Contingent Value Rights

When a company is publicly traded and has a high daily trading volume,
the market continually prices the shares, and buyers and sellers can
trade the shares at any time.

But when a company is privately held, there is usually little or no
market for shares, even though the shares have some value. It is
difficult to find buyers of privately held shares, precisely because
there is no ready market for the shares if the buyer decides later to
sell them.

And pricing shares in a privately held company is also extremely
tricky. I have heard of people overpaying wildly for privately held
shares because their value was misrepresented. But I have also heard of
shareholders having to sell shares in a fire-sale, for pennies on the
dollar, because they had to sell and couldn’t find a reasonable market
for the shares.

There are a few private equity firms like Millennium Technology Value Partners in NYC who specialize in providing liquidity for holders of generally illiquid assets.

But I have recently come across a financial instrument that I think
could be very useful for holders of illiquid assets who want to create
a fair transaction with a buyer, where the buyer is protected in case
the assets aren’t worth as much as was hoped, and the seller is
protected in case the assets are worth more than was assumed.

I think it could be deemed a “Two Way Contingent Value Rights Agreement.”

I have found many references to “contingent value rights” such as this
reference in the book “Expontential Functionals of Brownian Motion and
Related Processes” which I found on Google Print (an unbelievably valuable and little known resource) today. The book was published in 2001.

“To give an example very relevant in
corporate finance, we can also mention the so-called contingent value
rights: suppose a firm A wants to acquire a firm B. A is not willing to
pay too high a price for the shares of company B but knows that this
may lead to a failure of the takeover. Hence firm A will offer the
shareholders of company B a share of the new firm AB accompanied by a
contingent-value right on firm AB, maturing at time T (say two years
later). This contingent-value rights is nothing but an Asian put
option. The put provides the classical protection of portfolio
insurance; the Asian feature protects firm A for an exceptionally low
market price of the share AB on day T, as well as the shareholders B in
the case of a very high market price that day. These contingent-value
rights were used when Dow Chemical acquired Marion Laboratory, when the
French firm Rhone-Poulenc acquired the American firm Rorer and more
recently, when the insurance company Axa merged with Union des
Assurances de Paris to form the second largest insurance company in the
world (in the last case, the corresponding contingent value rights are
still trading today).

I can envision a time where illiquid assets can be bought and sold more
easily if sellers and buyers entered into a Two Way Contingent Rights
Agreement, where the future value of the assets (once they are more
liquid and the market determines pricing) leads to a modifying payment
to the buyer or seller so that the original deal turns out to be fair
for both parties.

This would be ideal, for example, to help shareholders of privately
held companies that are venture backed, where an exit is almost certain
to occur through an IPO or acquisition.

A silicon valley friend once told me he thought this was called a
“waverly loan.” Has anyone heard of pre-IPO shareholders using a
“waverly loan” or a “contingent value rights agreement” in selling
shares?

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One Comment

  1. Paul,

    Thanks for the info – I have been researching privately held stock arrangements recently and your post definitely sheds some input on situations where there is a clear exit strategy. My question is what possibilities exist for an employee working for a company with no clear exit strategy?

    Thanks,
    Preston

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