Private equity CFOs are giving more time and attention to quarterly performance updates to investors.
A majority (67 percent) of CFOs worldwide said they now perform a full valuation process every quarter – a process that includes documentation of individual portfolio company values and sign-off from a managing director and/or valuation committee. Previously many CFOs have only gone into this level of detail for annual audited financial statements.
The findings come from a survey of more than 100 private fund finance executives worldwide, a collaboration between professional services firm EY and our parent company PEI.
Between August to October 2013, CFOs were asked about new industry regulations, valuation and financial reporting processes and how to achieve greater levels of operational efficiency at the firm, among other topics. (The findings are being presented in full at PEI’s CFOs and COOs Forum, which starts today in New York).
Inevitably, priorities differed depending on firm size and geography. Firms based in North America, or managing more than $10 billion in capital, are most likely to perform full valuation procedures on a quarterly basis (roughly three out of four CFOs in both of these categories). In comparison, 47 percent of EU-based CFOs perform robust valuations each quarter. In Asia, the equivalent figure drops to 33 percent.
Investor requests, changes to accounting rules that required GPs to begin marking their assets to market in 2008, and the requirement that fund advisors register with the US Securities and Exchange Commission (SEC) as part of Dodd-Frank were the primary drivers of the trend, according to Scott Zimmerman, EY private equity assurance leader for Americas, one of the study’s lead authors.
“With valuation being a priority for SEC inspectors, they’re asking firms if they follow the same valuation procedures quarterly that they do on an annual basis. They want process, procedures and information to be consistent.”
While most private equity CFOs say they now perform robust valuation procedures on a quarterly basis, Zimmerman noted there is some debate within the community about what constitutes ‘robust’.
“How much rigor is really being put into these quarterly statements? For some CFOs, a ‘robust’ valuation means consulting with investments professionals, the people most familiar with the company’s performance. That can be challenging if investment teams see diminishing returns [in] updating the valuation of a private company held as a long-term investment every three months.”
Another factor mitigating against running full valuation exercises every quarter is the difficulty of managing investors’ expectations, CFOs have told PE Manager in the past. Similar to valuation practices prior to FAS 157 (now Topic 820), firms may not report an increase in value that could be later written down to the disappointment of investors; so instead, firms would hold their investments at cost and only update their estimates when some milestone event like a refinancing occurred. That's a strategy inconsistent with the principles of robust quarterly valuations.
Nonetheless, LPs’ own reporting requirements are helping to make full quarterly valuation exercises an industry best practice.
“In today’s environment, investors often feel pressure to report quarterly valuation information from their stakeholders. In these situations, the robust valuation processes of private equity firms can prove to be invaluable to investors,” said Zimmerman.