When is a sale price not a good indication of value?
November 14, 2019
With current market volatility and high-profile recent fund suspensions and wind-downs, the question of fair value is more pertinent than ever for those managers with illiquid and unquoted securities within their funds.
Where recent transaction prices are available for unquoted securities, this generally remains one of the best sources of evidence of arm’s length value, albeit with the necessity for the valuer to consider whether there have been any changes in circumstances of the business or the market subsequent to this transaction. However, what should the valuer do when there is evidence that the precedent transaction price has a distressed seller? IFRS (and US GAAP) make clear that the hypothetical market participant for fair value purposes is not a distressed seller.
In these cases, a valuer would not necessarily expect to mark to the recent transaction price if there is evidence that this is on a non-arm’s length basis. The analysis as to whether a transaction is distressed depends on how much visibility the valuer has and how much access to underlying information. It can be harder where the valuer is not directly involved in the transaction or has a minority stake with minimal information rights but there is still an expectation that the valuer would look at publically available data to see whether there are any indications that this is a distressed or non-arm’s length transaction.
Of course, any recent transaction price is an interesting and relevant data point so the expectation would be that this is documented and considered as part of the valuation. However, there may be very valid reasons for concluding on a value that differs to this recent transaction, particularly where the transaction is a fire sale or otherwise distressed seller.
This is consistent with current market practice for valuation of illiquid positions in closed ended funds. The International Private Equity and Venture Capital Guidelines (2018) for example, allow that fair value Net Asset Value (NAV) remains the best starting point for valuation of a fund interest. It is not common practice to see people marking to the level of discounts to NAV often observed in the secondary market for fund interests for precisely this reason: the argument is that the secondary transactions generally reflect distressed sales prices as non-distressed investors would not choose to exit a closed-ended fund position before maturity under normal circumstances. There are, of course, exceptions to this and it is important to consider whether the movements in the secondary market indicate NAV may not be the most relevant valuation point for a fund interest on a market participant basis.
Overall, beware of marking to non-arm’s length transaction prices. Just as you would not expect a valuer to mark up or down to a valuation point implied by a transaction where the investor had a wider strategic and business relationship with the business in question, you would not expect a valuer to mark down to a distressed sale price. However, careful consideration should be given as to whether the transaction is at an arm’s length price or not as external transaction prices generally remain the best evidence of market value, particularly for early stage and highly illiquid unquoted assets.