Your SlideShare is downloading. ×
I N T E R N AT I O N A L   P R I VAT E E Q U I T Y A N D       V E N T U R E C A P I TA LVA L U AT I O N G U I D E L I N E...
These guidelines have been developed by the IPEV Board with the valuable input and endorsementof the following association...
DisclaimerThe information contained within this paper has been produced with reference to the contributions of a numberof ...
CONTENTSPRE FA CE                                                             6IN T RODU CT ION                           ...
P R E FA C EThese Guidelines set out recommendations, intended to                                                         ...
INTRODUCTIONPrivate equity managers may be required to carry out                            The requirements and implicati...
DEFINITIONSThe following definitions shall apply in these Guidelines.                                                    F...
Net Asset Value (‘NAV’)                                                          Underlying BusinessNAV of a Fund is the a...
SECTION I:D E T E R M I N I N G F A I R VA L U E10   I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E ...
1. T H E C O N C E P T                                             OF              F A I R VA L U E  The Fair Value is the...
2. P R I N C I P L E S                            OF          VA L U AT I O NIn private equity, value is generally crystal...
Apportion the Attributable Enterprise Value  Because of the uncertainties inherent in                                     ...
3 . VA L U AT I O N M E T H O D O L O G I E S3.1. General                                                                 ...
An appropriate methodology will incorporate available                          Methodologies should be applied consistentl...
3. VA L U AT I O N M E T H O D O L O G I E SIn particular, the following factors may indicate that the price              ...
Marketing and sales measures:                                                 However, the necessity and magnitude of the ...
3. VA L U AT I O N M E T H O D O L O G I E SA revenue multiple is commonly the product of an                              ...
Whilst there is an argument that the market capitalisation                     When considering adjustments to reported mu...
3. VA L U AT I O N M E T H O D O L O G I E SHowever, their appropriateness in this respect is often                       ...
3.6. Discounted Cash Flows or Earnings     (of Underlying Business)                                                      I...
3. VA L U AT I O N M E T H O D O L O G I E SThis methodology, because of its flexibility, is capable of                   ...
3.9. Available Market Prices                                                   In determining the level of discount to app...
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
110130 international pe_vc_valuation_guidelines_sep_2009_update
Upcoming SlideShare
Loading in...5
×

110130 international pe_vc_valuation_guidelines_sep_2009_update

254

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
254
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
15
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Transcript of "110130 international pe_vc_valuation_guidelines_sep_2009_update"

  1. 1. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA LVA L U AT I O N G U I D E L I N E S Edition August 2010
  2. 2. These guidelines have been developed by the IPEV Board with the valuable input and endorsementof the following associations:AFIC - Association Française des Investisseurs en Capital*AIFI - Italian Private Equity and Venture Capital AssociationAMEXCAP - Mexican Private Equity AssociationAMIC - Moroccan Private Equity and Venture Capital AssociationAPCRI - Portuguese Private Equity and Venture Capital AssociationAPEA - Arab Private Equity AssociationASCRI - Spanish Private Equity and Venture Capital AssociationATIC - Tunisian Venture Capital AssociationAVCA - African Venture Capital AssociationAVCAL - Australian Private Equity and Venture Capital AssociationAVCO - Austrian Private Equity and Venture Capital OrganizationBVA - Belgian Venturing AssociationBVCA - British Venture Capital Association*BVK - German Private Equity and Venture Capital Association e.V.CVCA - Canada’s Venture Capital and Private Equity AssociationCVCA - China Venture Capital AssociationCVCA - Czech Venture Capital and Private Equity AssociationDVCA - Danish Venture Capital AssociationEMPEA - Emerging Markets Private Equity AssociationEVCA - European Private Equity and Venture Capital Association*FVCA - Finnish Venture Capital AssociationGVCA - Gulf Venture Capital AssociationHKVCA - Hong Kong Venture Capital AssociationHVCA - Hungarian Venture Capital and Private Equity AssociationILPA - Institutional Limited Partners AssociationIVCA - Irish Venture Capital AssociationLAVCA - Latin American Venture Capital AssociationLPEQ - LPEQ Listed Private EquityLVCA - Latvian Venture Capital AssociationNVCA - Norwegian Venture Capital & Private Equity AssociationNVP - Nederlandse Vereniging van Participatiemaatschappijen (Dutch Private Equity andVenture Capital Association)NZVCA - New Zealand Private Equity & Venture Capital AssociationPPEA - Polish Private Equity AssociationRéseau Capital - Québec Venture Capital and Private Equity AssociationRVCA - Russian Private Equity and Venture Capital AssociationSAVCA - Southern African Venture Capital and Private Equity AssociationSECA - Swiss Private Equity and Corporate Finance AssociationSLOVCA - Slovak Venture Capital AssociationSVCA - Singapore Venture Capital and Private Equity AssociationSVCA - Swedish Private Equity and Venture Capital Association(Endorsement as of 31 January 2011)* AFIC, BVCA and EVCA founded the IPEV Board in 2005. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 3
  3. 3. DisclaimerThe information contained within this paper has been produced with reference to the contributions of a numberof sources. The IPEV Board has taken suitable steps to ensure the reliability of the information presented.However, the IPEV Board nor other named contributors, individuals or associations can accept responsibilityfor any decision made or action taken, based upon this paper or the information provided herein.For further information please visit: www.privateequityvaluation.com
  4. 4. CONTENTSPRE FA CE 6IN T RODU CT ION 7DE FIN IT ION S 8SE CT ION I: DE T E RM INING FAIR VALUE 101. The Concept of Fair Value 112. Principles of Valuation 113. Valuation Methodologies 14 3.1. General 14 3.2. Selecting the Appropriate Methodology 14 3.3. Price of Recent Investment 15 3.4. Multiples 17 3.5. Net Assets 20 3.6. Discounted Cash Flows or Earnings (of Underlying Business) 21 3.7. Discounted Cash Flows (from the Investment) 21 3.8. Industry Valuation Benchmarks 22 3.9. Available Market Prices 234. Valuing Fund Interests 24 4.1. General 24 4.2. Adjustments to Net Asset Value 24 4.3. Secondary Transactions 25SE CT ION II: A PPL ICATION G UIDANCE 26Introduction 271. Specific Considerations 27 1.1. Insider Funding Rounds 27 1.2. Distressed Market 27 1.3. Deducting Higher Ranking Instruments 28 1.4. Bridge Financing 28 1.5. Mezzanine Loans 28 1.6. Rolled up Loan Interest 29 1.7. Indicative Offers 29 1.8. Impacts from Structuring 29E N DORSIN G A SSOCIATIONS 31
