System of values

The issue of portfolio valuation is an increasingly pressing one for private equity and venture capital firms. In the US, the Financial Accounting Standards Board’s FAS 157 goes into effect for fiscal years beginning after November 15, 2007, and firms are currently scrambling to make sure their methods comply. Europeans face no less stringent requirements: In recent years various industry organizations in dozens of countries have endorsed similar fair value standards, including the International Private Equity Valuation Board (IPEV) guidelines and those put out by the Private Equity Industry Guidelines Group (PEIGG).
The instructions are clear. But the methodology is less apparent: determining the worth of dozens of investments across multiple funds and asset classes is no simple exercise. More and more, private equity firms are realizing the importance of having a standardized system in place to tackle the process.
Chief financial officers typically approach the task by developing a customized template. Each CFO’s template is different, tweaked to suit the needs of the firm and the team. The complexity of the template and the extent to which it relies on software and technology, of course, depends on how much data the firm needs to track.
For French venture firm Sofinnova the process is not as arduous as it is for others, because the firm only invests in very early stage companies. Sofinnova adheres to the IPEV guidelines, says Monique Saulnier. Saulnier is a member of the IPEV board.
The IPEV guidelines suggest that firms value early stage companies using the most recent round of funding. Since Sofinnova’s investments all fall into this category, the firm need only keep track of the size of a portfolio company’s last round of financing, taking depreciation into account.
“This is a lot easier for venture capital firms, who invest in very young companies that have no revenues, no EBITDA,” Saulnier says. “What we mainly have to record are the data related to the round of financings. The data on transactions related to comparable companies need to be traced but are not necessarily directly used in the valuation process.”
But this could change, she says. As Sofinnova’s portfolio companies grow, the database will have to evolve as well.

Customized spreadsheets
When portfolio companies are large enough that private equity firms do need to use data on comparable companies to determine fair value, the process becomes a bit more complicated. US middle market firm ABS Capital Partners, which focuses on later stage companies in the business services, healthcare, media and communications and software sectors, has developed its own set of spreadsheets to manage the calculations.
The resulting template for each of ABS’s portfolio companies comprises two data sets. The first is an Excel spreadsheet that includes three years of prior summary income statements and balance sheet data, as well as projected income and balance sheet data for at least three years forward. The second set includes data from comparable public companies and information on M&A transactions for comparable companies, data culled from subscription services such as Hoover’s, Moody’s Investor Services or Capital IQ.
“Services like Capital IQ make it relatively easy to pull down comparable company data, but you have to apply quite a bit of judgment as to how that relates to your company,” says ABS CFO James Stevenson.
Once ABS has chosen which comparable companies to use in the valuation, it’s a simple matter to set up a spreadsheet linked to one of these subscription data services that automatically updates the relevant information each quarter.
The process of valuation at ABS is a firm-wide exercise, Stevenson says. ABS has anywhere from 22 to 28 portfolio companies at a given time, and nine investing partners. Each partner has an associate who prepares the initial quarterly summary, updating data on the portfolio company and the comparable companies. Then the partner reviews the associate’s work and makes any necessary changes before reporting to the rest of the partnership on the performance and valuation of their companies. During this meeting, there is often some “back and forth” as partners question each other on these valuations. Ultimately, Stevenson decides what value goes on the firm’s financial statements.
“It’s pretty much a total partnership effort when we do our valuations,” Stevenson says. “It might have been harder to get that level of support if it was just an accounting matter, but we tie it into the management of our portfolio and making sure that everybody knows what’s going on in all of the companies on at least a quarterly basis.”
Although the template can be tweaked from company to company, in general the type of data captured is standard for all investments, which are then evaluated using a linear programming model (LPM). Developing a standard model was one of the first things Stevenson did when he arrived at ABS five years ago. Before, each investment partner tended to have his own style of presenting a portfolio company. Now that the process is standardized, partners can readily grasp the status of each other’s companies without being intimately familiar with the investments.
ABS’s two-layer approach to valuation is a common one for firms of its size and appetite, no matter the type assets being analyzed. For middle market firms the process of combining a “nuts and bolts” set of data from portfolio companies with a layer of judgment-based intangibles that make the valuation more nuanced tends to be an effective one.

