One identifiable exit as a PWERM scenario, everything else as an option pricing model, both calibrated to the latest preferred round.
The hybrid method values common stock by weighting two models: a PWERM scenario for a specific near-term exit, and an option pricing model (OPM) for everything else, with the total backsolved so the latest preferred round is worth what was paid. On an illustrative company with a Series B at 2.50, a 30 per cent chance of a sale at 90.0 in 18 months puts the common at 1.78 a share, 71.2 per cent of the round price, against 1.55 from an OPM backsolve alone.
Worked in full in The Private Markets Valuation Specialist by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A pure OPM treats the future as a lognormal cloud: no event in particular, just volatility over an expected term. A pure PWERM treats it as a short list of discrete exits. Neither fits a company that has one identifiable near-term event, a sale process with a banker hired or an IPO in preparation, and an uncertain future if that event does not happen. The hybrid method gives the event its own scenario, with its own value and timing, and lets the OPM handle the rest. Valuation guidance for privately held equity describes it for exactly that situation, and it is common in quarterly fund marks and option-grant valuations of late-stage venture companies.
| Class | Shares | Issue price | Preference |
|---|---|---|---|
| Common | 10.0 | ||
| Series A, 1x non-participating | 5.0 | 1.00 | 5.0 |
| Series B, 1x non-participating, pari passu with A | 4.0 | 2.50 | 10.0 |
| Total, and post-money at 2.50 | 19.0 | 47.5 |
| Input | Value |
|---|---|
| Probability of the sale scenario | 30% |
| Equity value at the sale, everyone converts | 90.0 |
| Time to the sale | 1.5 years |
| Discount rate for the sale scenario | 25% |
| OPM: expected term, volatility, risk-free rate | 3.0 years, 60%, 4.0% |
The Series B closed recently at arm's length, so its price is the calibration point. All figures are illustrative.
Series B value = p × PV(B in sale) + (1 − p) × OPMB(V) = 2.50; solve for V
Common value = p × PV(common in sale) + (1 − p) × OPMcommon(V)
OPM tranche value = Call(V, lower breakpoint) − Call(V, upper breakpoint), split by who shares that tranche
In Excel, a Black-Scholes call: =V*NORM.S.DIST(d1,TRUE)-K*EXP(-r*T)*NORM.S.DIST(d2,TRUE), then Goal Seek on V.
Step 1, the sale scenario. At 90.0 every preferred share converts, so each of the 19.0 million shares receives 4.737. Discounted at 25 per cent for 1.5 years (factor 0.7155) that is 3.389 a share today, for every class alike.
Step 2, what the OPM must deliver. The Series B is worth 2.50 in total, so in the stay-private scenario it must be worth (2.50 − 30% × 3.389) / 70% = 2.119 a share.
Step 3, the breakpoints. The preferences take the first 15.0. The common alone takes the next tranche until it reaches the Series A's 1.00 a share, at 25.0, when the A converts. Common and A share until 2.50 a share, at 47.5, when the B converts. Above that all 19.0 million shares share equally.
Step 4, solve the OPM. The equity value at which the Series B is worth 2.119 in the OPM is 26.35:
| Tranche | Value | Common share | Series A share | Series B share |
|---|---|---|---|---|
| 0 to 15.0 | 10.53 | 0.000 | 0.333 | 0.667 |
| 15.0 to 25.0 | 3.98 | 1.000 | 0.000 | 0.000 |
| 25.0 to 47.5 | 4.92 | 0.667 | 0.333 | 0.000 |
| Above 47.5 | 6.91 | 0.526 | 0.263 | 0.211 |
| Per share | 1.090 | 1.394 | 2.119 |
Step 5, weight the two. Common = 30% × 3.389 + 70% × 1.090 = 1.780. Series A = 1.993, Series B = 2.500 by construction. The implied equity value of the company is 30% × 90.0 × 0.7155 + 70% × 26.35 = 37.76, and the three classes allocate exactly that.
The common is worth 1.78 a share, 71.2 per cent of the Series B price, before any discount for lack of marketability. A pure OPM backsolve on the same capitalisation gives an equity value of 34.56 and common at 1.549, 62.0 per cent of the round price. The hybrid result is 14.9 per cent higher because in the sale scenario the preferences fall away and the common shares equally with everyone.
| Probability of the sale | OPM equity value | Implied equity value | Common per share | Common / round price |
|---|---|---|---|---|
| 0% (pure OPM) | 34.56 | 34.56 | 1.549 | 62.0% |
| 15% | 31.14 | 36.13 | 1.662 | 66.5% |
| 30% | 26.35 | 37.76 | 1.780 | 71.2% |
| 45% | 19.41 | 39.65 | 1.916 | 76.6% |
Every 15 points of sale probability adds about 0.12 to the common. The calibration absorbs part of it: the more weight on the sale, the lower the OPM value has to be for the Series B still to come back to 2.50. Volatility works the other way round from intuition for the common: at 45 per cent the common is 1.687, at 75 per cent 1.865, because higher volatility shifts value toward the junior, option-like class.
Setting the sale probability from the management narrative and leaving the OPM uncalibrated. If the stay-private scenario is not solved jointly with the sale scenario, the Series B ends up worth more or less than the 2.50 just paid, and the model is valuing a company the market did not price. Backsolve the two together, document the probability with evidence (a signed engagement letter is not a 30 per cent chance of closing on its own), and show the table above so the reader sees how much of the common's value the probability carries. The pure scenario approach is in how to calculate a PWERM valuation, and the reason common trails the round price at all in why common stock is worth less than preferred.
The book's chapters 8 and 9 take value from the enterprise to the individual security; the free workbook for the waterfall and the bridge runs the preference stack and the breakpoints on its own capitalisation.
The OPM models all outcomes as one lognormal distribution of equity value; the hybrid method carves out a specific exit as its own scenario and uses the OPM only for the rest. On the illustrative company the OPM backsolve gives common 1.549 a share and the hybrid, with a 30 per cent sale scenario, 1.78.
Solve the OPM equity value so that the probability-weighted value of the latest preferred equals its price. With the sale scenario worth 3.389 a share today at 30 per cent probability, the Series B must be worth 2.119 in the OPM, which requires an equity value of 26.35 in that scenario.
In a backsolve it usually raises it, because the common behaves like a call option on the residual value. In the illustrative hybrid model common is 1.687 a share at 45 per cent volatility, 1.780 at 60 and 1.865 at 75, with the Series B held at 2.50 throughout.
Chapters 8 and 9 of The Private Markets Valuation Specialist take value from the enterprise to the individual security. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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