  5. 5. P R E FA C EThese Guidelines set out recommendations, intended to Where there is conflict between a recommendationrepresent current best practice, on the valuation of private contained in these Guidelines and the requirements ofequity and venture capital investments. The term “private any applicable laws or regulations or accounting standardequity” is used in these Guidelines in a broad sense to or generally accepted accounting principle, the latterinclude investments in early stage ventures, management requirements should take precedence.buyouts, management buyins and similar transactions andgrowth or development capital. No member of the International Private Equity and Venture Capital Valuation Guidelines (‘IPEV Guidelines’) BoardThe recommendations are intended to be applicable across (‘IPEV Board’), any committee or working party thereof canthe whole range of Private Equity Funds (seed and start-up accept any responsibility or liability whatsoever (whether inventure capital, buyouts, growth/development capital, etc) respect of negligence or otherwise) to any party as a resultand financial instruments commonly held by such Private of anything contained in or omitted from the GuidelinesEquity Funds. They also provide a basis for valuing nor for the consequences of reliance or otherwise oninvestments by other entities, including Funds-of-funds, the provisions of these Guidelines.in such Private Equity Funds. These Guidelines should be regarded as supersedingThe recommendations themselves are surrounded by previous Guidelines issued by the IPEV Board with effecta border and set out in bold type, whereas explanations, for reporting periods post 1 July 2009.illustrations, background material, context and supportingcommentary, which are provided to assist in theinterpretation of the recommendations, are set outin normal type.6 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  6. 6. INTRODUCTIONPrivate equity managers may be required to carry out The requirements and implications of financial reportingperiodic valuations of Investments as part of the reporting standards and in particular International Financialprocess to investors in the Funds they manage. Reporting Standards and US GAAP have been consideredThe objective of these Guidelines is to set out best practice in the preparation of these Guidelines. This has been done,where private equity Investments are reported at ‘Fair in order to provide a framework for Private Equity FundsValue’, with a view to promoting best practice and hence for arriving at a Fair Value for Investments which ishelping investors in Private Equity Funds make better consistent with accounting principles.economic decisions. It is not a requirement of accounting principles thatThe increasing importance placed by international these Guidelines are followed. However compliance withaccounting authorities on Fair Value reinforces the need these accounting principles can be achieved by followingfor the consistent use of valuation standards worldwide the Guidelines.and these Guidelines provide a framework for consistentlydetermining valuations for the type of Investments held These Guidelines are intended to represent current bestby Private Equity Funds. practice and therefore will be revisited and, if necessary, revised to reflect changes in international regulation orPrivate Equity Funds are typically governed by a combination accounting standards.of legal or regulatory provisions or by contractual terms.It is not the intention of these Guidelines to prescribe or These Guidelines are concerned with valuation fromrecommend the basis on which Investments are included in a conceptual standpoint and do not seek to addressthe accounts of Funds. The IPEV Board confirms fair value best practice as it relates to investor reporting, internalas the best measure of valuing private equity portfolio processes, controls and procedures, governance aspects,companies and investments in private equity funds. Committee oversights, the experience and capabilitiesThe board’s support for fair value is underpinned by required of the Valuer or the audit or review of valuations.the transparency it affords investors in funds, which usefair value as an indication of the interim performance of A distinction is made in these Guidelines between the basisa portfolio. In addition, institutional investors require fair of valuation (Fair Value), which defines what the carryingvalue to make asset allocation decisions, and to produce amount purports to represent, a valuation methodologyfinancial statements for regulatory purposes. (such as the earnings multiple technique), which details the method or technique for deriving a valuation, and inputs used in the valuation methodology (such as EBITDA). I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 7
  7. 7. DEFINITIONSThe following definitions shall apply in these Guidelines. Fair Value The Fair Value is the price at which an orderly transactionActive Market would take place between Market Participants at theA financial instrument is regarded as quoted in an active Reporting Date (measurement date).market if quoted prices are readily and regularly availablefrom an exchange, dealer, broker, industry group, pricing Fund or Private Equity Fundservice or regulatory agency, and those prices represent The Fund or Private Equity Fund is the generic term usedactual and regularly occurring market transactions on in these Guidelines to refer to any designated pool ofan arms length basis. investment capital targeted at all stages of private equity Investment from start-up to large buyout, including thoseA market is considered active when transactions are taking held by corporate entities, limited partnerships andplace regularly at an arms length basis with sufficient other investment vehicles.volume and frequency to determine a price on an ongoingbasis. The necessary level of trading required to meet these Fund-of-Fundscriteria is a matter of judgement. Fund-of-Funds is the generic term used in these GuidelinesAttributable Enterprise Value to refer to any designated pool of investment capital targeted at investment in underlying Private Equity Funds.The Attributable Enterprise Value is the Enterprise Valueattributable to the financial instruments held by the Fund Investee Companyand other financial instruments in the entity that rankalongside or beneath the highest ranking instrument The term Investee Company refers to a single business orof the Fund. group of businesses in which a Fund is directly invested.Distressed or Forced Transaction InvestmentA forced liquidation or distress sale (i.e., a forced An Investment refers to all of the financial instrumentstransaction) is not an orderly transaction and is not in an Investee Company held by the Fund.determinative of Fair Value. An entity applies judgementin determining whether a particular transaction Liquidityis distressed or forced. Liquidity is defined as the relative ease and promptness with which an instrument may be sold when desired.Enterprise ValueThe Enterprise Value is the value of the financial Market Participantsinstruments representing ownership interests in Market Participants are potential or actual willing buyersan entity plus the net financial debt of the entity. or willing sellers when neither is under any compulsion to buy or sell, both parties having reasonable knowledge of relevant facts and who have the ability to perform sufficient due diligence in order to be able to make orderly investment decisions related to the enterprise.8 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  8. 