What’s New in the AICPA “Cheap Stock” Guide

After several years of discussions on appropriate valuation methods for complex capital structures, the American Institute of Certified Public Accountants (AICPA) released a draft update in December 2025. The update revises the 2013 edition of the practice aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation, informally known as the “cheap stock” guide.

The draft reflects a multitude of changes throughout, including new chapters on market transactions and share buybacks. But some of the most impactful changes relate to the valuation of equity securities in complex capital structures, primarily covered in Chapter 6. In this article, we focus on some of the key updates from the prior version.

As with prior versions, the revised guide isn’t authoritative and establishes no new accounting or valuation rules. Instead, it aims to compile best practices and provide useful references for practitioners.

Methodologies

The guide still identifies the scenario-based method (SBM) and an option pricing method (OPM) to be the two most popular ways to value different classes within complex waterfalls. Variants of these methods may be applied depending on company-specific facts and circumstances, but these two serve as a starting point. See our issue brief for an illustrated breakdown of these methods.

At a high level, the guide advises greater caution in method selection and highlights their limitations. While most of the discussed customizations lack a proven track record, these methods certainly offer more realistic valuations than the one-size-fits-all framework appraisers have been using under the previous guide.

Scenario-Based Method (SBM)

Previously referred to as a probability-weighted expected return method (PWERM), the SBM considers discrete scenarios where the payoff for an award may differ significantly. Typically, the value of a security is calculated assuming an event occurs (such as IPO, sale, or dissolution), and the fair value is based on a probability-weighted average value from each of the above scenarios.

The guide recommends caution with input assumptions. For example:

• Discount rates may vary by scenario. Incorporating credit spreads can help capture the appropriate rate of return on the securities
• Time to liquidity depends on the state of the company. In unsuccessful scenarios, for instance, investors may prefer continued financing over liquidation if the potential for recovery exists

While the SBM has its advantages—like capturing scenario-based payouts consistent with a market participant perspective—it can become oversimplified when assumptions include a fixed time to liquidation, a single discount rate for all scenarios, or a static capital structure.

Accordingly, the guide recommends a hybrid method that considers weight on other methods (such as the OPM) alongside the SBM. This is consistent with market practice. A simple SBM is used only in rare circumstances where the outcomes are clear.

Option Pricing Method (OPM)

The OPM uses call option mechanics to allocate equity value across the capital structure. Equity classes receive value based on the company’s equity value reaching certain thresholds (also known as breakpoints). Unlike the SBM, which relies on discrete scenarios, the OPM considers the full range of equity values that are mathematically achievable at a future liquidation event, with associated probability weightings.

This results in a distribution like that used for stock prices. Equity values near the current level (grown at the risk-free rate) carry higher probability weightings, while more extreme—though still possible—equity values are assigned lower probabilities. For more discussions and illustrations of this method, please refer to our white paper.

Common Stock Equivalent (CSE) Method

The CSE method models each class of equity on an as-converted basis. It’s often used when the company’s equity value is sufficiently high for all classes to be considered economically equivalent, aside from any discounts for lack of marketability.

This approach ties into what investors often call a “post-money valuation.” It assumes the rights and preferences of all shares are equivalent. While this overvalues common shares, which lack the rights of preferred stock, companies nearing IPO may place weight on this method to reflect how investors may be considering the outcome.

Current Value Method (CVM)

The CVM allocates equity value assuming immediate liquidation. As such, unlike the OPM, this method doesn’t consider a range of equity values over time. It’s commonly used when liquidation is imminent.

Although simple to apply, the CVM is highly sensitive to changes in the underlying assumptions. As a result, it may become unrealistic relative to the expectations of market participants investing in private companies.

Refinements

The more interesting piece of the updated guide is the addition of a number of methods to combine and fine-tune the models. With all of these, the trade-off for greater precision is assumptions that are more complex and difficult to support.

As a result, we urge caution in balancing these crucial factors. An overly simplistic model may ignore economic realities, while an overly complex model may require so many speculative inputs as to be meaningless.

If this all feels like Goldilocks and the three valuation models, that’s not too far off.  Modeling is a constant tradeoff between modeling details more explicitly and aiming for simplicity, as not to bury the model with unworkable assumptions.

With that, here’s our take on some of the key factors that the guide suggests watching out for.

1. Variable Exit Timing

It’s impossible to accurately predict exit timing. Successful companies may exit earlier, while underperforming companies may experience extended holding periods as investors try to see if the company can recover.

