The tricky business of valuing private equity
Private equity – essentially investing in unlisted companies – can be a tricky business. For most investors, private equity forms part of their equity allocation. Investing in private equity opens up this allocation not only to companies listed on the sto
What makes investing in this type of equity unique?
First, because these companies are unlisted, they can’t be bought and sold quickly, so the holding period tends to be about three to seven years. The investments tend to be majority or large stakes in unlisted companies, rather than small stakes that would be taken in listed equity. And private equity managers often get involved in managing companies in which they invest so as to improve how these companies are run.
Revised guidelines
The newly published International Private Equity and Venture Capital Valuation Guidelines will be useful to private equity managers, accountants and others who need to value these investments from time to time as part of their reporting process.
According to Rory Ord, who heads up RisCura Fundamentals, the guidelines are updated every few years – the last update was in 2009. “These updates are important to respond to the practical issues identified by users, as well as to ensure consistency and convergence with accounting standards and other valuation standards from the US,” says Ord.
The revised guidelines have been published by the IPEV Association, of which the Southern African Private Equity and Venture Capital Association (SAVCA) is a member. This means that all SAVCA members will need to adopt these guidelines as they apply to current reporting periods (as from 1 January 2013).
The importance of Fair Value
Ord says that the revised guidelines put added emphasis on the market participant perspective that was in the previous version, because it is critical to the concept of Fair Value. “Fair Value is the value that a theoretical buyer and seller would transact at,” he explains. “The guidelines allow several different methods to estimate Fair Value; the most commonly used are the earnings multiples and discounted cash-flow methodologies. These methods both involve using market inputs as well as company-specific information to estimate Fair Value.”
The revised guidelines are applicable across the whole range of private equity funds and to all financial instruments held by private equity funds. This includes investments in early stage ventures, management buy-outs, management buy-ins, infrastructure, mezzanine debt and similar transactions and growth or development capital.
While the changes to the guidelines aren’t fundamental, they do refine concepts and ensure that accounting standards are consistent. Similarly, they ensure consistency when it comes to the principles of the International Valuation Standards Council’s (IVSC) valuation standards.
To download the revised guidelines, click here: http://www.riscura.com/IPEV-Guidelines-Dec-2012.
Editor’s thoughts: Revising best practice is always a good idea – if the IPEV guidelines help investors to make better economic decisions, so much the better. Creating fair value means investors are given a transparent view of their portfolio company’s performance and it is vital to explain to investors how ‘fair value’ has been calculated, in each case. Despite the risks, private equity has posted an annual return of 19.4% over three years to 30 June 2012, according to the SAVCA RisCura South African Private Equity Performance Report. The global financial crisis affected five-year returns (12.9%) but they have nevertheless been good. Have private equity returns met your expectations? Comment below or email [email protected].
