In-house valuation or out?

A debate that continued to rage in the private funds industry in 2016 concerned whether firms need to instruct third-party portfolio valuation services.

The Alternative Investment Fund Managers Directive obliges fund managers to produce independent portfolio valuations at least once a year, or before a fund employs a new investment strategy or engages with a different type of asset.

But despite widespread belief to the contrary, outsourcing fund valuation tasks to third-party service providers is not required under the directive.

A panel of fund managers at the British Private Equity and Venture Capital Association Summit in London debated the pros and cons of portfolio valuations being done externally by a third-party service provider or by an in-house team to save both time and money.

“When AIFMD suggested independence there were a lot of firms that thought this meant that they had to use a third party, whereas of course you can be independent internally,” says Graeme Dell, managing partner at private equity firm BC Partners.

BC Partner’s LPs, which include California State Teachers' Retirement System, ATP Private Equity Partners and SL Capital Partners, have been spurred by the directive to develop their valuation capabilities, said Dell.

“A lot of LPs value understanding the methodologies that are being used to get to the valuation and this gives them a starting point to work off when they go on to run their own numbers,” he added.

But Jordi Francesch, head of asset management at Glenmont Partners, believes a third-party valuer is preferable.

“Valuation is based on assumptions. I think that it is a healthy exercise for someone else to have a look at the same numbers that you have and come up with the numbers themselves. I think that LPs value it because it does not come from the GP it comes from someone else.”

There are, of course, instances in which third-party valuations are preferable. Fund managers usually err on the side of caution when it comes to pricing their holdings; external valuers tend to be more generous. For this reason, for certain funds – typically infrastructure – which have a longer lifespan and carry based on yield and valuation rather than exits, there is a strong case for the use of a third-party service.

For US managers, who are regulated by the Securities and Exchange Commission, the general consensus in the industry is that the regulator requires private equity firms to justify their valuation process, and as long as it is robust, there is no preference for an internal valuation or one that is subcontracted out.

“You won’t get extra credit from the regulator if you outsource your valuations. It’s fine to do so, if you need extra resources, or need to double check things, but it’s certainly not a requirement,” says one GP.

The key requirement for an in-house team is ensuring that the valuation is carried out by a team that is independent from the deal team. But working with a third party valuer can be “helpful for providing a third party perspective and an alternative approach and view to looking at a particular asset,” Dell says.