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LPs to sharpen focus on valuations

by Krystal Scanlon 15 June 2020

A growing number of LPs are calling for independent valuations of portfolio companies, according to the latest investor survey by Coller Capital.

The firm’s Global Private Equity Barometer Summer 2020, which surveyed 107 private equity global investors found that almost half (48%) require or will require their GPs to perform independent valuations. This is broken down as 21% already asking their GPs to do this, while 27% expect to do so in the future.

On the flip side, 52% of respondents said they are unlikely to ask their GPs for independent valuations.

According to Stephen Ziff, co-head of investor relations at Coller Capital, this finding is no surprise. “It may be the LPs are satisfied with audited valuations or they run their own valuation exercise,” he said. “However it’s important to note that the aftermath of Covid-19 will bring greater focus to valuations. Investors are very keen to understand the current value of their assets and how it’s being impacted by the pandemic. They need to know what their portfolio is worth today, not what it was worth three months ago, and that again highlights the importance around transparency and communication between GPs and LPs.”

LPAC representation

Two thirds (67%) of LP respondents think LPACs do not provide equal representation of all investors in a fund, with LPs sitting on various LPACs holding this same view.

Ziff explained this finding doesn’t mean LPs think LPACs don’t represent them well, but clarifies investors don’t think LPACs represent everyone equally.

“LPACs have clearly evolved over time and become much more of a sounding board rather than a formal governing body,” he said. “In that situation, you’re going to see differences of opinion because it’s difficult to please everyone at all times. There will be some LPs on the LPAC that are closer to the GP and so naturally they will have a different relationship with the private equity firm. For example, some LPs may think certain LPAC members are in a position of conflict because they’ve co-invested with the firm.”

Direct communication

The survey also found the majority (73%) of LP respondents feel they would benefit from more direct interactions with one another, while only 27% believe they wouldn’t see any further gains.

“The important thing to bear in mind is, the 27% of LPs are not saying they aren’t having any direct interactions at the moment,” explained Ziff. “Those investors may feel they have sufficient interaction with other LPs, or a level that suits them, and they don’t feel they need more.”

This could be a natural result of LPs behaving differently - with some investors preferring more discreet operations and communications while others are happy to be more representative of their peers in the industry.

Transparency

Of those surveyed, 82% of LPs are satisfied with the levels of transparency displayed by most GPs. Despite the Coronavirus pandemic, this is a stark contrast to the years after the global financial crisis, when only 40% were satisfied in summer 2009, but dipped to 39% by summer 2012.

LP usage of data aggregator services

Coller also found a third (35%) of LPs currently use a data provider to collect standardised performance data directly from GPs, while a further 24% said they are likely to do this in the next three years.

On the flip side, less than half (41%) of LPs said they don’t currently use a data provider and have no plans to change this in the future.

“There is a thirst across all industries, not just private equity, for more data and to digest that information and work out what it means in the context of the business,” added Ziff. “I think there is an increasing role data aggregators can play in collating the information in a form which is valuable to both LPs and GPs.”

EBITDA add-backs

An EBITDA add-back is an expense added back to the profits of the business for the sole purpose of improving the profits of the company. In most cases, add-backs are earnings before interest, taxes, depreciation and amortisation or EBITDA.

Aad-backs are a legal expense and they appear in financial statements of the business, such as an income statement, profit and loss statement or tax return. However, they have no economic value in the performance of the business.

With that in mind, Coller’s Barometer found two thirds (67%) of LP respondents are concerned about the use of EBITDA add-backs by private equity funds because it materially inflates the risk of PE investments.

“When a GP values a company, one metric they use is EBITDA,” explained Ziff. “The question is then what is the EBITDA number and is it a true reflection of the performance of the business or have any elements been added back, which might artificially misrepresent the EBITDA - so that’s why LPs would be concerned.”

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