Valuation of private companies using a real options approach and the harmony theorem

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One of the most interesting and intriguing problems in finance is the valuation of private companies; that is, companies that are not yet publicly traded and for which there is no market. Their pricing is very challenging, since traditional methods used for evaluating tradable assets are not applicable. The problem becomes even more interesting, but more complicated as well, when the company we wish to valuate is also a start up, recently founded by an entrepreneur or a group of entrepreneurs, that designs a new, in most cases innovative, product. The task of performing evaluation of such type of companies is very important. There are people who are interested in knowing the value of a start up company that is still private. These include entrepreneurs, venture capitalists, other investors (e.g. people trading private stocks of the company in the secondary markets), potential or current employees of the company and Wall street analysts. All those individuals try to, at least roughly, approximate the current value of a company that they are interested in. That would help them make decisions (e.g. buying the company, selling it or investing in it), depending on the role that each of them has. The method that we propose incorporates both the Net Present Value (NPV) and the Internal Rate of Return (IRR) criteria, that are typically used by the owner of the company and its investors, respectively. That gives us the ability to include both the entrepreneur and the venture capitalists in the model. Our model is the first one that achieves that, and it does by using a very powerful concept, the Harmony Theorem. According to this, the owner of a venture and someone who invests to it will follow the same operational strategy, although their criteria are different. The Harmony Theorem is not the only tool that is used in our model. Our valuation method is also based on real options approaches and projection pricing concepts. In particular, we used real options to represent the possible alternatives (options) that the company has; several rounds of financing from venture capitals, possible IPO, or possible abandoning of the project and sell of the Intellectual Property (IP). Projection pricing is used in the form of the correlation pricing formula (CPF), since we consider private companies, which means that CAPM or Black-Scholes cannot be used for its valuation. We apply our model for three companies that went public during the next couple of years: LinkedIn, Pandora Media and Groupon. The predictions of our model regarding the IPO's of those companies are much better to the ones proposed by analysts and professionals at the time these companies were still private. It is really important that our model performed well for all three companies that belong in different sectors and had different success level.


Type of resource text
Form electronic; electronic resource; remote
Extent 1 online resource.
Publication date 2014
Issuance monographic
Language English


Associated with Giannakakis, Ioannis
Associated with Stanford University, Department of Management Science and Engineering.
Primary advisor Luenberger, David G, 1937-
Primary advisor Weyant, John P. (John Peter)
Thesis advisor Luenberger, David G, 1937-
Thesis advisor Weyant, John P. (John Peter)
Thesis advisor Lai, T. L
Advisor Lai, T. L


Genre Theses

Bibliographic information

Statement of responsibility Ioannis Giannakakis.
Note Submitted to the Department of Management Science and Engineering.
Thesis Thesis (Ph.D.)--Stanford University, 2014.
Location electronic resource

Access conditions

© 2014 by Ioannis Giannakakis
This work is licensed under a Creative Commons Attribution Non Commercial 3.0 Unported license (CC BY-NC).

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