Power plant stats
For US firm Energy Investors Funds, the process is slightly different because of the assets in which the firm invests: power plants and transmission lines, both operational companies and early stage projects still being developed. Instead of an LPM the firm uses a 20-year cash flow projection based on all the facilities inputs, revenues and expenses. Since the revenues of these assets are driven primarily by power purchase agreements from local utility authorities, the model is fairly reliable, says CFO Mitch Coddington.
The firm then colors the valuation produced by that model with its knowledge of market pricing, comparable recent transactions and applicable discount rates, among other factors. EIF occasionally brings in third party consultants to do market forecasts for power prices, and the firm is in conversation with its auditors throughout the process.
Most of the valuation process is handled by a subgroup of three people in the firm: Coddington, the comptroller and the partner responsible for the firm’s asset management group. Having these informal point people oversee the process helps EIF to maintain consistency across various portfolios, Coddington says. The three consult with the partners in charge of each investment, and later submit each valuation to the entire investment committee for review.
“We convene these lengthy multi-hour calls where we get into quite a bit of discussion and analysis of every asset in each and every fund,” Coddington says. “Usually there are two calls, sometimes three, to get to the point where we have approved all of the valuations.”
US distressed investor Monomoy Capital Partners has streamlined the first layer of the valuation process through the development of a proprietary SQL database. The database allows management at Monomoy’s portfolio companies to input data such as last 12 months’ EBITDA, revenues and income statement items into a web interface designed by Monomoy. Monomoy CFO Andrea Cipriani and her accounting team pull that data into an Excel spreadsheet,
and then pull information on comparable companies from Capital IQ. In the final step of the process, Monomoy’s advisory board approves the valuations.
Monomoy’s systems are still evolving to meet the requirements of FAS 157, Cipriani says. Like many firms, Monomoy’s valuation process won’t have to change substantially to meet the requirements of FAS 157. The real change is that Monomoy will have to disclose its valuation methods, reporting each step of the process to LPs and auditors. The firm doesn’t yet have its reporting in place for this, Cipriani says, but is currently in dialogue with its auditors, who will weigh-in on what other private equity firms are putting on their financial statements, and its LPs, who have their own reporting requirements to meet.

NEA’s database
For New Enterprise Associates, the valuation process is greatly complicated by the sheer volume of data that needs to be managed. The Maryland-based venture firm has more than 250 companies in its portfolio, and currently manages $8.5 billion in assets. The IT needed to manage that amount of data takes on far more importance for NEA than for its smaller peers, and the firm has developed its own proprietary systems and software to handle the burden.
The firm has had a proprietary database since 1983 that tracks all of its portfolio company and investment information, says COO and administrative partner Gene Trainor. But six years ago NEA embarked on a major overhaul to transform the database into a web-based interface in an easily modified language. The revamped database captures every element of an investment in the company, from basic information such as board members and locations to complex financial metrics. This vast “central repository” is managed by a dedicated team, Investment Operations.
The central repository is a sort of hub, around which NEA has since developed several “spokes” that cater to the firm’s ancillary needs. The firm pulls weekly reports from the database summarizing all of the firm’s companies and NEA’s positions in the companies, giving NEA an idea of the overall status of their funds. The firm also pulls information from this database that is used to create and maintain “minimum data sets” (MDS). Currently the creation of the MDS is the only part of the process that is done manually, Trainor says. The MDS is a one page write-up for each company that summarizes information including investment thesis, milestones, risks, outcomes, financial projections and exit assumptions. The MDS is used for internal reporting, but is also critical for valuation.
For the process of quarterly valuation, NEA’s finance team, its CFO, its controller and the Investment Operations team all work hand in hand, drawing on information in the MDS reports and stratifying companies into the three levels of assets as defined under FAS 157. Based on which bucket the companies fall into, NEA then calculates valuation using quoted prices, recent transactions or data from comparable companies.