The ability to value an investment with confidence is important for liquidity. If valuation is difficult, it is much harder to come to an agreement on a price than if valuation is simple.
Seats were structured to be easier to value than traditional equity securities. Consider these three features:
Single Payment: Seats only have one payment event. A Seats investor is not buying perpetual cash flows as with common stock, he is only buying one cash flow with a duration that is much more predictable. If he can construct several possible payment outcomes and assign probabilities, he is well on the way to obtaining a reasonable valuation.
Single Metric: Seats are based on revenue. If an investor can predict revenue, then she can predict the cash flows on the Seats contract. Compare that to the valuation of common stock, where value is often expressed as the present value of a future value – there’s not a lot of precision there to say the least.
Relative Value: Possibly the most important element of Seats for valuation is the nature of the revenue bands - each band is related to the other in an absolute way. The lower bands must be worth more than the higher bands because there is a higher probability of the lower bands being hit, and if they are hit, they will be hit earlier than the higher bands. Additionally, the relationship in value between the bands is only based on the conditional probability of hitting the higher band assuming the lower band has been achieved.
For example, consider a band at $1,000,000 and a band at $1,100,000. The band at $1,000,000 must trade at a higher price than the band at $1,100,000. The difference in price is based on the probability of hitting $1,100,000 assuming $1,000,000 has been hit.
These relationships between Seats bands make valuation much easier and liquidity much more likely. The full “curve” of future Seats bands can be created much like a yield curve. We can start with near term revenue probability and “bootstrap” from there based on incremental conditional probabilities. If the actual pricing of the revenue bands does not follow this relationship, then arbitrage will lock the curve back into place like tuning a piano.
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