Top 10 tips for PE firms to achieve robust valuations
December 16, 2013
Valuation continues to pose challenges for private equity companies under the increasing scrutiny of investors and regulators.
Updated guidelines from the International Private Equity and Venture Capital Board (IPEV) were issued in December 2012, highlighting the need to keep on top of best practice to ensure a robust valuation process.
The Alternative Investment Fund Manager Directive (AIFMD) requires that companies have a dedicated valuation function and mandates a ‘proper and independent’ valuation of the funds’ portfolio.
Quite apart from that, financial reporting valuations that are not in accordance with best practice are likely to lead to additional time and pain during the audit process and increasing questions from investors. We have seen that a robust and well documented valuation process provides significant time savings for finance teams at year end.
We have compiled a guide which covers ten of the most common errors and queries we see from our private equity clients. These ten tips will help you to achieve supportable valuations for your year-end reporting process so that they withstand close inspection:
- Calibrate the valuation inputs to the original deal model - Consider the market inputs underlying the original deal price or deal model in subsequent valuation updates. Calibrate the valuation inputs to the original deal price (IPEVCG Section 1: 2.6).
- Consider funding/refinancing requirements - Check any funding and refinancing requirements, regulatory capital requirements, covenant headroom and potential value of options and warrants (IPEVCG Section 2: 5).
- Focus on normalising portfolio company earnings - Market multiples have increased during 2013 in many sectors and the FTSE 250 has rebounded but the key focus continues to be on portfolio company maintainable earnings (IPEVCG Section 2: 3.4).
- Analyse transaction multiples before applying them - Be careful with transaction multiples as transactions since 2010 have been biased towards the highest quality assets and there are relatively few deals closing in the market (IPEVCG Section 2: 3.4).
- Make appropriate adjustments to the multiple (including for marketability) - Make appropriate adjustments to the multiples of one or a small number of comparable companies or transactions e.g. for gearing risk, size, growth potential, control or discount for lack of marketability (IPEVCG Section 2: 2.3).
- Pay particular attention to problem assets and/or close to sale assets - Pay particular attention to problem assets or assets close to sale as the subjective judgements in these cases are likely to be more challenging.
- Document the thought process for subjective judgements - Ensure that robust support, particularly documented evidence and justification, is in place for all investment valuations.
- Question whether nil valued assets are really worth zero - Are investments or financial instruments in investments valued at nil really worth zero or is there some value?
- Check surplus assets are truly surplus - Check that the cash and cash equivalents included in the net debt calculation are surplus assets rather than cash required as part of the working capital cycle (IPEVCG Section 1: 3.4).
- Value as at valuation date - Value portfolio investment companies as at the valuation date or ensure valuations are rolled forward to the year-end date (IPEVCG Secti0n 2: 2.3).
You can find the IPEV valuation guidelines here.
Click here for further information on valuations.
If you'd like to discuss achieving supportable valuations in further detail please contact us to set up a meeting.
