At the end of last month, the International Private Equity Valuation Board (IPEV) issued a draft of the latest version of its valuation guidelines, which for many years have set the market standard in valuations for the private equity and venture capital industry. Established in 2005 by the British, European and French industry associations – and now operationally independent, with support from associations around the world – IPEV regularly reviews and updates its guidelines. The result is that they are widely respected by fund managers and investors alike.
Regular reviews are, of course, necessary – in part because market participants provide valuable feedback and need further guidance on existing policies, and because market developments make it necessary to add new sections (or expand existing ones). The 2018 revisions are not radical – many of the changes are in fact designed to make the document more coherent and readable – but there are some significant substantive changes.
One noteworthy enhancement is elaboration of the recommendations on valuation of debt instruments. Previous versions were somewhat light on debt, so this will be welcome, but equally IPEV has not written a treatise on the subject (and they so easily could have done). Industry insiders will welcome the balance struck between helpful guidance and prescriptive detail.
Also addressed in the guidelines is the knotty question of when “cost” can be used to establish a value. “Price of recent investment” will no longer be permitted as the basis for valuation of a recent deal. However, it may still be appropriate to use cost as the value, if the valuer can prove that it represents the fair value of the asset. This clarity is helpful – although it represents an approach that had been widely adopted anyway – and puts greater onus on the valuer to establish the fair value, even when an asset is being assessed for the first time. Assessment of fair value early in the life of an investment is regarded as an important part of the calibration process.
Reflecting increasing regulation, there are additional requirements for valuers to maintain robust, written valuation policies and procedures, with clear methodologies and good supporting records. Also mirroring European regulation, there is a note that “common and better practice” suggests the use of independent internal valuation committees and/or external advisers to review valuation methodologies and significant inputs; and IPEV also encourages firms to use backtesting as part of the valuation process. Learning from the past is clearly an important part of any robust process and, although many firms will already be doing it, there is undoubtedly scope for improvement.
There is more material on valuation of early stage investments to make the document more helpful to venture and growth capital firms (and the 2018 version uses the term “Private Capital” to make it clear that it covers unlisted investments in early stage, buyouts, infrastructure, credit and similar assets, as well as funds investing in such assets). But, importantly, despite adding this new material, IPEV has resisted the temptation to expand its guidelines significantly: the 2015 version had 57 pages, and the 2018 draft runs to 67. This in itself will be welcome to firms, especially the smaller and mid-size GPs who are the main users.
It seems unlikely that the industry will have much to say that will result in dramatic changes, but the draft guidelines are now out for consultation until November 27.
Simon Witney is special counsel at Debevoise & Plimpton.
Neil Harding, director of fund investor relations at 3i and a board member of IPEV, and Jonathan Martin, partner at KPMG, helped with their contributions to this commentary.
This is part of a series, European Funds Comment, by Debevoise & Plimpton.