What is it really worth?
It’s the most important question in business. As a founder or CFO, you might know your company's total valuation. But what about that "convertible note" from your first funding round? Or the stock options (ESOPs) you promised your first engineer?
Those aren't simple shares. They are "complex securities," financial tools with special rules, triggers, and "what-if" clauses that make them incredibly tricky to price.
Here's the key: you can't just guess. Regulators, auditors, and new investors require you to have a precise, defensible value for every single one of these instruments in your financial statements.
This is where complex securities valuation comes in.
It sounds difficult, but it doesn't have to be. At My Valuation, our job is to turn that complexity into a clear, simple number you can trust. This guide explains exactly what these are, why they matter, and how they are valued.
Understanding the Field of Complex Securities.
Complex securities are financial instruments, or assets that have unique and often non-standard features. These instruments can result in non-standard payouts and are often structured with various elements to meet specific investment goals or risk profiles.
These types of assets are becoming very popular among corporates and startups for fund-raising, employee benefits, M&A transactions, and external financing. These complex securities often include financial derivatives or structured elements, which makes their valuation and risk assessment much more difficult. Valuation Services for these complex securities are therefore gaining importance for accounting, reporting, and taxation purposes, and they often have significant financial implications.
Some common examples of complex securities include:
1. Derivative Instruments
These are financial tools whose value is derived from an underlying asset, like your company's stock. Their value is all about probabilities and future events.
- Options(like ESOPs) : An Employee Stock Option (ESOP) gives an employee the right (not the obligation) to buy a share of company stock at a fixed price (the "strike price") in the future. Its value today depends on the chance that the company's stock will be worth more than that strike price.
- Warrants: These are very similar to options but are typically given to investors or partners as a "sweetener" for a deal (like a loan). They have a right to buy shares at a set price for a set time, and they must be valued.
2. Convertible Securities
These are instruments that can be converted into another type of security, most often common stock. The complexity comes from their "what-if" conversion terms.
- Convertible Notes (or CCDs): An investor loans you money. This loan (debt) has terms that say it will automatically convert into equity (shares) at your next qualified funding round. Its value is complex because it depends on a future, unknown event, and the conversion price is often at a discount or limited by a valuation cap.
- SAFEs (Simple Agreements for Future Equity): Popular in early-stage fundraising, a SAFE is a promise for future shares, not debt. Like a convertible note, its value is tied to a future funding round and its specific cap and discount terms.
- Preference Shares (or Preferred Stock): This is what most VCs get. These are shares with special rights, like a liquidation preference (they get paid first in a sale). They are a complex form of equity because they have terms that make them more valuable than simple common stock.
3. Structured Products
These are "groups" of various financial assets or derivatives. In the startup world, you can think of a complex funding round as a structured product.
- Preference Shares with Multiple Features: A "Series A" preference share isn't just one thing. It's a set of different rights. It might include: 1) a 1x liquidation preference, 2) participation rights (they "double dip"), 3) anti-dilution protection, and 4) conversion rights. Each of these features must be valued as part of the whole "package."
- Earnouts (in M&A): When a company is sold, the seller may get additional payments in the future if the company hits certain performance targets. This "earnout" is a complex security that must be valued at the time of the sale.
4. Hybrid Securities
These are instruments that blend the characteristics of both debt and equity.
- Convertible Notes (again): This is the classic hybrid. It acts like debt because it usually has an interest rate and a maturity date (if you don't raise money, you might have to pay it back). But it acts like equity because it's intended to convert into shares. Its dual nature makes it a perfect example of a hybrid.
- Mezzanine Debt: This is a type of financing that sits between senior debt and equity. It's often used by more established companies and typically comes with an "equity kicker," like attached warrants, making it a hybrid.
Why are Complex Securities Valuations required?
1. Risk Assessment
Complex securities often come with unique features and underlying assets, making it challenging to assess their associated risks. Valuation helps investors and financial institutions define the potential risks involved in holding or trading these securities.