The OPM, however, uses a fixed liquidation date for all future scenarios. It assumes that investors will sell even at lower values. In reality, investors are likely to base the decision to liquidate on factors like their desired level of return, the company’s future prospects, and market conditions instead of exiting at a fixed point in time.

The guide suggests using a simulation-based method, where exit occurs when equity value reaches a certain threshold.

Pros:

• More consistent with the way sales occur
• Considers capital structure at exit rather than valuation date
• Allows for more detailed scenarios (like basing the exit decision on a metric such as multiple on invested capital)

Cons:

• Computationally expensive
• Requires judgmental assumptions (such as hurdle value)
• No track record of reasonable results
• Not consistent with the methods private equity or venture capital investors use
• Results largely driven by the longest possible holding period. Using a simple OPM with a longer holding period might provide similar values without the added complexity

Our view:

We expect limited adoption due to complexity. Instead, we believe that adjusting the holding period within an OPM framework—to capture the inverse relationship between equity value and the holding period, as explained above—can be a reasonable way to capture investor decision-making.

For example, if the equity value is 50% of the preferred liquidation preference, we may adjust management’s expected holding period by 1.50x.

2. Additional Financing Rounds and Interim Cash Flows

Companies (especially in the early stage) often go through several capital raises, even before any growth occurs. Companies may also have capital raises in market downturns. The OPM assumes a static capital structure throughout the holding period. Therefore, it doesn’t capture the risk to the senior securities if a more senior round is issued in the future.

One solution is to model future funding rounds based on company expectations, rather than model as if the next round is an exit event. In cases (such as tranche preferred) where financing is conditional on achieving certain milestones, the guide suggests using a hybrid method (e.g., scenario-based OPMs) to effectively capture the probability of future financings. In a similar vein, SAFE and convertible notes that convert into future financing rounds may also have an unknown liquidation preference that can be modeled within the future capital structure.

However, in practice, the terms of future financing rounds are unknown at the valuation date, which makes it difficult to estimate the impact to other securities within an OPM. In these cases, it likely makes sense to ignore instruments like SAFE notes because their impact on the capital structure isn’t yet known.

Our view:

Forecasting financing rounds, and the rights attached, is tricky but can be done based on cash flow and other forecasts. This is one area where we’ve seen practices vary. Careful consideration is required to balance the complicated factors at play.

3. Dilution From Stock-Based Compensation

Treatment of stock-based compensation (SBC) within a private company’s capital structure has been a common point of discussion among practitioners in the past. Chapter 5 of the guide outlines two ways to incorporate SBC within an OPM framework:

• Expense treatment. Equity value reflects the price a market participant would pay, knowing that the company will issue SBC in the future. As a result, the equity value is measured net of this expense. For this method, dilution from future issuances isn’t considered
• Capital structure treatment. Equity value reflects the price a market participant would pay, knowing that outstanding options or future issuances may share some of the company’s equity appreciation over the expected term. For this method, dilution from both current and future issuances should be considered

There are still a few nuances that practitioners should consider when applying these methods. For example, in-the-money options are likely to be receiving upside value. As a result, adjustments to the waterfall may still be necessary, even under the expense treatment.

Another nuance arises when calibrating equity value to a transaction. For example, suppose an investor buys all of the equity for $200 million, and the company subsequently issues profits interest units with a $200 million threshold. Under the expense treatment, the implied equity value would still be $200 million. Under the capital structure treatment, however, the equity value may exceed $200 million, with the excess attributable to the time value of the profits interest units.

Although the expense treatment is commonly applied to SBC among investors purchasing securities, it’s important to still consider the outstanding options when using an OPM. If a company already has options outstanding, for instance, the equity value from an OPM should be adjusted downward. This is done by subtracting the aggregate exercise price of those options to arrive at the appropriate equity value under the expense treatment.

That said, there’s no need to consider future issuances within the waterfall. Their impact is already reflected, since the equity value is measured net of the expected expense.

Our view:

While the fair value of options should be calculated separately from an OPM to accurately reflect the expected term, outstanding options should still be considered within an OPM to capture their dilutive impact from participation in the upside.

We typically don’t consider future issuances that aren’t planned as of the valuation date, partly due to the uncertainty around their dilutive effect. This also reflects the fact that they’re issued in place of other compensation and are therefore not truly dilutive. As such, there are no significant changes from the prior guidance.