8. Net Asset Value (‘NAV’) Underlying BusinessNAV of a Fund is the amount estimated as being The Underlying Business is the operating entities in whichattributable to the investors in that Fund on the basis the Fund has invested, either directly or through a numberof the Fair Value of the underlying Investee Companies of dedicated holding companies.and other assets and liabilities. ValuerOrderly Transaction The Valuer is the person with direct responsibility forAn orderly transaction is a transaction that assumes valuing one or more of the Investments of the Fundexposure to the market for a period prior to the Reporting or Fund-of-Funds.Date to allow for marketing activities that are usual andcustomary for transactions involving such assets or liabilities.Quoted InstrumentA Quoted Instrument is any financial instrument for whichquoted prices reflecting normal market transactions arereadily and regularly available from an exchange, dealer,broker, industry group, pricing service or regulatory agency.RealisationRealisation is the sale, redemption or repayment ofan Investment, in whole or in part; or the insolvency ofan Investee Company, where no significant return tothe Fund is envisaged.Reporting DateIs the date for which the valuation is being prepared,which equates to the measurement date.Secondary TransactionA Secondary Transaction refers to a transaction whichtakes place when a holder of an interest in unquoted orilliquid Funds trades their interest to another party.Unquoted InstrumentAn Unquoted Instrument is any financial instrument otherthan a Quoted Instrument. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 9
  9. 9. SECTION I:D E T E R M I N I N G F A I R VA L U E10 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  10. 10. 1. T H E C O N C E P T OF F A I R VA L U E The Fair Value is the price at which an orderly transaction would take place between Market Participants at the Reporting Date. For Quoted Instruments, available market prices will be the primary basis for the determination of Fair Value. For Unquoted Investments, the estimation of Fair Value requires the Valuer to assume the Underlying Business is realised at the Reporting Date, appropriately allocated to the various interests, regardless of whether the Underlying Business is prepared for sale or whether its shareholders intend to sell in the near future.The objective is to estimate the hypothetical Although transfers of shares in privateexchange price at which Market Participants businesses are often subject to restrictions,would agree to transact at the Reporting Date. rights of pre-emption and other barriers, it should still be possible to estimate whatFair Value is not the amount that an entity amount a willing buyer would pay to takewould receive or pay in a forced transaction, ownership of the Investment.involuntary liquidation or distressed sale.However the hypothetical exchange price musttake into account current market conditionsfor buying and selling assets.2. P R I N C I P L E S OF VA L U AT I O N The Fair Value of each Investment In estimating Fair Value for an should be assessed at each Reporting Investment, the Valuer should apply a Date. methodology that is appropriate in light of the nature, facts and circumstances of the Investment and its materiality inIn the absence of an active market for a the context of the total Investmentfinancial instrument, the Valuer must estimate portfolio and should use reasonableFair Value utilising one or more of the valuation data and market inputs, assumptionsmethodologies. and estimates. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 11
  11. 11. 2. P R I N C I P L E S OF VA L U AT I O NIn private equity, value is generally crystallised through Due to the complex interaction of these factors anda sale or flotation of the entire Underlying Business, often the lack of directly comparable market transactions,rather than through a transfer of individual shareholder care should be applied when using publicly availablestakes, the value of the business as a whole at information regarding other entities in deriving a valuation.the Reporting Date (Enterprise Value) will often provide In order to determine the Fair Value of an Investment,a key insight into the value of investment stakes in the Valuer will have to exercise judgement and makethat business. necessary estimates to adjust the market data to reflect the potential impact of other factors such as geography, credit risk, foreign currency, rights attributable, The Fair Value is estimated by the Valuer, equity prices and volatility. whichever valuation methodologies are used, from the Enterprise Value, as follows: As such, it must be recognised that, whilst valuations (i) Determine the Enterprise Value of the do provide useful interim indications of the progress Investee Company using the valuation of a particular Investment or portfolio of Investments, methodologies; ultimately it is not until Realisation that true performance is firmly determined. A Valuer should be aware of reasons (ii) Adjust the Enterprise Value for surplus assets why realisation proceeds are different from their estimates or excess liabilities and other contingencies of Fair Value. and relevant factors to derive an Adjusted Enterprise Value for the Investee Company; Fair Value should reflect reasonable estimates and (iii) Deduct from this amount any financial assumptions for all significant factors that parties to an instruments ranking ahead of the highest arm’s length transaction would be expected to consider, ranking instrument of the Fund in a including those which impact upon the expected cash liquidation scenario (e.g. the amount that flows from the Investment and upon the degree of risk would be paid) and taking into account associated with those cash flows. the effect of any instrument that may dilute the Fund’s Investment to derive In assessing the reasonableness of assumptions and the Attributable Enterprise Value; estimates, the Valuer should: (iv) Apportion the Attributable Enterprise Value • note that the objective is to replicate those that between the company’s relevant financial the parties in an arm’s-length transaction would make instruments according to their ranking; at the Reporting Date; • take account of events taking place subsequent to the (v) Allocate the amounts derived according to Reporting Date where they provide additional evidence the Fund’s holding in each financial of conditions that existed at the Reporting Date; instrument, representing their Fair Value. • take account of current market conditions at the reporting date; andIt is important to recognise the subjective nature of • take account of materiality considerations.private equity Investment valuation. It is inherently basedon forward-looking estimates and judgements about theUnderlying Business itself: its market and the environmentin which it operates; the state of the mergers andacquisitions market; stock market conditions andother factors that exist at the Reporting Date.12 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  12. 