A THOROUGH UNDERSTANDING OF PRIVATE EQUITY

RETOUR SOMMAIRE

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - 2010

FISCAL AND OPERATIONAL ISSUES

unquoted investments, the estimation of fair value requires the valuer to assume the underly- ing business is realised at the reporting date, appropriately allocated to the various interests, regardless of whether the underlying business is prepared for sale or whether its shareholders intend to sell in the near future. Thus, in order to determine the fair value of an investment, the valuer will have to exercise judgement and make necessary estimates to adjust the market data to reflect the potential impact of other factors such as geography, credit risk, foreign currency, rights attributable, equity prices and volatility. Hereafter is an illustration of issues to consider: • When valuing debt instruments, loans or mezzanine loans, cash flow forecasts are impor- tant but the GP should also assess other items such as the borrower’s solvency; • For distressed strategies for example, the valuation is done on three different axes: The future cash flows, the value of collaterals and the potential restructuring opportunities. Furthermore, there are five main valuation methodologies for unquoted instruments. The most widely used are as follows: • Price of recent investment (i.e. use of the initial cost of the investment itself or the price at which a significant amount of new investment was made); • Multiples (i.e. the application of an earnings multiple to the earnings of the business being valued in order to derive a value for the business); • Net assets (i.e. deriving the value of a business by reference to the value of its net assets); • Discounted Cash Flows (DCFs) or earnings of underlying business (i.e. deriving the value of a business by calculating the present value of expected future cash flows or the present value of expected future earnings); • Industry valuation benchmarks (i.e. use of industry-specific norms such as price per sub- scriber for cable television companies for example). The valuation methodology should be clearly described in the fund’s PPM and discussed with the administrative agent and the auditor. Some methodologies can be used for cross- checking. Thus, discounted cash flows are mostly used as cross-check methodology. V aluation guidelines Over the past few years, much attention has been paid to the development of valuation guidelines: • In Europe, a consortium of three private equity and venture capital associations (AFIC, BVCA, EVCA) have founded the IPEV Board, which has issued international valuation guidelines 46 , intended to conform to the International Accounting Standards Board (IASB) rules. They reflect the need for greater comparability across the industry and for con- sistency with IFRS (International Financial Reporting Standards) and US GAAP (Generally Accepted Accounting Principles) accounting principles. These valuation guidelines are used by the industry for valuing private equity investments and provide a framework for fund managers and investors to monitor the value of existing investments. In order to be consistent with IFRS and US GAAP, the new guidelines are based on the overall principle of fair value. Indeed, the IPEV Board confirms fair value as the best measure of valuing private equity portfolio companies and investments in private equity funds.

46 IPEV Board, “International private equity and venture capital valuation guidelines”, September 2009 47 PEIGG, “Updated US private equity valuation guidelines”, March 2007

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