4. Management Implications

In this section, we have talked extensively about real options and how to include such options in the valuation of (startup) firms. The main takeaways are as follows.

  1. Real options can be extremely valuable
  2. The value drivers of a project are not fixed. Managers can work hard to improve the value of the underlying asset (S) and the can try to position their "option" in a segment of the market that offers higher uncertainty and therefore makes options to buy more valuable.
  3. It is crucial to be able to spot the option and to get a VERY ROUGH sense of its potential value.
  4. To be able to do so, we need to understand the critical part of the project that generates the option. If it is not truly embedded in the project, you have an opportunity rather than an option.
  5. We have to be careful when pricing real options, since the available models often make strict assumptions that are rarely met in practice.
  6. Sometimes, real options are used opportunistically to justify bad projects ("the business looks bad but it gives us access to better business.") Such a strategy does not work, on average.
  7. To see whether a real option is real (vs. an opportunity), three simple questions can help:
    • Is there an option embedded in the decision?
    • Is there exclusivity?
    • Can we value the option with our valuation models?