12. Apportion the Attributable Enterprise Value Because of the uncertainties inherent in appropriately estimating Fair Value for private equity The apportionment should reflect the respective amounts Investments, care should be applied in exercising accruing to each financial instrument holder in the event judgement and making the necessary estimates. of a sale or flotation at the Reporting Date. As discussed However, the Valuer should be wary of applying further in section II 1.8., where there are ratchets or excessive caution. share options or other mechanisms (such as ‘liquidation preferences’, in the case of Investments in early-stagePrivate Equity Funds often undertake an Investment with businesses) in place which are likely to be triggereda view to build, develop and/or to effect substantial in the event of a sale of the company at the givenchanges in the Underlying Business, whether it is to its Enterprise Value at that date, these should be reflectedstrategy, operations, management, or financial condition. in the apportionment.Sometimes these situations involve rescue refinancing ora turnaround of the business in question. Whilst it might The estimation of Fair Value should be undertaken onbe difficult in these situations to determine Fair Value, the assumption that options and warrants are exercised,it should in most cases be possible to estimate the amount where the Fair Value is in excess of the exercise price anda Market Participant would pay for the Investment accordingly it is a reasonable assumption that these will bein question. exercised. The aggregate exercise price of these may result in surplus cash arising in the Underlying Business ifThere may be situations where: the aggregate exercise price is significant.• the range of reasonable Fair Value estimates is significant; Differential allocation of proceeds may have an impact on• the probabilities of the various estimates within the value of an Investment. If liquidation preferences exist, the range cannot be reasonably assessed; these need to be reviewed to assess whether they are• the probability and financial impact of achieving a key expected to give rise to a benefit to the Fund, or a benefit milestone cannot be reasonably predicted; and to a third party to the detriment of the Fund.• there has been no recent investment into the business. Where significant positions in options and warrants areWhile these situations prove difficult, the Valuer must held by the Fund, these may need to be valued separatelystill come to a conclusion as to their best estimate of from the underlying investments using an appropriatethe hypothetical exchange price between willing option based pricing model.Market Participants.Estimating the increase or decrease in Fair Value insuch cases may involve reference to broad indicatorsof value change (such as relevant stock market indices).After considering these broad indicators, in some situations,the Valuer might reasonably conclude that the Fair Valueat the previous Reporting Date remains the best estimateof Fair Value.Where a change in Fair Value is perceived to haveoccurred, the Valuer should amend the carrying valueof the Investment to reflect the estimated impact. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 13
  13. 13. 3 . VA L U AT I O N M E T H O D O L O G I E S3.1. General Movements in rates of exchange may impact the value of the Fund’s Investments and these should be takenA number of valuation methodologies that may be into account.considered for use in estimating the Fair Value ofUnquoted Instruments are described in sections 3.3. to3.8. below. These methodologies should be amended as Where the reporting currency of the Fundnecessary to incorporate case-specific factors affecting Fair is different from the currency in whichValue. Methodologies for valuing Quoted Instruments are the Investment is denominated, translationdescribed in section 3.9. below. into the reporting currency for reporting purposes should be done using the bid spot exchange rateFor example, if the Underlying Business is holding surplus prevailing at the Reporting Date.cash or other assets, the value of the business shouldreflect that fact. 3.2. Selecting the AppropriateBecause, in the private equity arena, value is generally Methodologycrystallised through a sale or flotation of the entireUnderlying Business, rather than through a transfer The Valuer should exercise their judgement toof individual shareholder stakes, the value of the business select the valuation methodology that is the mostas a whole at the Reporting Date will often provide a key appropriate for a particular Investment.insight into the value of investment stakes in that business.For this reason, a number of the methodologies describedbelow involve estimating the Enterprise Value as an The key criterion in selecting a methodology is that itinitial step. should be appropriate in light of the nature, facts and circumstances of the Investment and its materiality in theThere will be some situations where the Fair Value will context of the total portfolio of Investments. The Valuerderive mainly from the expected cash flows and risk may consider utilising further methodologies to checkof the relevant financial instruments rather than from the Fair Value derived, if appropriate.the Enterprise Value. The valuation methodology usedin these circumstances should therefore reflect this fact. When selecting the appropriate methodology each Investment should be considered individually. Where an immaterial group of Investments in a portfolio are similar in In determining the Fair Value of an Investment, terms of risk profile and industry, it is acceptable to apply the Valuer should use judgement. This includes a the same methodology across all Investments in that detailed consideration of those specific terms of immaterial group. The methodology applied should be the Investment which may impact its Fair Value. consistent with that used for material investments with In this regard, the Valuer should consider the a similar risk profile in that industry. substance of the Investment, which may take preference over the strict legal form.14 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  14. 14. An appropriate methodology will incorporate available Methodologies should be applied consistently from periodinformation about all factors that are likely materially to to period, except where a change would result in betteraffect the Fair Value of the Investment. estimates of Fair Value.The Valuer will select the valuation methodology that The basis for any changes in valuation methodologiesis the most appropriate and consequently make valuation should be clearly understood. It is expected that thereadjustments on the basis of their informed and experienced would not be frequent changes in valuation methodologiesjudgement. This will include consideration of factors such as: over the course of the life of an investment.