Hello,
Asking WSO to think through this with me. How would you value a future buy-out clause in a contract today? I.e. Company X can purchase Company Y's equity in five years for a payment of $XXX today.
Or -- would a better way to structure it be something along the lines of:
"Company X can purchase Company Y's equity in five years at a price subject to a third party appraiser at the time of the buyout."
I'm trying to think through the value of including this option in a JV relationship today. What - if any -** monetary value should this type of option warrant** (outside of the future equity purchase). Thanks for helping me think about this. Hope this is clear.
Your description isn't entirely clear. Does the company you're valuing already hold some kind of option, or it is looking at different ways to lock in an equity purchase and you want to compare the valuation implications?
Regardless, I would probably use black-scholes, with comparable companies' volatility (assuming your target co doesn't have publicly traded equity).
If you want to compare that to your option b - company can buy the target at a future appraised price, then I think you run out the target projections, and PV the cash flows and/or apply an average comparable co multiple to the expiration year's earnings or ebitda or whatever, and pick the price you would offer today to generate your target IRR
Thanks, FellowTraveler ... this is helpful.
To clarify: This is currently a JV relationship with no buyout options / clauses from either party. The latter part of your first statement is accurate - looking at the valuation / financial implications of including this type of clause as an incentive.
EDIT: After some reflection (and googling)... the black-scholes model with comparable companies' volatility is likely the key here. Thanks again, FellowTraveler! Really appreciate it.
You could do a DCF, derive multiples from it and state: Company A can buy Company B in 5y time for EV/EBITDA multiple X.Xx
Would not structure it as an equity value clause as that is dependent on leverage in 5y. Irrespective of EV and performande, the likelihood of the option being used is higher if the JV repays its debt.
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