INTELLIGENT PROTECTION MANAGEMENT CORP. Fair Value Disclosure
6. Fair Value Measurements
The fair value framework under the FASB’s guidance requires the categorization of assets and liabilities into three levels based upon the assumptions used to measure the assets or liabilities. Level 1 provides the most reliable measure of fair value, whereas Level 3, if applicable, would generally require significant management judgment. The three levels for categorizing assets and liabilities under the fair value measurement requirements are as follows:
| ● | Level 1: Fair value measurement of the asset or liability using observable inputs such as quoted prices in active markets for identical assets or liabilities; | |
| ● | Level 2: Fair value measurement of the asset or liability using inputs other than quoted prices that are observable for the applicable asset or liability, either directly or indirectly, such as quoted prices for similar (as opposed to identical) assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; and | |
| ● | Level 3: Fair value measurement of the asset or liability using unobservable inputs that reflect the Company’s own assumptions regarding the applicable asset or liability. |
The following table summarizes the liabilities measured at fair value on a recurring basis as of December 31, 2015:
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||
| LIABILITIES: | ||||||||||||||||
| Warrant liabilities | $ | - | $ | - | $ | 273,425 | $ | 273,425 | ||||||||
| Compound embedded derivative | - | - | 200,000 | 200,000 | ||||||||||||
| Total derivative liabilities | $ | - | $ | - | $ | 473,425 | $ | 473,425 | ||||||||
The following table summarizes the liabilities measured at fair value on a recurring basis as of December 31, 2014:
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||
| LIABILITIES: | ||||||||||||||||
| Warrant liability | $ | - | $ | - | $ | 23,425 | $ | 23,425 | ||||||||
| Total derivative liability | $ | - | $ | - | $ | 23,425 | $ | 23,425 | ||||||||
Level 3 liabilities are valued using unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the liabilities. For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company’s accounting and finance department, who report to the Chief Financial Officer, determine its valuation policies and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s accounting and finance department and are approved by the Chief Financial Officer.
Level 3 Valuation Techniques:
Level 3 financial liabilities consist of the derivative liabilities for which there is no current market for these securities such that the determination of fair value requires significant judgment or estimation. Changes in fair value measurements categorized within Level 3 of the fair value hierarchy are analyzed each period based on changes in estimates or assumptions and recorded as appropriate.
The Company deems financial instruments which do not have fixed settlement provisions to be derivative instruments. The common stock purchase warrants and the conversion feature embedded in the Note do not have fixed settlement provisions because their exercise prices may be lowered if the Company issues securities at a lower price in the future. In addition, the Company issued warrants to purchase common stock in January 2011 in conjunction with an equity financing. In accordance with ASC Topic 480, Distinguishing Liabilities from Equity, the fair value of these warrants is classified as a liability on the Company’s Consolidated Balance Sheets because, according to the terms of the warrants, a fundamental transaction could give rise to an obligation of the Company to pay cash to its warrant holders. In addition, the Company entered into an Advisory Services Agreement (the “Advisory Agreement”), dated as of February 13, 2015, by and between the Company and Sigma Capital Advisors, LLC (“Sigma”), that contains certain provisions whereby the Company will be required to make certain make-whole cash payments to the holder of the Note payable upon the occurrence of certain future events, as more fully described in Note 10. Such instruments do not have fixed settlement provisions and have also been recorded as derivative liabilities. Corresponding changes in the fair value of the derivative liabilities are recognized in earnings on the Company’s Consolidated Statements of Operations in each subsequent period.
The Company’s derivative liabilities are carried at fair value and were classified as Level 3 in the fair value hierarchy due to the use of significant unobservable inputs. In order to calculate fair value, the Company uses a custom model developed with the assistance of an independent third-party valuation expert. This model calculates the fair value of the warrant derivative liabilities at each measurement date using a Monte-Carlo style simulation, as the value of certain features of the warrant derivative liabilities would not be captured by the standard Black-Scholes model. A significant increase in the volatility and/or stock price of the Company would, in isolation, result in significantly higher fair value.
The following table summarizes the values of certain assumptions used by the Company to estimate the fair value of the warrant liabilities as of December 31, 2015 and December 31, 2014:
| December 31, | December 31, | |||||||
| 2015 | 2014 | |||||||
| Stock price | $ | 0.08 | $ | 0.20 | ||||
| Weighted average strike price | $ | 0.64 | $ | 2.50 | ||||
| Remaining contractual term (years) | 4.12 | 1.1 | ||||||
| Volatility | 95.0 | % | 125.7 | % | ||||
| Risk-free rate | 1.54 | % | 0.3 | % | ||||
| Dividend yield | 0.0 | % | 0.0 | % | ||||
The following table summarizes the values of certain assumptions used by the Company to estimate the fair value of the compound embedded derivative as of December 31, 2015:
| December 31, | ||||
| 2015 | ||||
| Stock price | $ | 0.08 | ||
| Strike price | $ | 0.20 | ||
| Remaining contractual term (years) | 1.12 | |||
| Volatility | 95.0 | % | ||
| Risk-free rate | 0.7 | % | ||
| Dividend yield | 0.0 | % | ||
The following table sets forth a summary of the changes in the fair value of our Level 3 financial liabilities that are measured at fair value on a recurring basis:
| Years Ended | ||||||||
| December 31, | ||||||||
| 2015 | 2014 | |||||||
| Beginning balance | $ | 23,425 | $ | 140,550 | ||||
| Fair value of derivatives issued | 2,090,000 | - | ||||||
| Change in fair value of derivative liabilities | (1,640,000 | ) | (117,125 | ) | ||||
| Ending balance | $ | 473,425 | $ | 23,425 | ||||
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About Fair Value Disclosures
Fair value disclosures classify all assets and liabilities measured at fair value into a three-level hierarchy: Level 1 (quoted market prices), Level 2 (observable inputs like yield curves), and Level 3 (unobservable inputs requiring management estimates). The proportion of Level 3 assets directly reflects how much of the balance sheet depends on internal models rather than market evidence.
Key signals: a growing Level 3 balance relative to total fair-value assets increases valuation uncertainty and earnings volatility risk. Watch for transfers between levels — assets moving from Level 2 to Level 3 often signal deteriorating market liquidity. Unrealized gains and losses on Level 3 positions flow through earnings or other comprehensive income, so large swings deserve scrutiny. For financial institutions, examine the sensitivity disclosures that show how Level 3 valuations change under alternative assumptions. Compare the fair value of debt against its carrying amount to gauge hidden leverage.