• the relative applicability of the methodologies used The table below identifies a number of the most widely given the nature of the industry and current market used methodologies conditions;• the quality, and reliability of the data used in each METHODOLOGY methodology; Price of Recent Investment• the comparability of enterprise or transaction data; Multiples• the stage of development of the enterprise; Net assets• the ability of the enterprise to generate maintainable Discounted cash flows or earnings (of Underlying Business) profits or positive cashflow; and Discounted cash flows (from the Investment)• any additional considerations unique to the enterprise. Industry valuation benchmarksIn assessing whether a methodology is appropriate, theValuer should be biased towards those methodologies that 3.3. Price of Recent Investmentdraw heavily on market-based measures of risk and return. Where the Investment being valued was itself madeFair Value estimates based entirely on observable market recently, its cost may provide a good indication of Fairdata should be of greater reliability than those based on Value. Where there has been any recent Investment inassumptions. In some cases observable market data may the Investee Company, the price of that Investment willrequire adjustment by the Valuer to properly reflect provide a basis of the valuation.the facts and circumstances of the entity being valued.This adjustment should not be automatically regarded The validity of a valuation obtained in this way is inevitablyas reducing the reliability of the Fair Value estimation. eroded over time, since the price at which an Investment was made reflects the effects of conditions that existedMethodologies utilising discounted cashflows and industry on the date that the transaction took place. In a dynamicbenchmarks should rarely be used in isolation of the market- environment, changes in market conditions, the passagebased measures and then only with extreme caution. of time itself and other factors will act to diminish theThese methodologies may be useful as a cross-check of appropriateness of this methodology as a means ofvalues estimated using the market-based methodologies. estimating value at subsequent dates.Where the Valuer considers that several methodologies In addition, where the price at which a third party hasare appropriate to value a specific Investment, the Valuer invested is being considered as the basis of valuation,may consider the outcome of these different valuation the background to the transaction must be taken inmethodologies so that the results of one particular method to account.may be used as a cross-check of values or to corroborateor otherwise be used in conjunction with one or moreother methodologies in order to determine the Fair Valueof the Investment. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 15
  15. 15. 3. VA L U AT I O N M E T H O D O L O G I E SIn particular, the following factors may indicate that the price The Price of Recent Investment methodology is commonlywas not wholly representative of the Fair Value at the time: used in a seed, start-up or an early-stage situation, where there are no current and no short-term future• different rights attach to the new and existing earnings or positive cash flows. For these enterprises, Investments; typically, it is difficult to gauge the probability and financial• disproportionate dilution arising from a new investor; impact of the success or failure of development or research• a new investor motivated by strategic considerations; activities and to make reliable cash flow forecasts.• the transaction may be considered to be a forced sale or ‘rescue package’; or Consequently, the most appropriate approach to determine• the absolute amount of the new Investment is relatively Fair Value is a methodology that is based on market data, insignificant. that being the Price of a Recent Investment.This methodology is likely to be appropriate for all private If the Valuer concludes that the Price of Recent Investment,equity Investments, but only for a limited period after the unadjusted, is no longer relevant, and there are nodate of the relevant transaction. Because of the frequency comparable companies or transactions from which towith which funding rounds are often undertaken for seed infer value, it may be appropriate to apply an enhancedand start-up situations, or in respect of businesses engaged assessment based on an industry analysis, sector analysisin technological or scientific innovation and discovery, and/or milestone analysis.the methodology will often be appropriate for valuingInvestments in such circumstances. In such circumstances, industry-specific benchmarks/ milestones, which are customarily and routinely usedThe length of period for which it would remain in the specific industries of the Investee Company,appropriate to use this methodology will depend on can be used in estimating Fair Value where appropriate.the specific circumstances of the Investment and In applying the milestone approach, the Valuer attemptsis subject to the judgement of the Valuer. to ascertain whether there has been a change in the milestone and/or benchmark which would indicateIn stable market conditions with little change in the entity that the Fair Value of the investment has changed.or external environment, the length of period for whichthis methodology is likely to be appropriate will be longer For an investment in early or development stages,than during a period of a rapidly changing environment. commonly a set of agreed milestones would be established at the time of making the investment decision. These will In applying the Price of Recent Investment vary across types of investment, specific companies and methodology, the Valuer uses the initial cost of industries, but are likely to include; the Investment itself or, where there has been subsequent investment, the price at which a Financial measures: significant amount of new Investment into the • revenue growth; company was made, to estimate the Enterprise • profitability expectations; Value, but only for a limited period following • cash burn rate; the date of the relevant transaction. During the • covenant compliance. limited period following the date of the relevant transaction, the Valuer should in any case assess at Technical measures: each Reporting Date whether changes or events subsequent to the relevant transaction would • phases of development; imply a change in the Investment’s Fair Value. • testing cycles; • patent approvals.16 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  16. 16. Marketing and sales measures: However, the necessity and magnitude of the adjustments are relatively subjective and require a large amount of• customer surveys; judgment on the part of the Valuer. Where deterioration in• testing phases; value has occurred, the Valuer should reduce the carrying• market introduction; value of the Investment reported at the previous Reporting• market share. Date to reflect the estimated decrease.In addition, the key market drivers of the Investee Company, If there is evidence of value creation, such as those listedas well as the overall economic environment are relevant to above, the Valuer may consider increasing the carryingthe assessment. value of the Investment. Caution must be applied so that positive developments are only valued when theyIn applying the milestone analysis approach, the Valuer contribute to an increase in value of the Underlyingattempts to assess whether there is an indication of change Business when viewed by a Market Participant.in Fair Value based on a consideration of the milestones. When considering these more subtle indicators of valueThis assessment might include considering whether: enhancement, in the absence of additional financing• there has been any significant change in the results rounds or profit generation, the Valuer should consider of the Investee Company compared to budget plan what value a purchaser would place on these indicators, or milestone; taking into account the potential outcome and the costs• there have been any changes in expectation that and risks to achieving that outcome. technical milestones will be achieved;• there has been any significant change in the market In the absence of significant revenues, profits or positive for the Investee Company or its products or potential cash flows, other methodologies such as the earnings products; multiple are generally inappropriate. The DCF methodologies• there has been any significant change in the global may be utilised, however the disadvantages inherent in economy or the economic environment in which these, arising from the high levels of subjective judgement, the Investee Company operates; may render the methodology inappropriate.