Valuing Contingent Value Rights in M&A Transactions

Contingent value rights (“CVRs”) remain popular instruments in M&A transactions to help bridge the valuation gap between buyers and sellers. CVRs are typically structured such that the holder receives either a lump sum cash payment or shares of stock once a specific milestone is hit. Common milestones include hitting specified financial metrics such as sales and EBITDA targets and achieving specified operational metrics such as launching a new product or securing a stated new client/contract. Because accounting standards often require holders of CVRs to carry them at fair value, determining their fair value in a reasonable, supportable manner is critical.

Valuing CVRs can be a complex process due to the inherent uncertainty associated with the specified metrics. However, there are several valuation techniques that can be used to estimate the fair value of CVRs, and the choice of technique will depend on the specific facts and circumstances of each transaction.

Key Factors in Valuing CVRs

Several factors play a crucial role in determining the value of CVRs:

• Probability of Achieving the Milestone
• Magnitude and Structure of the Payout
• Time to Payment
• Risk of Nonpayment

Challenges in Valuing CVRs

Valuing CVRs presents several challenges:

• Uncertainty of Success: CVRs can have multiple layers of triggering events and financial conditions, which may create uncertainty and ambiguity about the timing and amount of payments.
• Lack of Market Data: The limited number of CVR transactions and the lack of a centralized market make it challenging to establish reliable valuation benchmarks.
• Data Sensitivity: Valuation models are highly sensitive to input parameters, requiring careful consideration of data quality and assumptions.
• Subjectivity of Estimates: Despite advancements in valuation techniques, there remains a degree of subjectivity in estimating the fair value of CVRs.

Despite these challenges, CVRs continue to be a valuable tool in deals, providing a mechanism to bridge valuation gaps between buyers and sellers.  As such, it’s critical to understand and manage the economic and financial reporting considerations inherent in their use.

Common Valuation Techniques for CVRs

Various valuation techniques can be employed to estimate the fair value of CVRs, each with its own strengths and limitations:

• Monte Carlo Simulation: This technique involves simulating various scenarios and their probabilities to estimate the expected value of the CVR payout.
• Option Pricing Models: Models like Black-Scholes-Merton can be used to value CVRs by considering their option-like characteristics.
• Decision Tree Analysis: This approach involves constructing a decision tree to represent the possible outcomes and their probabilities, leading to an expected value for the CVR.
• Market Comparable Analysis: Comparing CVRs from similar transactions can provide insights into their valuation multiples.
• Real Options Analysis: This technique considers the flexibility embedded in CVRs, such as the option to delay or defer payouts, to enhance their valuation.

The choice of valuation technique must be tailored to the specific characteristics of the CVR, and different techniques might be employed for different milestones in the same CVR.

How Centri Can Help

Centri’s valuation specialists can advise buyers and sellers on the fair value of any CVRs included within the purchase price of the deal as well as the range of expected value within a given confidence interval to better understand the balance sheet impact and assist with deal negotiation. Furthermore, in partnership with the technical accounting teams, Centri assists in the financial reporting of the business combination, including technical accounting memos, preparation of the closing/opening balance sheet and walk across files, determination of the fair value of purchase consideration, and allocation of purchase price to assets acquired and liabilities assumed. This ensures a smoother, more efficient acquisition process. Contact us to learn more.