4. Constant Volatility

We often assume the volatility to be stable, but in real life, it’s constantly changing. Volatility can move even faster as speculative startups with many operational hurdles evolve into maturing public companies.

Since the OPM assumes constant volatility, it doesn’t capture potential jumps in equity value tied to major milestones, such as when a biotech company’s product receives FDA approval.

The OPM also may understate volatility because private company volatility is typically benchmarked to guideline public companies. The guide recommends adjusting volatility assumptions to better capture the wide range of potential outcomes for early-stage companies and provides some sample calculations.

Our view:

A quantitative adjustment to the volatilities can get complicated and confusing. But there is a middle ground. One reasonable approach is to use volatilities toward the higher end of the range for guideline public companies. Another is to apply scenario-based models with different values and equity volatilities based on outcomes from major events. At the same time, the most likely event may cause excess volatility. So, practitioners should always assess the aggregate implied volatility from their models and confirm that it makes sense for the company.

5. Hybrid Models Consistent With Exit Expectations

If the OPM allocates most of the value of senior shares to their liquidation preference, yet management intends to take the company public, the model might not capture the conversion payout correctly. Conversely, if the company is in a distressed situation, an OPM would allocate too much value to a conversion upside and fail to capture the risk of non-payment accurately.

A hybrid approach can help address these limitations, say by using an SBM or CSE method with greater weight on the most likely scenarios. To illustrate, suppose a company expects an 80% chance of going public in nine months. Then the practitioner could apply a CSE method with an 80% weighting and a high equity value. The remaining 20% could be modeled using an OPM with a longer term (e.g., three years), reflecting the possibility that  the IPO falls through, delaying liquidation. In this case, the OPM would incorporate a conditional equity value assuming the IPO doesn’t occur.

Alternatively, suppose a company’s value could go to zero if a critical financing failed to materialize. In that case, the equity values for the success and failure scenarios may need to be adjusted accordingly.

Pros:

• CSE scenario is consistent with the way PE and VC investors determine pre and post-money valuation
• Provides flexibility to weight scenarios based on management’s expectations
• Easy to implement

Cons:

• Requires judgmental assumptions (such as event probabilities and timings), which may be hard to validate
• Can be susceptible to extreme scenarios (e.g., all shares have the same rights or all shares receive no value)

Our View:

For most companies with typical exit expectations, a standard OPM is the right approach. Practitioners should be informed about hybrid methods, but exercise discretion in their implementation. When appropriately deployed, hybrid models provide genuine value by aligning the valuation model with exit expectations and method in ways the traditional OPM cannot. In practice, we’ve already begun to see auditors push for an implementation of a hybrid method where circumstances indicate a traditional OPM falls short.

6. Non-Convertible and Participating Preferred Stock Treated as Debt

Some PE and VC-backed companies grant preferred shareholders priority via a liquidation preference, with the remaining proceeds allocated across all shares (including preferred) on an as-converted basis. This creates a debt-like payout that’s not accurately captured within a traditional OPM, which emphasizes conversion upside.

The guide introduces a “debt-like preferred plus upside” approach to address this issue. Under this method, the liquidation preference of preferred is modeled as debt, based on yields, and the residual equity is modeled as a conversion option representing the upside. The value per share of the participating preferred stock is then the sum of these two components.

Pros:

• Easy to implement
• Incorporates credit spreads for preferred, in addition to equity components
• More precise for capital structures that have multiple preferred classes with different seniority, due to the ability to calculate different yields for different liquidation preferences

Cons:

• Recovery rate consideration may become challenging when aggregate liquidation preferences exceed equity value
• Requires judgmental assumptions on yields and credit spreads, which may be hard to validate
• No track record of demonstrating reasonable results

Our View:

The “debt-like preferred plus upside” approach addresses the inconsistency of applying an equity volatility to a debt-like liquidation preference. The proposed method links the valuation of preferred classes to the familiar debt plus upside framework but requires a defensible credit spread for the debt-like component to be widely adopted.

Wrap-Up

Overall, the updated guide is more comprehensive than previous versions. It also addresses numerous concerns with commonly used models. While the proposed solutions seem complex to implement and have less of a track record, we expect practitioners to adopt these methods selectively or, at the very least, be more vigilant about these concerns going forward. We also expect auditors to apply more scrutiny to these valuations, requiring quantitative or qualitative support for valuation conclusions.