• there has been any significant change in the observable performance of comparable companies, or in the 3.4. Multiples valuations implied by the overall market; This methodology involves the application of an earnings• any internal matters such as fraud, commercial disputes, multiple to the earnings of the business being valued in litigation, changes in management or strategy order to derive a value for the business.If the Valuer concludes that there is an indication that This methodology is likely to be appropriate for anthe Fair Value has changed, they must estimate the Investment in an established business with an identifiableamount of any adjustment from the last Price of Recent stream of continuing earnings that are considered to beInvestment. By its very nature such adjustment will be maintainable.subjective. This estimation is likely to be based on objectivedata from the company, and the experience of the This section sets out guidance for preparing valuations ofinvestment professionals and other investors. businesses on the basis of positive earnings. For businesses that are still in the development stage and prior to positive earnings being generated, multiples of revenue may be used as a basis of valuation. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 17
  17. 17. 3. VA L U AT I O N M E T H O D O L O G I E SA revenue multiple is commonly the product of an Guidance on the interpretation of the terms in boldassumption as to the ‘normalised’ level of earnings that is given below.can be generated from that revenue. The methodologyand considerations set out here for earnings multiples Appropriate multipleequally apply if a multiple of revenue is utilised. A number of earnings multiples are used, including price/ earnings (P/E), Enterprise Value/earnings before interestThis methodology may be applicable to companies with and tax (EV/EBIT) and depreciation and amortisationnegative earnings, if the losses are considered to be (EV/EBITDA). The particular multiple used should betemporary and one can identify a level of ‘normalised’ appropriate for the business being valued. (N.B: The multiplesmaintainable earnings. of revenues and their use are presented in 3.8. Industry Valuation Benchmarks).This may involve the use of adjusted historic earnings,using a forecast level of earnings or applying a ‘sustainable’ In general, because of the role of financial structuringprofit margin to current or forecast revenues. in private equity, multiples should be used to derive an Enterprise Value for the Underlying Business. Where EBITDAThe most appropriate earnings to use in this methodology multiples are available, these are commonly used.would be those likely to be used by a prospective When unavailable, P/E multiples may be used since thesepurchaser of the business. are more commonly reported. For a P/E multiple to be comparable, the two entities should have similar financing In using the Earnings Multiple methodology structures and levels of borrowing. to estimate the Fair Value of an Investment, the Valuer should: Therefore, where a P/E multiple is used, it should generally be applied to an EBIT figure which is adjusted for finance (i) Apply a multiple that is appropriate and costs relating to operations, working capital and tax. reasonable (given the risk profile and earnings These adjustments are designed to eliminate the effect on growth prospects of the underlying company) the earnings of the acquisition finance on the Enterprise to the maintainable earnings of the company; Value since this is subsequently adjusted. (ii) Adjust the Enterprise Value for surplus assets or excess liabilities and other contingencies By definition, earnings multiples have as their numerator and relevant factors to derive an Adjusted a value and as their denominator an earnings figure. Enterprise Value for the Investee Company; The denominator can be the earnings figure for any specified period of time and multiples are often defined as ‘historical’, (iii) Deduct from this amount any financial ‘current’ or ‘forecast’ to indicate the earnings used. It is instruments ranking ahead of the highest important that the multiple used correlates to the period ranking instrument of the Fund in a and concept of earnings of the company being valued. liquidation scenario (e.g. the amount that would be paid) and taking into account the Reasonable multiple effect of any instrument that may dilute the Fund’s Investment to derive the Attributable The Valuer would usually derive a multiple by reference to Enterprise Value; current market-based multiples, reflected in the market valuations of quoted companies or the price at which (iv) Apportion the Attributable Enterprise Value companies have changed ownership. This market-based appropriately between the relevant financial approach presumes that the comparator companies are instruments. correctly valued by the market.18 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  18. 18. Whilst there is an argument that the market capitalisation When considering adjustments to reported multiples,of a quoted company reflects not the value of the company the Valuer should also consider the impact of thebut merely the price at which ‘small parcels’ of shares are differences between the liquidity of the shares being valuedexchanged, the presumption in these Guidelines is that and those on a quoted exchange. There is a risk associatedmarket based multiples are indicative of the value of with a lack of liquidity or marketability. The Valuer shouldthe company as a whole. consider the extent to which a prospective acquirer of those shares would take into account the additional risksWhere market-based multiples are used, the aim is associated with holding an unquoted share.to identify companies that are similar, in terms of riskattributes and earnings growth prospects, to the company In an unquoted company the risk arising from the lackbeing valued. This is more likely to be the case where of marketability is clearly greater for a shareholder whothe companies are similar in terms of business activities, is unable to control or influence a realisation process thanmarkets served, size, geography and applicable tax rate. for a shareholder who owns sufficient shares to drive a realisation at will. It may reasonably be expected that aIn using P/E multiples, the Valuer should note that prospective purchaser would assess that there is a higherthe P/E ratios of comparator companies will be affected risk associated with holding a minority position than forby the level of financial gearing and applicable tax rate a control position.of those companies. The multiple at the date of acquisition should be calibratedIn using EV/EBITDA multiples, the Valuer should note against the market comparable multiples. Differences, ifthat such multiples, by definition, remove the impact on any, should be understood and similar differences may bevalue of depreciation of fixed assets and amortisation of expected or need to be understood at subsequentgoodwill