clients determine fair value estimates and lower the risks of late filings, restatements, delays and additional cost associated with SEC comment letters. We bring deep experience valuing a wide range of complex securities, including credit/debt instruments, derivatives, equity and structured products.
Complex securities are typically rich in economic features and closely linked to an equity, debt or hybrid instrument. Many include features that alter cash flows over the life of the security, such as options, return multiples or thresholds, and/or specific IRR and price-performance targets. In corporate settings, securities with these characteristics are often created as part of incentive compensation, corporate transactions, capital raises or external financing activities.
We assist a wide range of clients with complex-securities valuations, including public and private corporations, asset managers, private equity funds, hedge funds, endowments, public and private pension plans, fund administrators and business development companies. Engagements often arise from needs relating to:
- Early- or development-stage companies
- Share-based payments including equity compensation awards (ASC 718)
- Derivatives and hedging instruments (ASC 815)
- Nonqualified deferred compensation plans (IRC Section 409A) and related tax scenarios
- Other hard-to-value financial instruments and arrangements such as earnouts
Our team of experts applies sophisticated financial modeling techniques appropriate to each security. Complex securities generally require a mathematical model based on a numeric method, rather than a closed-form approach, as it’s necessary to capture each instrument’s unique features. Securities with price-path dependency are generally suited for Monte Carlo models. Those with “early exercise” features are typically well-suited to lattice models.
Fair value estimates for credit and/or debt securities must account for the economic features of these securities that may shape future cash flows. For example, convertible bonds are well-suited to lattice models that consider how multiple features – such as issuer call or soft-call options, holder conversion or put options, make-whole triggers and other early settlement features – interact.
Other credit and/or debt securities that often include dependent-state features include floating and fixed-rate loans, first- and second-lien loans, and secured and unsecured mezzanine debt.
Derivatives (ASC 815)
Derivatives are widely used to provide hedging or flexibility in investing. Under Accounting Standards Codification 815 (ASC 815), financial reporting must recognize derivatives and hedging activities as either assets or liabilities and express their fair values.
VRC’s Complex Instruments Group brings a deep understanding of both underlying assets and the terms of derivative contracts. Our specialized modeling process applies Monte Carlo or lattice methods, as appropriate, to value these instruments on a supportable basis.
In private contexts, VRC’s Complex Instruments Group values complex securities with economic rights relating to preferred stock, warrants and LLC profit interests. We apply option pricing, taking into account specific capital structure and distribution rights.
For public companies, we apply complex modeling to stock options, restricted stock and other share-based compensation. For example, we apply Monte Carlo analysis to establish the current fair value of Total Shareholder Return (rTSR) plan obligations with vesting features incorporated into the model.