Whilst many of the changes are designed to make the document more straightforward to read, there are some changes worthy of a second analysis:
Valuation polices – In line with ever increasing commentary and improvements to general governance and regulation, the 2018 Guidelines contain a section called “Application of the Guidelines” which includes content relating to a robust valuation process and details some common and better practices such as:
- A written robust valuation policy, incorporating the 2018 Guidelines, that requires documentation of the procedures and methodologies to be used to determine the fair value of each individual investment in the fund’s portfolio;
- Documentation of the inputs and assumptions included in the valuation analysis and the rationale supporting the conclusion of value;
- Use of an independent internal valuation committee and/or external advisers to review methodologies, significant inputs, and fair value estimates for reasonableness; and
- Incorporation of back-testing as a component of the valuation process.
Whilst many of the larger funds can boast robust and transparent valuation policies, some of the smaller to mid-range funds could use the implementation of the 2018 Guidelines as an opportunity to enhance the policies they currently have in place. The short list above forms an excellent starting point in the development of a fund’s valuation process.
Cost and fair value – The valuation models listed in the 2018 Guidelines now have a noticeable, but intended, omission compared with the 2015 Guidelines – “The price of recent investment”. This means cost can no longer be used as the basis of the valuation for a recently acquired investment. The guidelines make it very clear that the price of recent investment is not a default that precludes re-estimating fair value at each reporting date. This reinforces that the valuation of the underlying investment should be undertaken at each reporting date and hence is fully in line with accounting standards.
It may still be appropriate to use cost as the fair value under the 2018 Guidelines but it is now clarified that the entry price (cost) should be calibrated to a stated valuation model and then considering whether there are any changes or events subsequent to the entry that would imply a change in the fair value at the reporting date. Whilst this has generally been seen as best practice the increased clarity and explanation is gratefully received.
Debt investments – The 2018 Guidelines, whilst not being excessive, have expanded on the previously light guidance around the valuation of debt instruments and have also recognised these as a separate asset class. The document also now uses the term “Private Capital” as opposed “Private Equity” which reflects the growing nature of debt and similar credit asset classes.
Seed, start-ups and early stage investments – The 2018 Guidelines have been expanded to contain more detail around the valuation of these investments including detail on the use of milestones, possible scenarios and calibration; the latter being a process of applying a recent price to a valuation model and using this to create future fair values. This will be a welcome addition for funds investing in this area.
Real estate investments and infrastructure investments – The 2018 Guidelines include guidance around the valuation of these investments. Whilst fairly mainstream, the inclusion of this guidance shows the continued growth in these asset classes.
The 2018 Guidelines are effective for reporting periods commencing on or after 1 January 2019, although earlier adoption is encouraged.
The 2018 Guidelines can be found here http://www.privateequityvaluation.com/Valuation-Guidelines