Why, mathematically, startups make more sense than ever today(chrisyeh.blogspot.com)
chrisyeh.blogspot.com
Why, mathematically, startups make more sense than ever today
http://chrisyeh.blogspot.com/2013/06/why-mathematically-startups-make-more.html
3 comments
Yeah, there are a lot of unstated premises here.
Volatility is important to option valuation but the mechanics of real option valuation (what we are talking about) are materially different from black/scholes. In fact, black scholes is more descriptive of option trading than predictive of option valuation. Since there needs to be an active market for this to be relevant, I wouldn't use it for thinking about startups.
That said, these highfalutin financial concepts are definitely applicable to startups, but really the question is "what do you think the terminal value of your startup is?"
If you think you have a shot at owning a big chunk of a billion dollar company, the value of that shot is:
(Probability of success) * (Terminal value)
If the undertaking has a 1% chance of being worth 1,000,000,000 and 99% chance of being worth nothing, then the whole opportunity is worth about ten million dollars.
So, yeah. Volatility doesn't matter all that much. Also if you are doing a Startup because of a black scholes model you are probably insane.
Volatility is important to option valuation but the mechanics of real option valuation (what we are talking about) are materially different from black/scholes. In fact, black scholes is more descriptive of option trading than predictive of option valuation. Since there needs to be an active market for this to be relevant, I wouldn't use it for thinking about startups.
That said, these highfalutin financial concepts are definitely applicable to startups, but really the question is "what do you think the terminal value of your startup is?"
If you think you have a shot at owning a big chunk of a billion dollar company, the value of that shot is:
(Probability of success) * (Terminal value)
If the undertaking has a 1% chance of being worth 1,000,000,000 and 99% chance of being worth nothing, then the whole opportunity is worth about ten million dollars.
So, yeah. Volatility doesn't matter all that much. Also if you are doing a Startup because of a black scholes model you are probably insane.
This argument is flawed. Yes startups have payoff akin to out of the money options, but that is obvious. However, the number of other startups would not affect the volatility. If anything it would be analogous to increasing the interest rate, since it increases the opportunity cost or cost of capital of investing in one particular startup vs other ones and decrease the value of the call option marginally. What would be analogous to "high vol" would be the speed of the startup to iterate and get to a real business model.
I see what the author is going for but this seems like a pretty weak argument. But this line:
> Second, the crowded startup market that results is more volatile, increasing the value of the option.
doesn't seem to hold. More startups doesn't necessarily increase the volatility at all. Its entirely possible to have more start ups and less volatility. Whether or not that's true I'm not sure.
Furthermore, even if you subscribe to the market being more volatile, Black scholes isn't interested in the volatility for the market, but just for the individual stock/company. Which isn't guarenteed to go up at all either:)
And then there is this "cover my ass" tidbit...
> According to Black-Scholes, all other things being equal, increasing volatility increases the price of the option.
This is basically saying, there are many factors that affect the outcome of a startup, I'm only going to chose one of them and assume the others stay the same. Furthermore I"m going to assume that the one variable I'm going to chance will move in a direction that supports my claim and not in any other direction.
This claim strikes me as being a bit dubious.
I do think this is an interesting thought experiment though:)