2. Regulatory Compliance
Financial regulators and accounting standards often require the valuation of complex securities to ensure transparency and accurate reporting. Compliance with these regulations is essential for financial institutions and investment funds.
3. Investment Decision-Making
Investors need accurate valuations to make informed decisions about buying, selling, or holding complex securities. The valuation process provides insights into whether a security is overvalued, undervalued, or fairly priced.
4. Financial Reporting
For companies that hold complex securities on their balance sheets, accurate valuations are necessary for financial reporting purposes. This includes determining fair values for financial statement disclosure and compliance with accounting standards (e.g., International Financial Reporting Standards - IFRS or Generally Accepted Accounting Principles - GAAP).
5. Investor Confidence
Providing transparent and reliable valuations of complex securities enhances investor confidence. When investors trust the valuation process and the information provided, they are more likely to participate in the market.
6. Portfolio Management
Portfolio managers and fund managers need to value the various assets held within their portfolios, including complex securities. Accurate valuations help them assess portfolio performance, make allocation decisions, and manage risk.
Complex Securities Valuations Methodologies
How do we get the number?
We can't use a simple calculator because the payoffs aren't simple. We have to use special valuation models for financial instruments designed to handle "what-if" scenarios.
Here are the three most common models used by professionals:
1. The Black-Scholes Model
- What it is: A Nobel-Prize-winning formula originally designed to price stock options.
- Best for: Simple, "plain vanilla" options and warrants, like many ESOPs.
- How it works (Simply): It's a formula that takes 5–6 key "factors" to calculate the value of an option:
- The company's current stock price
- The option's "strike price" (the buy price)
- The time left until the option expires
- The "risk-free" interest rate (like a government bond)
- Volatility (the most important one: how much the company's stock price "wobbles")
2. The Binomial Model (or "Lattice Model")
- What it is: A more flexible, step-by-step model.
- Best for: More complex options, like those that can be exercised early (common with US-style ESOPs) or have changing features over time.
- How it works (Simply): Instead of one formula, this model builds a "decision tree." It maps out all the possible future paths the stock price could take (e.g., "In 6 months, it could go up 20% or down 15%"). By working backward from all those future possibilities, it finds the single fair value today.
3. The Monte Carlo Simulation
- What it is: The "heavy-duty" powerhouse of valuation.
- Best for: The most complex instruments, like convertible notes with multiple triggers, or securities whose value depends on two or three different, interacting factors.
- How it works (Simply): A computer runs thousands (or even millions) of "what-if" scenarios. It simulates the future path of the company's stock, interest rates, and other variables, all at once. It's like rolling the dice 100,000 times to see all the possible outcomes, and then it takes the average of all those results to find the most likely fair value.
Challenges in Complex Securities Valuation
This is hard to do, even for experts. This is why auditors and investors analyze it so much.
- The "No-Data" Problem: Most of these instruments are private. You can't just look up the price on Google or the stock market. This is called "illiquidity."
- The Assumption Problem: The models are only as good as the "guesses" (assumptions) you put in. The biggest challenge is volatility. For a private company, how do you measure its "motion"? We have to use complex statistical analysis of similar public companies. A small change in this one assumption can dramatically change the final value.
- The "Fine Print" Problem: The valuation expert must read the legal "fine print." Does that convertible note have a 2x cap? Does the preference of sharing have an anti-dilution clause? The math must perfectly match the legal terms of the agreement.
Conclusion
Complex securities valuation isn't just a compliance checkbox. It's a core part of your financial and strategic foundation.
Getting it wrong creates risk: failed audits, investor friction, and regulatory exposure.
Getting it right builds trust: it ensures compliance, streamlines fundraising, and gives you the clarity to make smart decisions.
At My Valuation, our team specializes in this. We use advanced, accepted models every day to provide auditor-ready valuation reports for everything from Startup Valuation and ESOP Valuation to the most complex hybrids for IND AS reporting.
Schedule a free consultation with our experts today.
