When do I have to start implementing the updated (December 2012) International Private Equity and Venture Capital Valuation Guidelines?
These Valuation Guidelines should be implemented for reporting period post 1 January 2013. However, this recommendation does not override contractual or regulatory requirements.
Should I apply the International Private Equity and Venture Capital Valuation Guidelines to my current fund(s) or should I apply them to the next fund I will raise?
These Valuation Guidelines should be implemented for reporting period post 1 January 2013, including funds in existence. However this recommendation does not override contractual or regulatory requirements.
Are the International Private Equity and Venture Capital Valuation Guidelines compliant with IFRS and US GAAP?
It is not the intention of these Guidelines to prescribe or recommend the basis on which Investments are included in the accounts of funds. However, the requirements and implications of the International Financial Reporting Standards (IFRSs) and US GAAP have been considered in the preparation of these Guidelines. This has been done in order to provide a framework for arriving at a Fair Value for private equity and venture capital Investments which is consistent with these accounting principles.
Why are the real option or the Ohlson models not mentioned in the International Private Equity and Venture Capital Valuation Guidelines?
The Guidelines are intended to represent current best practice and therefore the Valuer should be predisposed towards those methodologies that are generally accepted. However, the Valuer can apply a methodology not presented in the Guidelines so that the results of one particular methodology presented in the Guidelines can be cross-checked.
The guidelines do suggest that where significant positions of options and warrants are held that these may need to be valued separately from the underlying investment using an appropriate option pricing model.
Can I use a different valuation methodology relevant to a specific Investment than the ones presented in the International Private Equity and Venture Capital Valuation Guidelines?
The Guidelines are intended to represent current best practice and therefore the Valuer should be predisposed towards those methodologies that are generally accepted. However, the Valuer can use a methodology not presented in the Guidelines so that the results of one particular methodology presented in the Guidelines can be cross-checked. Moreover, it is acceptable to use alternatives when you have invested in an industry that has particular valuation dynamics, such as Life Assurance businesses that use an embedded value calculation.
How should a significant event (e.g. a transaction, an indicative offer …) occurring between the reporting date and the date of production of the report be treated?
When estimating the Fair Value, the Valuer should take account of events taking place subsequent to the reporting date where they provide additional evidence of conditions that existed at the reporting date. In the example above, a reliable offer may provide such additional evidence of conditions at the reporting date, however variations in the value of the currency after the reporting date are in most of the cases indicative of conditions that arose after the reporting date.
When using the price of a recent investment, should I use the post money valuation or the pre-money valuation and add cash as of the reporting date?
The Price of Recent Investment methodology requires the use of the post money valuation.
Can I apply the entry multiple I paid for a portfolio company to its current earning in order to determine its current Fair Value?
The entry multiple is only appropriate to use if it remains indicative of current market conditions.
The International Private Equity and Venture Capital Valuation Guidelines recommend the use under certain circumstances of a taxed EBIT for the Earnings Multiple methodology. How do you calculate a taxed EBIT?
Where market-based multiples are used, the aim is to identify companies that are similar both in terms of risk attributes and earnings growth prospects. Many private equity companies are more highly leveraged than their quoted comparables, making a comparison of earnings (after interest charges) less relevant. Using an EBIT, adjusted for tax, as an approximation of earnings is a way of adjusting for differences in the working capital structure of the companies. In this context EBIT is adjusted by deducting the expected tax charge, calculated at the applicable tax rate.
A potential buyer has made an offer for a portfolio company which is above its current carrying value. Although it is only an indicative offer, should we increase the value of this portfolio company?
The treatment of indicative offers are presented in Section III-5.7 of the International Private Equity and Venture Capital Valuation Guidelines. Typically, indicative offers provide useful additional support for a valuation estimated by one of the valuation methodologies, but are insufficiently robust to be used in isolation.
When deterioration in value has occurred, can the Valuer apply a discount in tranches to the carrying value of the Investment reported at the previous reporting date to reflect the estimated decrease?
Whenever the Valuer is estimating Fair Value, this should be based on the current circumstances, facts and assumptions considered relevant by the Valuer, rather than using ‘standard’ or formulaic deductions.
When using a P/E multiple, how should I treat earnings from associated companies when the comparator reports its investments in associates according to the equity method (I should specify that the company I’m valuing has no associated company)?
The Valuer should assess the impact of these associates on the P/E ratio of the comparator. If this impact is deemed to be material, the Valuer might consider adjusting both the numerator and denominator of the P/E ratio to eliminate the impact of these associates. The fact that associates are active in different industries than the ones of the comparator is one indication among other different factors that associates might have an impact on the P/E ratio.
When calculating a taxed EBIT of a company being valued, how should I treat the impact of associates that are reported according to the equity method (I should specify that the company I’m using as comparator has no associate)?
The taxed EBIT would preferably not include earnings from equity method associates, unless these associates can be assessed as similar in nature with the company being valued.
If associates are not similar in nature, the Valuer should consider if they have an impact on the value of the company being valued. If the impact is material, the Valuer should estimate the fair value of these assets to adjust accordingly the amount derived from applying the multiple observed for the comparator.
Can I keep the Price of Recent Investment as an indicator of Fair Value during the year following the transaction?
The IPEV Guidelines indicate that the validity of the Price of Recent Investment methodology is inevitably eroded over time, especially in a dynamic environment with changes in market conditions and other factors. The IPEV Guidelines also specify that the “Valuer should in any case assess at each Reporting Date whether changes or events subsequent to the relevant transaction would imply a change in the Investment’s Fair Value” (see Part I-Section 3.3. Price of Recent Investment). Therefore this methodology is likely only relevant for private equity investments for a limited period only. If the Valuer assesses that the price no longer reflects the Fair Value of the investment, another appropriate methodology should be applied instead.
Can I still apply a marketability discount for an unquoted company after calculating its Attributable Enterprise Value to determine its current Fair Value?
Marketability is defined as the time required to effect a transaction or sell an investment. Accounting standards dictate that the Marketability period begins sufficiently in advance of the Measurement Date such that the hypothetical transaction determining Fair Value occurs on the Measurement Date. Therefore, accounting standards do not allow a discount for Marketability when determining Fair Value.
However, the impact of liquidity or illiquidity should be taken into account when determining Fair Value (see the Valuation Guidelines Section II -3.4. Reasonable multiple).
When using a earnings multiple, how much reliance can be placed on extracted data from a ‘distressed market’?
Such situation is presented in Section III-5.2 of the Valuation Guidelines. If a market where data is extracted is viewed as ‘distressed’ this does not mean that all transactions within that market are necessarily distressed. Significant judgement is needed in determining whether individual transactions are indicative of Fair Value considering any legal requirements to transact and indications of a forced sale. Fair value is indicative of an “orderly” transaction given current market conditions, even if the current market is deemed distressed.
As an investor in a Fund, is Net Asset Value appropriate for estimating the Fair Value of the interest in the Fund?
The reported Net Asset Value is an appropriate starting point for the Valuer. It may be necessary to make adjustments. Many factors should be assessed as to whether there is a need to adjust the NAV as reported. This consideration should include anything which might have changed since the reporting date. Suggested potential areas of adjustment are set out in (Section II-4.2. Adjustments to Net Asset Value).
By referring to the fact that quoted prices are indicative of the value of the company as a whole, the Guidelines appear to forbid the use of control premia.
The Guidelines suggest that the Valuer should always use their judgement to assess the adjustments required to any quoted multiple to appropriately reflect the value of an unquoted entity. This consideration might include an assessment of whether a third party might pay a higher price than that quoted, on the basis that they would acquire a sufficient portion of the company to give them control (the ‘control premium’). In assessing the size of any adjustment, the Valuer should seek to support their judgement with market evidence. Commonly an acquirer pays a premium to acquire a majority in a public company. Conversely, significant stakes in public companies are frequently placed at a discount to the market price. The Guidelines focus on the use of judgment to estimate the price at which an orderly transaction would take place between knowledgeable Market Participants at the Reporting Date.
Many of the European funds that I invest in follow the IPEV Guidelines. Are the Guidelines suitable for use by a US fund?
Yes. The Valuation Guidelines are entirely consistent with US GAAP. The Valuation Guidelines Edition December 2012 are endorsed by the US National Venture Capital Association and the Private Equity Growth Capital Council.
What is the difference between NAV and NPV and what is NPV used for?
NAV (Net Asset Value) is defined as the amount estimated as being attributable to the investors in that Fund on the basis of the Fair Value of the underlying Investee Companies and other assets and liabilities (as defined in the Definitions section of the IPEV Guidelines).
The NPV (Net Present Value) is defined as the present value of the fund’s expected cash flows and thus combines the value of current investments as well as the expected future value of undrawn commitments.
The NPV requires complex assumptions about future cash flows, value development and an appropriate discount rate (further details can be found in the EVCA Private Equity Fund Risk Measurement Guidelines).
NPV can be useful in the context of measuring private equity risk as is required for some institutions in the context of Basle II and Solvency II.
How should an issuer make reference to its use of the IPEV Valuation Guidelines in their published financial statements?
An issuer should take the following steps to make reference to its use of the IPEV Valuation Guidelines in their financial statements:
Formally adopt the use of the IPEV Guidelines in their Valuation Policies and Procedures.
Include in their footnotes accompanying the financial statements the following or similar statement:
“In developing the specific procedures and processes used for developing its estimates of fair value, the Fund has used the industry guidance set forth in the IPEV Valuation Guidelines.”
Typically this statement would be included in the footnotes either where the accounting policies are discussed or where the fair value disclosures are made.
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