and other intangibles. If such multiples are used valuation dates.without sufficient care, the Valuer may fail to recognisethat business decisions to spend heavily on fixed assets or For example, the reasons why the comparator multiplesto grow by acquisition rather than organically do have real may need to be adjusted may include the following:costs associated with them which should be reflected • the size and diversity of the entities and, therefore,in the value attributed to the business in question. the ability to withstand adverse economic conditions; • the rate of growth of the earnings;It is important that the earnings multiple of each • the reliance on a small number of key employees;comparator is adjusted for points of difference between • the diversity of the product ranges;the comparator and the company being valued. These points • the diversity and quality of the customer base;of difference should be considered and assessed by • the level of borrowing;reference to the two key variables of risk and earnings • for any other reason the quality of earnings may differ; andgrowth prospects which underpin the earnings multiple. • the risks arising from the lack of marketability ofIn assessing the risk profile of the company being valued, the shares.the Valuer should recognise that risk arises from a range ofaspects, including the nature of the company’s operations, Recent transactions involving the sale of similar companiesthe markets in which it operates and its competitive are sometimes used as a frame of reference in seeking toposition in those markets, the quality of its management derive a reasonable multiple. It is sometimes argued, sinceand employees and, importantly in the case of private such transactions involve the transfer of whole companiesequity, its capital structure and the ability of the Fund whereas quoted multiples relate to the price for ‘smallholding the Investment to effect change in the company. parcels’ of shares, that they provide a more relevant source of multiples. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 19
  19. 19. 3. VA L U AT I O N M E T H O D O L O G I E SHowever, their appropriateness in this respect is often 3.5. Net Assetsundermined by the following: This methodology involves deriving the value of a business• the lack of forward looking financial data and other by reference to the value of its net assets. information to allow points of difference to be identified and adjusted for; This methodology is likely to be appropriate for a business• the generally lower reliability and transparency of whose value derives mainly from the underlying Fair Value reported earnings figures of private companies; and of its assets rather than its earnings, such as property• the lack of reliable pricing information for holding companies and investment businesses (such as the transaction itself. Funds-of-funds as more fully discussed in 4. Valuing Fund Interests).It is a matter of judgement for the Valuer as to whether,in deriving a reasonable multiple, they refer to a single This methodology may also be appropriate for a business thatcomparator company or a number of companies or is not making an adequate return on assets and for whichthe earnings multiple of a quoted stock market sector or a greater value can be realised by liquidating the businesssub-sector. It may be acceptable, in particular circumstances, and selling its assets. In the context of private equity,for the Valuer to conclude that the use of quoted sector it may therefore be appropriate, in certain circumstances,or sub-sector multiples or an average of multiples from for valuing Investments in loss-making companies anda ‘basket’ of comparator companies may be appropriate. companies making only marginal levels of profits.Maintainable earnings In using the Net Assets methodology to estimateIn applying a multiple to maintainable earnings, it is the Fair Value of an Investment, the Valuer should:important that the Valuer is satisfied that the earningsfigure can be relied upon. Whilst this might tend to favour (i) Derive an Enterprise Value for the companythe use of audited historical figures rather than unaudited using appropriate measures to value its assetsor forecast figures, it should be recognised that value is by and liabilities (including, if appropriate,definition a forward-looking concept, and quoted markets contingent assets and liabilities);more often think of value in terms of ‘current’ and ‘forecast’ (ii) Deduct from this amount any financialmultiples, rather than ‘historical’ ones. In addition, there is instruments ranking ahead of the highestthe argument that the valuation should, in a dynamic ranking instrument of the Fund in aenvironment, reflect the most recent available information. liquidation scenario (e.g. the amount thatThere is therefore a trade-off between the reliability and would be paid) and taking into account therelevance of the earnings figures available to the Valuer. effect of any instrument that may dilute theOn balance, whilst it remains a matter of judgement Fund’s Investment to derive the Attributablefor the Valuer, he should be predisposed towards using Enterprise Value; andhistorical (though not necessarily audited) earnings figures (iii) Apportion the Attributable Enterprise Valueor, if he believes them to be reliable, forecast earnings appropriately between the relevant financialfigures for the current year. instruments.Whichever period’s earnings are used, the Valuer shouldsatisfy himself that they represent a reasonable estimate ofmaintainable earnings, which implies the need to adjustfor exceptional or non-recurring items, the impact ofdiscontinued activities and acquisitions and forecastmaterial changes in earnings.20 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  20. 20. 3.6. Discounted Cash Flows or Earnings (of Underlying Business) In using the Discounted Cash Flows or Earnings (of Underlying Business) methodology to estimateThis methodology involves deriving the value of a business the Fair Value of an Investment, the Valuer should:by calculating the present value of expected future cashflows (or the present value of expected future earnings, (i) Derive the Enterprise Value of the company,as a surrogate for expected future cash flows). The cash using reasonable assumptions and estimationsflows and ‘terminal value’ are those of the Underlying of expected future cash flows (or expectedBusiness, not those from the Investment itself. future earnings) and the terminal value, and discounting to the present by applying theThe Discounted Cash Flows (DCF) technique is flexible appropriate risk-adjusted rate that quantifiesin the sense that it can be applied to any stream of cash the risk inherent in the company;flows (or earnings). In the context of private equity (ii) Deduct from this amount any financialvaluation, this flexibility enables the methodology to be instruments ranking ahead of the highestapplied in situations that other methodologies may be ranking instrument of the Fund in aincapable of addressing. While this methodology may liquidation scenario (e.g. the amount thatbe applied to businesses going through a period of great would be paid) and taking into accountchange, such as a rescue refinancing, turnaround, strategic the effect of any instrument that may diluterepositioning, loss making or is in its start-up phase, the Fund’s Investment to derive thethere is a significant risk in utilising