Valuing portfolio companies is essential for private equity funds to make informed decisions, meet reporting standards, and plan successful exits. As markets grow more complex, so do the challenges of accurate valuation.
Often funds may prefer to invest through a combination of financial instruments including equity shares, debt (convertible/non-convertible), Simple Agreements for Future Equity (SAFE) notes and preference shares (convertible/redeemable).
Need for Valuation
Valuations are becoming complex due to volatility of ever-changing markets, geo-political situations and capital market trends. Valuations are important for reasons ranging from regulatory requirements to strategic decision making:
- Financial reporting requirements: The financial statements prepared for investors in a private equity fund could vary depending on the applicable financial reporting framework such as International Financial Reporting Standards (IFRS). For most reporting frameworks, funds are often required to present the investments at fair value for each financial reporting date.
- Evaluation of potential investments: Private equity funds will need to analyse the worth of their existing investments in companies before deciding to take additional exposure.
- Exit valuation: For investors, understanding the true value of an investment and calculating the return on investment (ROI) often requires a formal valuation at the point of exit — such as during a trade sale, listing, or merger.
Challenges to Valuation
- Valuation is an interplay of multiple factors. Operational performance may not always align with investor expectations, creating discrepancies in perceived value.
- Absence of comprehensive historical business data and the illiquid nature of investments further complicate accurate assessments.
- Lack of reliable market inputs for comparable transactions on account of privacy, valuation judgment, negotiation element and case specific variables.
- Valuation of complex financial instruments may pose significant challenges while making assumptions, assigning weightage and interpretation of conditional rights & preferences.
Valuation methodology
- The International Private Equity and Venture Capital Valuation (IPEV) Guidelines set out recommendations, intended to represent current best practice.
- Choice of valuation method may vary based on factors such as the industry, stage of company’s life cycle, availability of financial data and market conditions.
- Some generally accepted valuation methods include Discounted Cash Flow Analysis, Comparable Company Analysis and Market Transaction Analysis.
A robust valuation not only satisfies reporting requirements but also helps investors in price discovery thus enabling informed decision making.
For a more in-depth discussion on valuing your portfolio companies, reach out to our Valuations team.
