Global disharmony

It might seem as if the argument in favor of valuing portfolio companies according to fair value principles has been won in Europe. After all, since the French, British and European trade bodies got together in March 2005 to launch the joint ?International Private Equity and Venture Capital Valuation Guidelines,? they have subsequently been endorsed by a total of 32 regional and national industry associations (see box).

At the outset, it would be remiss not to point out that fair value can mean different things to different people. Ask Google to find you a definition of fair value and the search engine will provide you with no less than 11 different alternatives. The one that really matters to private equity, however, is that found in the FAS Statement No. 157. Namely, ?the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.?

Fair value effectively usurps the prior method of valuing portfolio companies at cost. Previously, private equity firms could pull rabbits out of the hat by exiting companies at a significant upside while providing few clues as to how the value of those companies had changed during the interim period.

The new push for the adoption of fair value, starting November 15, 2007, is welcomed by many as an attempt to provide more realistic valuations of portfolio companies on an ongoing basis. Says Herman Daems, chairman of the International Private Equity and Venture Capital Valuation Board, as well as chairman of Belgian private equity firm GIMV: ?In Europe, there are many listed funds like GIMV and, given the fact that you must report regularly, it's important that you also do so systematically. There is more and more scrutiny now of what private equity players are doing. It's important to remember that we are investing money on behalf of pensioners and they want a real sense of what is happening to their money.?

The grand ambition of fair value protagonists is ?harmonization,? to ensure that the same valuation methods are applied by all types of private equity firm in all territories around the world. This has been complicated by the fact, however, that there has been no industry body promoting fair value guidelines in the US. The National Venture Capital Association has not aligned itself with the push to fair value, recommending only that valuation methodologies should be agreed with limited partners and conform to generally accepted accounting principles (GAAP).

PEIGG in the vanguard
The push to fair value in the US has instead been taken up by the Private Equity Industry Guidelines Group, a volunteer group of industry-wide representatives who came together in 2002 to debate and establish a set of reporting guidelines for the industry. PEIGG won significant support in October 2005, when its guidelines received the backing of the Institutional Limited Partners Association, which had previously backed separate valuation guidelines established for the US and international markets.

Daems says IPEV is keen to develop close ties with PEIGG, adding: ?ILPA has a clear interest in trying to develop a good working relationship between the PEIGG and IPEV. That suits us, because we want a common understanding. In our guidelines, we have adjusted whatever is less acceptable to the PEIGG. We are trying to arrive at wording that suits their requirements.?

In a concrete sign of this closer co-operation, Daems says that IPEV will unveil David Larsen as its first board representative from the US when it stages its next meeting in Canada in September this year. Larsen, a managing director at investment banking and advisory firm Duff & Phelps, has been heavily involved in the valuation debate in the US as a special adviser to ILPA and board member and technical adviser to PEIGG.

While the recruitment of Larsen to the IPEV board is a welcome sign, challenges still remain before Europe and the US can stand shoulder to shoulder on the issue of fair value. It's not the only challenge that lies ahead. Another is that, even where fair value is adopted, the precise methodology used may differ from one GP to the next.

Says John Gripton, managing director in the Birmingham, UK office of alternative asset management group Capital Dynamics: ?Many GPs across Europe have moved to fair value, but they are still using a conservative methodology and when they exit we are still seeing some upside to the valuation.?

As far as he is concerned, however, what is crucial is not that GPs value companies in exactly the same way but that they are open with their investors about what they are doing. ?The most important thing is that the way in which a company is valued is transparent,? he says. ?We need to know the basis of the valuation and we are glad that Europe has moved forward on this issue. Steps have been taken in the right direction.?

The rush to sign upThe IPEV guidelines have been endorsed by 32 regional and national associations: