On May 15, the AICPA’s Financial Reporting Executive Committee released a working draft of the AICPA Accounting and Valuation Guide Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies. The document provides guidance and illustrations for preparers of financial statements, independent auditors, and valuation specialists regarding the accounting for and valuation of portfolio company investments of venture capital and private equity funds and other investment companies. The comment period ends August 15, 2018.
Weighing in at nearly 650 pages, the guide defies quick summary. As noted in the preliminary “Guide to the Guide” section, different chapters in the working draft are likely to be of greater interest to some groups of intended users than others. In this introduction to the Guide, we provide a brief overview of the chapters and appendices with which PE and VC managers should develop familiarity.
The Guide distinguishes between the economic and non-economic rights typical of senior classes of preferred stock. Analysts generally value the economic rights attached to different share classes using one of four methods: scenario-based methods, the option pricing method, the current value method, or the hybrid method. The Guide provides a comprehensive overview of the relative strengths and weaknesses of these methods and describes which circumstances are most conducive to the use of each.
Chapter 10 of the Guide discusses the calibration framework and provides examples of how initial valuation assumptions used in valuing a debt or equity investment in a business can be calibrated with the original transaction price and subsequently adjusted to take into account changes in the subject investment and market conditions at the measurement date. When subsequent funding rounds take place, calibrating to the most recent transaction is typically most relevant, and the Guide outlines six different types of transactions and the process of potentially inferring value from these types of transactions.
The primary purpose of backtesting is to assess and improve the valuation process going forward. The Guide provides an overview of the backtesting process and advice on how to identify and evaluate factors that can contribute to a difference in value for a particular investment between the measurement date and event date. The final section of Chapter 11 provides nine examples illustrating the backtesting process across different types of investments and under various scenarios.
In short, the new Guide is a welcome addition to the resources available for fund managers in developing reliable fair value measurements for portfolio investments. We expect that having a common set of acknowledged best practices will promote efficiency in the preparation and auditing of fair value measurements. We will provide more detailed comments on specific elements of the draft Guide in the coming weeks. In the meantime, please do not hesitate to call us to discuss how any element of the new Guide may affect your portfolio valuation process.
This article originally appeared in Mercer Capital’s Portfolio Valuation Newsletter, Second Quarter 2018.
Travis W. Harms leads Mercer Capital’s Family Business Advisory Services Group. Travis’s practice focuses on providing financial education, valuation, and other strategic financial consulting to multi-generation family businesses. The Family Business Advisory Services Group helps ...
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