Valuation challenge: Consortium deals

GPs collaborating on a deal will spend much time and effort asking other club members for their thoughts on a company’s valuation.

And for good reason. As more GPs participate in club deals, they should be aware that many investors and auditors are looking at the valuations of other members in the consortium. Major discrepancies can lead to questions over consistency, or if one club member’s valuation policy was lacking in rigor.

GPs in fact are “very aware” of what other club members valuation estimates are, says one US-based private equity chief financial officer speaking to PE Manager. And before estimates are even calculated, the club members will arrange a joint-discussion around some of the investment’s key details.

Sources say this discussion touches on a number of items, including what comparables to use, multiples, and whether discounted cash flow is a better method for a particular asset.

“They will likely get to a stage where some agree with others on the valuation and some do not. It is not uncommon for there to be different views between firms, especially for private equity where there are many areas of subjectivity,” says Doug McPhee, global head of valuations at KPMG.

“These views could be driven by size of stake held or type/ranking of investment instrument within the structure as well as individual views on market prospects,” elaborates McPhee. 

The goal of course is for each member to eventually agree on the entry and projected exit value of the asset, but sources say that this more often than not changes over time.

One factor helping GPs reach a consensus is that some GPs, usually the lead investor, will invariably carry more weight in the discussion than others, which can nudge them towards agreeing with the more influential GP's opinion. But even when agreement can’t be reached, the problem may be resolved by simply discovering which questions resulted in varying answers and then revisiting the analysis behind those conclusions, says the chief financial officer.

However, if a GP is swayed too far by any one GP’s opinion, that can present its own problems. Firms must stay true to their own internal policies, and LPs may be curious as to why the methodology behind a club deal diverged noticeably from other valuations in the portfolio.

Then again having people with different perspectives and different takes on an investment can be of significant value in evaluating the firm’s internal procedures, says the chief financial officer.” A GP can use other people’s ideas and compare them to their own.”  

Sources also tell PEM that even when consortium members don’t significantly collaborate on valuations, by employing fair value guidelines, the results may be close enough to be 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,” said one US-based private equity auditor in a past interview. 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, LPs may be paying close attention.