Valuations what’s new, what’s not and what matters
Valuation methods are coming under increased pressure and scrutiny from investors and regulators alike. With this, a plethora of new rules and updates to existing guides have hit the industry, with a particular focus on fair value. The most notable changes stem from The International Private Equity and Venture Capital Valuation (IPEV) Guidelines, and the American Institute of Certified Public Accountants (AICPA) rules. On top of these valuation regimes, there are also new regulations to take into account, most pressing of which is the Senior Management & Certification Regime (SMRC). Putting all of this together, what should CFOs be considering when it comes to valuations?
IPEV: Core values
The International Private Equity Valuations (IPEV) aims to provide uniform, globally-acceptable, best practice guidelines for PE and VC professionals, which can help with their accounting and regulatory requirements.
According to Sharon Davies, managing director, valuation services at Duff & Phelps the latest version (updated in 2018), includes two particular areas have caused a great deal of confusion.
Price of recent investment
“At each Measurement Date, Fair Value must be estimated using appropriate valuation techniques. The Price of a Recent Investment is not a default that precludes re-estimating Fair Value at each Measurement Date.” taken from IPEV Valuation Guidelines, December 2018, page 34.
While the December 2012 IPEV guidelines points out the price of recent investment could be used for a certain period of time and it’s probably still acceptable, the December 2015 update explains this figure isn’t appropriate as factors might have changed.
Davies says the latest update has gone a step further still by clarifying that price of recent investment is not a standalone valuation technique, because that figure may not be relevant anymore.
“You’ve got to do the work now, and you might end up with the same conclusion you did originally and that’s okay,” she says. “But you can’t start on the premise that the original price of recent investment is enough.”
While these changes have caused some upset and confusion, Davies stresses the actual principles of the guidelines haven’t changed. “The shift was created to make sure people weren’t just blindly relying on it,” she adds.
Concept of calibration
“Calibration validates that the Valuation Techniques using contemporaneous market inputs will generate Fair Value at inception and therefore that the Valuation Techniques using updated market inputs as of each subsequent Measurement Date will generate Fair Value at each such date.” taken from IPEV Valuation Guidelines, December 2018, page 16.
There is much more importance put on calibration in IPEV’s 2018 update compared with previous editions. Davies says in the latest document, calibration of entry point gives information about how you came to that figure today. When updating the valuation, there needs to be corresponding evidence of the factors and milestones. Similarly to the price of recent investment, it can’t be assumed that the recent figure still works. Further workings out must be completed to consider the appropriateness of that figure for this given time.
AICPA: Guiding star
The American Institute of Chartered Public Accountants published its guidelines in August this year. Compared with the IPEV document, which in its latest format is 70 pages long, the AICPA edition is in excess of 700 pages.
For those adhering to the IPEV guidelines, the much lengthier AICPA book contains far more detail and helpful case studies. “Most funds in Europe would say they comply with the IPEV guidelines, but then use the AICPA guidelines to help them with the implementation of the IPEV because it gives so many case studies and examples for every scenario,” says Davies.
Despite its tome-like length, the AICPA guidelines are well laid-out, enabling readers to dip in and out on a section-by-section basis.
It would appear the newly-released document is filling a much needed gap for those working on valuations. “The IPEV guidelines don’t give us as valuation practitioners, or CFOs sitting within funds, much detail on how to apply it, whereas the benefit of the complementary AICPA guidelines is that it’s very comprehensive,” says Davies.
“If you’re looking for specific case studies, or if you have detailed questions on how to deal with difficult, complex issues in PE, the AICPA document is much more in-depth and provides extra knowledge and the steps you need to take to complete the action, with a number of example case studies.”
SMCR: Name not shame
The SMCR demands a designated person responsible for valuation in every private equity firm, and that individual is registered with the FCA.
This likely poses the biggest challenge for larger funds, with a greater number of underlying portfolio companies, how will CFOs have sufficient detail of every single investment? Or they may have less experience in producing valuations and therefore not have the sufficient skills.
Having sole responsibility for the valuation and the process behind it puts huge pressure on CFOs (or specifically named person). One way to ease this is to create a culture of good governance to ensure all team members are doing their part, to support the CFO in signing off the valuations with confidence.
While investors might require valuations to be compliant with the IPEV and AICPA guidelines, the FCA’s new SMCR status will ensure that not only compliance is met, but valuations are produced in a sturdy way and there’s a single point of contact for each.
“The FCA are auditors and want to know who you comply with,” says Davies. “The managers obviously comply with IFRS or their local accounting requirements which is consistent with fair value, and the FCA are looking to see that valuations are prepared in a robust enough way.”