In December 2018 the IPEV Board published the latest edition of the International Private Equity and Venture Capital Valuation Guidelines (the “2018 Guidelines”). The update is part of the IPEV Board’s ongoing commitment to revisit and review the Valuation Guidelines triennially. They are effective for reporting periods beginning on or after 1 January 2019, although earlier adoption is encouraged.
The 2018 Guidelines include the continued experiences of industry practitioners in applying IFRS 13 and US GAAP’s ASC Topic 820 and feature additional coverage over a wider range of private investments, notably now referring to such investments as “private capital”. This reflects the expansion of private equity firms into other asset classes in recent years.
Early-stage investments are now covered in more detail, attempting to address the challenges that result where there are no current or short-term future earnings. Additional guidance is provided over private debt investments, including scenarios relating to non-performing collateralised investments, and standalone debt. The 2018 Guidelines clarify that amortised cost is not considered a suitable methodology for measuring fair value, and that holding debt to maturity is not a relevant consideration from a valuation perspective.
A significant change that may apply to any funds acquiring private investments, is the removal of ‘price of a recent investment’ as a valuation technique. This results from misinterpretation of previous editions of the Valuation Guidelines, with many practitioners using ‘price of a recent investment’ as a default position for up to 12 months after the acquisition date. By removing this as a valuation technique, the 2018 Guidelines reinforce the premise that fair value must be re-estimated at each reporting date. This does not preclude fair value from being informed by the price of a recent investment, however where this is the case, further analysis will be needed, particularly in relation to changes in market conditions or the investee’s performance.
Analysis of market conditions is particularly pertinent in the current economic climate. The fourth quarter of 2018 was marked by increased volatility and many public markets entering a bear market in December, leading to fears of a recession. This will make it important to consider how ‘recession-proof’ companies are, for example how income-elastic their products or services are. For forward-looking valuations, ‘next-twelve-months’ budgets may be an area of difficulty. Uncertainty continues to linger over Brexit, which we expect to be a key consideration affecting the valuation of many investments, not just in British portfolio companies reliant on EU customers or suppliers, but also in European portfolio companies reliant on British customers or suppliers.
A robust valuation process is fundamentally important to applying the Valuation Guidelines. The 2018 Guidelines include a section on application of the Valuation Guidelines, which covers best practices regarding the valuation process and documentation. IPEV recommend at a minimum; back-testing, written policies covering each investment in the portfolio, documentation of inputs, assumptions and rationale, and the use of an internal valuation committee or external advisers.
The 2018 Guidelines may in some cases necessitate changes from current practice, however they also represent an opportunity to continue to develop the reliability and relevance of fair value estimates. KPMG in the Channel Islands’ dedicated private equity team has a wealth of experience in supporting investment advisers and general partners through the valuation process, providing clarity and insight into valuing private equity investments. Our professionals leverage global expertise and are ideally placed to help funds address the challenges of current market conditions, and ultimately add value for investors.