I can’t believe that in all these weeks and all these articles, I have not touched on what ranks among my favorite subjects, optionality. Don’t get me started, for I could go on and on. Every time an entrepreneur talks about how different his or her business has become in comparison to the day he or she started it, I say to myself, it was on that day that he or she (maybe unwittingly) acquired an option. Every time a VC talks about how different an investment has become in comparison to the day the VC funded it, I say to myself, with that funding the VC (maybe more wittingly than the entrepreneur) purchased an option. And I hear these stories all the time.
There is a lot to be learned about an economic environment from the ways in which investors seek optionality, and how much they are willing to pay for it. Nowadays, with changes taking place almost before the original event has occurred, equity investing and option acquisition become increasingly synonymous. With increased volatility, option value rises. With uncertain economic prospects, option value becomes a larger proportion of an investor’s equity ownership: the option to influence, the option to exit, the option to change course, the option to double up, the option to postpone a decision, or to accelerate it… the option to be in a business that one didn’t at first know one was in.
With all the discussion in recent months about deteriorating limited partnership (LP) interests in alternative investment classes, most notably venture capital, one can’t help but read the discussion from the perspective of optionality. So much capital had been infused into the system, which had to be put to work, that the discipline of paying the true option price for the option purchased was lost, and instead the price paid was more like full equity value for assets that had not yet outgrown the option stage. (I am referring to early stage ventures.) In such an environment, it’s tough to make the economics work, and that isn’t due to any inherent issue with the underlying assets – which are as risky as these have ever been – but rather as a result of very basic financial laws, which are also the same as always, and from which many had deviated.
But anyway… I was reminded about all of this when reading a few days ago that my Knicks – the perennial masters of overpaying for equity (in their case, guaranteed long term contracts) – have signed two lynchpins of their recent [cough] dynasty to… one-year contracts! A one-year contract in sports is by definition an expiring contract, which is in essence a team option on a player. Now this is more like it, well done, boys!
For sports buffs and other students of volatility, there are parallels to the story everywhere, and especially in venture investing and other aspects of finance. In an economically challenged environment, even the richest and most stable of media platforms – such as Madison Square Garden – looks to increase flexibility. Even a wealthy, stable, and proven business such as Madison Square Garden looks to maximize optionality and structure new deals accordingly.
Now everybody -
