Valuation of PE portfolio investments for financial reporting can be challenging for many reasons. PE investments are, by nature, illiquid. Portfolio companies are not publicly traded, and holding periods are generally long. PE investments often employ complex capital structures that include several tranches of equity, debt or hybrid securities with differing rights to intermediate and exit proceeds. In addition, derivative instruments are also popularly used in incenting management teams.
Market participants are increasingly sensitive to (the appearance of) conflicts of interest in PE valuations. In the absence of public, transparent information, investors have to rely on valuation marks provided by PE managers to assess performance, review allocations, determine compensation and fulfill their own reporting requirements. Regulatory agencies, including the SEC, are increasingly scrutinizing valuation practices within PE and other alternative investment managers.
In the absence of public price discovery, analysts must rely on or devise models to conduct valuations of portfolio companies and investments. At the same time, accounting principles prescribe maximizing the use of publicly observable inputs in the valuation models. A defensible valuation opinion needs to consider, conduct, and document a number of procedures including historical financial review, independent analysis of public guideline or comparable companies and private transactions, evaluation of acceptable and relevant income methods (capitalization or discounted cash flow), and tests for internal consistency.
Mercer Capital has years of experience in providing third-party valuation opinions on illiquid investments to PE clients’ and other stakeholders’ satisfaction. Our recent presentation, “Best Practices for Fair Value Measurement,” available at http://mer.cr/pe-val-ppt, throws some light upon a number of valuation issues specific to PE portfolios.
It is vital that analysts exercise impartiality in conducting portfolio valuations. Larger PE funds increasingly rely on valuations prepared by third-party specialists to ensure objective reporting of portfolio investments. Investor-facing groups including the Institutional Limited Partner Association, European Private Equity and Venture Capital Association, and the Alternative Investment Management Association acknowledge and recommend the use of independent third-party valuation specialists.
Contact a Mercer Capital professional to discuss your needs for independent valuation and consulting services.
Sujan Rajbhandary, vice president, is a senior member of Mercer Capital’s Financial Reporting Valuation Group, which provides fair value opinions and related advisory services to public companies, private companies, and alternative investment vehicles. Sujan has valued financial ...
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Portfolio Valuation Can Be Complex, Risky