this methodology. Attributable Enterprise Value;The disadvantages of the DCF methodology centre around (iii) Apportion the Attributable Enterprise Valueits requirement for detailed cash flow forecasts and the appropriately between the relevant financialneed to estimate the ‘terminal value’ and an appropriate instruments.risk-adjusted discount rate. All of these inputs requiresubstantial subjective judgements to be made, and thederived present value amount is often sensitive to small 3.7. Discounted Cash Flows (from thechanges in these inputs. Investment) This methodology applies the DCF concept and techniqueDue to the high level of subjectivity in selecting inputs to the expected cash flows from the Investment itself.for this technique, DCF based valuations are useful asa cross-check of values estimated under market-based Where Realisation of an Investment or a flotation ofmethodologies and should only be used in isolation of the Underlying Business is imminent and the pricingother methodologies under extreme caution. of the relevant transaction has been substantially agreed, the Discounted Cash Flows (from the Investment)In assessing the appropriateness of this methodology, methodology (or, as a surrogate, the use of a simplethe Valuer should consider whether its disadvantages discount to the expected Realisation proceeds or flotationand sensitivities are such, in the particular circumstances, value) is likely to be the most appropriate methodology.as to render the resulting Fair Value insufficiently reliable. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 21
  21. 21. 3. VA L U AT I O N M E T H O D O L O G I E SThis methodology, because of its flexibility, is capable of In circumstances where a Realisation is not foreseeable,being applied to all private equity Investment situations. the terminal value may be based upon assumptions ofIt is particularly suitable for valuing non-equity Investments the perpetuity cash flows accruing to the holder of thein instruments such as debt or mezzanine debt, since the Investment. These circumstances (which are expected to bevalue of such instruments derives mainly from instrument- rare in private equity) may arise where the Fund has littlespecific cash flows and risks rather than from the value of ability to influence the timing of a Realisation and/or thosethe Underlying Business as a whole. shareholders that can influence the timing do not seek a Realisation.Because of its inherent reliance on substantial subjectivejudgements, the Valuer should be extremely cautious of In using the Discounted Cash Flows (from theusing this methodology as the main basis of estimating Investment) methodology to estimate the FairFair Value for Investments which include an equity element. Value of an Investment, the Valuer should derive the present value of the Investment, usingThe methodology will often be useful as a sense-check reasonable assumptions and estimations ofof values produced using other methodologies. expected future cash flows and the terminal value and date, and the appropriate risk-adjusted rateRisk and the rates of return necessary to compensate for that quantifies the risk inherent to the Investment.different risk levels are central commercial variables in themaking of all private equity Investments. Accordingly thereexists a frame of reference against which to make discount 3.8. Industry Valuation Benchmarksrate assumptions. A number of industries have industry-specific valuationHowever the need to make detailed cash flow forecasts benchmarks, such as ‘price per bed’ (for nursing-homeover the Investment life may reduce the reliability and operators) and ‘price per subscriber’ (for cable televisioncrucially for equity Investments, there remains a need companies). Other industries, including certain financialto estimate the ‘terminal value’. services and information technology sectors and some services sectors where long-term contracts are a key feature,Where the Investment comprises equity or a combination use multiples of revenues as a valuation benchmark.of equity and other financial instruments, the terminalvalue would usually be derived from the anticipated value These industry norms are often based on the assumptionof the Underlying Business at Realisation. This will usually that investors are willing to pay for turnover or marketnecessitate making assumptions about future business share, and that the normal profitability of businesses inperformance and developments and stock market and the industry does not vary much.other valuation ratios at the assumed Realisation date.In the case of equity Investments, small changes in these The use of such industry benchmarks is only likelyassumptions can materially impact the valuation. In the to be reliable and therefore appropriate as thecase of non-equity instruments, the terminal value will main basis of estimating Fair Value in limitedusually be a pre-defined amount, which greatly enhances situations, and is more likely to be useful as athe reliability of the valuation. sense-check of values produced using other methodologies.22 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S
  22. 22. 3.9. Available Market Prices In determining the level of discount to apply, the Valuer should consider the extent of compensation a holderPrivate Equity Funds may be holding Quoted Instruments, would require when comparing the Investment in questionfor which there is an available market price. with an identical but unrestricted holding. Instruments quoted on an active stock market A Valuer may consider using an option pricing model should be valued at their bid prices on the to value the impact of this restriction on realisation, Reporting Date. If bid price is not required however in practice for restrictions which only cover by accounting regulation and not deemed to be a limited number of reporting periods, this is simplified appropriate, the most representative point to a simple mathematical discount to the quoted price. estimate in the bid/ask spread may be used. The Valuer should consistently use either the bid The discount applied should appropriately reflect the time price or the most representative point estimate value of money and the enhanced risk arising from the in the bid/ask spread. reduced liquidity. The discount rate used is a matter of judgement influenced by expected volatility which should reduce to zero at the end of the period.For certain Quoted Instruments there is only one marketprice quoted, representing, for example, the value at whichthe most recent trade in the instrument was transacted.For other Quoted Instruments there are two market pricesat any one time: the lower ‘bid’ price quoted by a marketmaker, which he will pay an investor for a holding (i.e.the investor’s disposal price), and the higher ‘ask’ price,which an investor can expect to pay to acquire a holding.However, as an alternative to the bid price (where notrequired by regulation), is the mid-market price (i.e. theaverage of the bid and ask prices), where this is consideredthe most representative point estimate in the bid/ask spread.This methodology should apply when the prices are set onan Active Market. Discounts should not be applied to prices quoted on an Active Market, unless there is some contractual, Governmental or other legally enforceable restriction that would impact the value realised at the Reporting Date. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 23

×