Comment: Known or knowable? It depends

By Nic Müller, CEO of Avega Capital Management

Every couple of years, the valuation community gets together to discuss the latest trends in the application of fair value, which culminates in the publication of a revised International Private Equity and Venture Capital Valuation (IPEV) guidelines. In case you missed it – the consultation was publicly available and closed last month. While some of the changes are cosmetic, there are a few hidden gems in this document, one of which I want to highlight: the clarifications on ‘Known or Knowable’.

This has been a source of debate for many years, especially given the apparent conflict with auditing standards on events after the reporting date, also called subsequent events. Auditors consider them either ‘adjusting’ (i.e. triggering a change in a primary statement, for instance a value of a receivable) or ‘non-adjusting’ (which may be disclosed if material). They would generally not be adjusting unless they shed light on an event or condition which happened before the balance sheet date. Classic example: Your main factory burns down on New Year’s eve, but the CFO only learns about it on January 4th. This is an example for a) poor governance and b) an adjusting event. If the factory burns down two minutes after midnight though, it would technically be considered non-adjusting.

Where is the conflict potential for the private funds industry? Assume a term sheet about a new financing round is tabled and materially agreed but not signed before January 2nd. Does it trigger a change in fair value as at December 31st? Auditors would think yes because the signature could merely be seen as a post-balance sheet event indicating that an event or condition was already present as at December 31st. The valuation practitioner’s view? Not so sure.

The new IPEV guidelines plan to add the following: “Known or Knowable information pertains to facts, conditions, or observable information which exists as of the measurement date and is available to the valuer or would reasonably be available to valuer through routine inquiry or due diligence.” This language sounds familiar to you? Probably you flipped through the AICPA’s accounting and valuation guide which serves as a major source of inspiration for the IPEV guidelines. In fact, I’m counting 18 instances of “knowable” vs seven in the current version of the guidelines. As much as it clarifies (it is definitely not “known” that a term sheet has been signed, because, well, in fact it hasn’t), it also opens the room for further interpretation – could the fact that a term sheet is literally final be reasonably be considered to be information available to market participants through routine inquiry or due diligence? I personally would say yes, but I have every respect for anyone who has seen deals falling through the last minute. And what about that? Supposedly it is not signed by January 2nd and the start-up needs to shut down operations by February 15th when their investors haven’t closed their books yet – is this knowable? Would it be adjusting in the auditors’ eyes?

Those concepts are not necessarily aligned and can only be solved by rigorous application of policies and procedures that govern your valuation process to ensure that similar events and conditions are treated similarly across your portfolios, and are in line with your regulator’s and auditor’s local application of GAAP and GAAS. Now it is made explicit in the IPEV guidelines and my hope is that this re-ignites this discussion and hopefully brings consistency across fund domiciles and accounting frameworks.