Due to the illiquidity of the asset class and absence of a secondary market, the performance measurement of ongoing unrealized portfolio company investments (interim valuation) is complicated and offers high discretion for fund management in valuing the funds’ investments.
Therefore, private equity industry valuation guidelines have been developed to standardize valuation approaches, increase transparency and promote confidence between investors and fund managers, as well as set best practice examples for the private equity industry.
The first set of valuation guidelines for venture capital and private equity investments was introduced in the United States in 1989 by the U.S. National Venture Capital Association (NVCA).
In Europe, the first set of valuation guidelines was published by the British Venture Capital Association (BVCA) in 1991 followed by valuation standards of the European Venture Capital and Private Equity Association (EVCA) in 1993. Revised standards have been published by both organizations in 2003 and 2001, respectively.
However, all those initiatives were based on a conservative framework mainly with a cost-based approach. According to this approach, an investment in a fund should be carried at cost unless a material impairment indicated a write-down or a new financing round including a new outside investor supported an increase in the value of the portfolio company.
U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards, however, require the fair value measurement of portfolio companies. In addition, fund investors themselves want fair values to be reported and need this information from their fund managers.
Consequently, the Private Equity Industry Guidelines Group (PEIGG), a volunteer group of representatives from the private equity industry (investors, general partners, and service providers from both the venture capital and buyout segment), issued U.S. Private Equity Valuation Guidelines in December 2003.
In Europe, the EVCA together with the BVCA and the French private equity association introduced the International Private Equity & Venture Capital Valuation Guidelines in March 2005.
Meanwhile, more than 35 regional and national private equity associations support the International Private Equity & Venture Capital Valuation Guidelines, which are continuously reviewed and further developed by an appointed Valuation Guidelines Board consisting of academics and practitioners.
Both recently introduced valuation guidelines provide detailed provisions how fund managers derive a fair value of their portfolio companies. Empirical studies indicate that the International Private Equity & Venture Capital Valuation Guidelines in Europe are more accepted than the U.S. Private Equity Valuation Guidelines in the United States.
Another set of valuation standards, which was originally developed by the CFA Institute for traditional asset classes (public equity and fixed income portfolios), is meanwhile expanded to private equity. Those Global Investment Performance Standards are more orientated toward future investors during fundraising and not focused on existing investors.
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| Valuation Guidelines |
