Collaborating values

Even the auditors agree that valuations are not an exact science, but they’ll also be quick to point out that sufficient rigor keeps everyone’s interpretations within a given range. When a firm is the sole investor on a deal, differences in valuations of that company get hammered out with their auditors. When they invest as part of a consortium, differences in valuations within the club often get hammered out by the LPs.
This is not always the case, but as more GPs participate in club deals, they should be aware that many investors and auditors are looking at the valuations of their fellow club members. The auditors seek such valuations to corroborate their own calculations as they debate with their clients who’d prefer to avoid both writeups and write-downs. LPs, frequently invested in more than one member of that club, are tracking valuations and noting any wild fluctuations among the group. Even without taking FAS 157 into account, GPs would do well to remember they aren’t deriving valuations in a vacuum.
At the moment, plenty of firms are more focused on ensuring that their own internal processes have sufficient rigor to pass muster with auditors in lieu of the new demands of FAS 157’s guidance on fair value. “We’ve worked with a few co-equity sponsors before, but I don’t know that we’re that concerned with how they are valuing our investments,” says Marc Unger, CFO and COO of New York-based CCMP Capital Advisors. “What we’re comfortable with is our valuation policies and procedures.” In many cases, that approach might very well be sufficient, but firms should be aware auditors and LPs might be curious about those other valuations.
“I think auditors will look for corroborating data points,” says Dimitri Drone, an auditor within the transactions services department of PricewaterhouseCoopers. “Where possible, auditors will try to understand what other co-investors may have considered in making their fair value estimates. Given the challenges in valuing private equity investments between liquidity events, it is quite possible that sophisticated investors will have different views of fair value at interim dates. In fact, it wouldn’t surprise me if co-investors had different estimates of fair value right up to an event that gives rise to a realization of the investment.”
The auditors may line up those other valuations to their work, but LPs are liable to dig even deeper into any discrepancies within a club’s valuations. “We are sensitive to variations [in valuations] among consortium members,” says Karin Lagerlund, a senior VP and controller of the Boston-based fund of funds HarbourVest Partners, “Especially since in many cases we’ve invested in many of the funds involved in the transaction.”
Often the fund of funds will start by contacting the lead investor to gain as much information as possible on the deal, and then obtain valuations from the other investors. HarbourVest then uploads all the company data received from the various funds into a database that allows them to view each of their stakes in the company.
Next, they determine if the same security is held in each case, and then they proceed to investigate any variations in valuations. “We have a portfolio performance team, an accounting group and if we’re involved in the deal directly
[as an investor], our investment staff will all look at these details,” says Lagerlund.
Lagerlund explains that often they’ve seen funds within a consortium take write-ups or write downs before, or after, other members of the group. “The key for us is to discern why there are variations.
Does one member of the club know something that the others don’t? Or is it simply a matter of their internal valuation policy?” she says. Lagerlund expects that such variations will shrink as more firms apply fair value as detailed in the FAS 157 guidelines. “Frankly the guidance will prompt them to work more closely together and be as knowledgeable as any of the other members,” she says.
Even when consortium members don’t collaborate on valuations, by employing the fair value approach from FASB, the results may be close enough to negligible. “I’ll say that in the cases [of club deals] I’ve worked on, the results have all fallen within what I’ll say is an acceptable range,” says Drone. That may be the case, but GPs should remain aware that while they may not be interested in the valuations of the rest of the club, plenty of others are paying close attention.