Bankruptcy Valuation Considerations with Stock Options & Warrants
By: John Trefethen, Director & Co-Founder
Valuation is an integral part of the bankruptcy process. Throughout the bankruptcy code there are requirements to value the assets and liabilities of the filing company. Among the most challenging items to value are financial products, in particular financial derivatives. Some of the most challenging derivatives to value are stock options and warrants. Some people use the terms stock options and stock warrants interchangeably, which leads to confusion between the two. In this article, I will discuss the major differences between these instruments, how each are used by companies, and what attorneys should look for when guiding a company through a bankruptcy proceeding.
Stock options are issued to key employees, directors and service providers. Generally, there is a stock option plan under which a set number of options can be issued. The option is a means of compensation and is intended to increase a key person’s overall compensation if the company’s stock price increases. Under a stock option plan, a key employee awarded options is granted the right to buy a defined number of company shares at a pre-set price over a certain period of time.
Alternatively, warrants are not considered a form of compensation. Instead, they are issued in connection with a company’s raising of capital, either through a debt or equity issuance, and are used to “sweeten” the deal for the investor. When attached to an equity or debt issuance, they give the holder the right to buy additional shares at a certain price before the expiration. When a warrant is exercised, the company issues new shares, increasing the total number of shares outstanding.
How to value stock options and warrants is beyond the scope of this article. But it is important to appreciate the complexity in valuing these instruments, especially for privately held companies where data is limited. Security specific financial modeling is required to arrive at an accurate option or warrant valuation. Transparency into the valuation methodology is critical in a bankruptcy to know you can rely on the values used in a bankruptcy filing. Determining the value of an option or warrant can be subjective, making it important to work with a valuation specialist who thoroughly understands these instruments. Subjectivity can exist from the following:
Market data is a key input into valuation of options and warrants and is often difficult to find, especially for privately held companies. In cases like this, the valuation agent may need to create “proxies” to determine key data inputs. This requires a strong understanding of relevant markets as well as acceptable valuation methodologies.
Models used for valuation purposes are not standardized and can create differing values. Often in the case of options and warrants, unique models need to be developed by the valuation specialist to arrive at a valuation.
Multiple data providers may provide some of the same core data, but the actual data provided may differ based on the provider and its own proprietary data creation, and timing of the data.
When viewing values on a company or bank statement, the company or bank may be influenced by their own position(s), which could bias the value they report.
Having an independent, third-party valuation specialist calculate fair value(s), provide documentation on the valuation methodology, and certify to their reasonableness will give you comfort knowing that you are receiving reliable values that can be used in a bankruptcy proceeding. Independent third-parties that provide valuations must maintain relevant data licenses and agreements with the various exchanges in order to have access to current and accurate market data. They must also work with a pricing system(s) that is validated and reliable.
HedgeStar maintains the relevant data licenses and exchange agreements and operates in a state-of-the-art pricing system. Our systems and procedures are vetted annually through independent reviews and audits. HedgeStar values a broad range of financial instruments, from plain vanilla to exotic, and has extensive experience valuing domestic municipal and corporate bonds, international debt, illiquid securities, stock warrants and options, and all forms of interest rate, currency and commodity derivatives.
As a leading independent valuation agent, HedgeStar is uniquely qualified to help with bankruptcy proceedings to meet the valuation requirements related to financial assets and liabilities.