Employee Share Options, which entitle the holder to buy shares in a company at a future date for a pre-determined price, are an integral part of employee compensation in the start-up scene. It’s a way for privately held companies that may be large on ideas and growth but short on cash fight for and retain fresh talent. ESOs also incentivize employees as their payoff through exercising their options will be directly tied to the performance of the company. Deliveroo is no exception to this compensation structure, but it is their valuation of their existing ESOs that has garnered attention in Shubber’s article.
Shubber focuses the assumption Deliveroo makes in valuing their options in employing a volatility of 2%. To put it in perspective, this implies that there is a 68% probability that the stock’s return in 10 years to be within 6% of the risk free rate. This seems even more odd when considering that their share option plan offers a wide range of exercises prices (0.61-16.28GB), and is also in contrast with the historical volatility that Deliveroo’s peer companies such as Just Eat and Delivery Hero experienced after going public, of around 25-60%. From an accounting perspective, IFRS requires stock options to be measured at fair value and charged as a compensation expense, and the compensation expense is split across the life of the stock option. Under the Black-Scholes model which Deliveroo uses for their option pricing, a higher volatility increases the value of the option. By underestimating the option’s volatility, Deliveroo would effectively undervalue the options and reduce their operating expenses. In this instance, by shifting from 45% volatility to 2% volatility, the options became four times less valuable, by which amount their net operating profit would have benefited. Such practice may fail the test of verifiability, as an independent party may choose to use a much higher volatility rate to account for the value of the options, transparency, given the large gap between expenses related to the option during the vesting period and the potential balance sheet impact upon exercising the option, and comparability, considering the large difference in volatility used with their peers. It also …show more content…
In their 2015 report, the firm assumed a 45% volatility to calculate the fair value of their ESOs, which seem much more in line with the figures used by competitors. A possible explanation could be that as Deliveroo witnessed rapid growth and gained its “unicorn” status, there have been increasingly more jitters on the possibility of their IPO in the near future. In such a case, Deliveroo may be gearing up to present themselves to a different audience; the public. When receiving funding from industry veterans in the PE/VC world who will see right through such valuations and rather focus on the growth potential of the company, such play on numbers may have not made a difference. However, as a company that recorded a negative operating cash flow of £111m last year, that is preparing themselves to be publicly traded, window dressing their financial statements and making the headline numbers like EBIT look better may have risen higher in Deliveroo’s list of priorities.
The biggest problem about valuing options on unlisted equity instruments is that so much relies on the validity of the assumptions being made. The Deliveroo case is a perfect example of how the degree of subjectivity allowed in just one of the inputs in the Black Scholes method can materially impact the financial reporting of a
Shubber focuses the assumption Deliveroo makes in valuing their options in employing a volatility of 2%. To put it in perspective, this implies that there is a 68% probability that the stock’s return in 10 years to be within 6% of the risk free rate. This seems even more odd when considering that their share option plan offers a wide range of exercises prices (0.61-16.28GB), and is also in contrast with the historical volatility that Deliveroo’s peer companies such as Just Eat and Delivery Hero experienced after going public, of around 25-60%. From an accounting perspective, IFRS requires stock options to be measured at fair value and charged as a compensation expense, and the compensation expense is split across the life of the stock option. Under the Black-Scholes model which Deliveroo uses for their option pricing, a higher volatility increases the value of the option. By underestimating the option’s volatility, Deliveroo would effectively undervalue the options and reduce their operating expenses. In this instance, by shifting from 45% volatility to 2% volatility, the options became four times less valuable, by which amount their net operating profit would have benefited. Such practice may fail the test of verifiability, as an independent party may choose to use a much higher volatility rate to account for the value of the options, transparency, given the large gap between expenses related to the option during the vesting period and the potential balance sheet impact upon exercising the option, and comparability, considering the large difference in volatility used with their peers. It also …show more content…
In their 2015 report, the firm assumed a 45% volatility to calculate the fair value of their ESOs, which seem much more in line with the figures used by competitors. A possible explanation could be that as Deliveroo witnessed rapid growth and gained its “unicorn” status, there have been increasingly more jitters on the possibility of their IPO in the near future. In such a case, Deliveroo may be gearing up to present themselves to a different audience; the public. When receiving funding from industry veterans in the PE/VC world who will see right through such valuations and rather focus on the growth potential of the company, such play on numbers may have not made a difference. However, as a company that recorded a negative operating cash flow of £111m last year, that is preparing themselves to be publicly traded, window dressing their financial statements and making the headline numbers like EBIT look better may have risen higher in Deliveroo’s list of priorities.
The biggest problem about valuing options on unlisted equity instruments is that so much relies on the validity of the assumptions being made. The Deliveroo case is a perfect example of how the degree of subjectivity allowed in just one of the inputs in the Black Scholes method can materially impact the financial reporting of a