Steve Darrington

WHAT'S THE STATE OF VALUATION STANDARDS IN EUROPE? ARE THEY STARTING TO CONVERGE?
They're relatively well bedded in now. The fair value resistance which has been fairly active for most quarters has subsided. And I think we're probably now in the convergence phase. I think the challenge is there's only a very limited set of constituents that really want fair value. For example, the majority of our investors are entirely happy with sort of ongoing cost or impaired value as long as they've got the information to draw their own conclusions such as what an exit might look like. The long and the short of it is we've all stopped moaning about it quite as vigorously. Everyone's kind of accepted it and started getting on with it.

WHAT VALUATION STANDARD DOES YOUR FIRM ABIDE BY?
On our fund documentation we observe the BVCA guidelines.

WHEN DID YOU ADOPT THAT AND HOW DID IT CHANGE THE PROCESS?
We adopted it about three years ago, and it has caused or required our fund portfolio management executives to provide a significant amount more information in relation to the underlying methodology they use to get to the valuations.

I happen to be a big subscriber to gut feeling; if you're working with the business on a regular basis, you know what's going on, you know where the business sits in the marketplace, you know if you have more or less momentum than your competitors, and therefore you've got a pretty good idea, broadly speaking, what the vectors are in terms of valuation. What the valuation standards have required is quantifying that and looking at finding comparable transactions, which is often very, very difficult by the nature of private equity deals, they're not quoted, so getting comparable information is quite difficult because the comparatives are ? particularly within our sort of mid-market area ? usually private companies, so therefore by definition the information tends to be private.

So it's quite hard to get some of the information, but it has required them to go through a much more structured process. We've now got standardized templates and documentation that we go through [when] we go through the valuation process twice a year, in June and December.

HAS YOUR FUND ADMINISTRATION CHANGED AT ALL IN TERMS OF WHAT'S DONE IN-HOUSE AND WHAT IS OUTSOURCED?
Not as a result of valuation. We have a hybrid because we run offshore funds, so we're required to have a level of offshore administration. I would say we do most of the heavy lifting in-house and we will continue to do that. We haven't had to change the onshore offshore structure. One of the things we do do is we have an advisory board review of our valuations before we go through with them. That's the only procedural change we've put in our structure in order to make sure that our investors are informed effectively before we go to audit.

WHAT'S THE BIGGEST CHALLENGE REGARDING VALUATION STANDARDS?
Quantifying gut feeling, because you can't do it by definition. And yet, it's certainly more than 25 percent ? and possibly more than 50 percent ? of the intellectual input that is required to come up with a good valuation.

You can pretty much, within a reasonable set of bounds, make a valuation whatever you want it to be and to be perfectly honest, that's more often than not the way things work ? you decide what you want the business to be valued at and then you find a way of justifying it. That's just the way it is.

The real important bit to that process is, what's the business really doing? Where is it going? Is the management team coming to the end of their useful life? Is the business really leading its sector or is it following? Is it going to be a function of a cyclical downturn or can it buck that? Those are the things that are virtually impossible to quantify with statistics or with comparatives, but it's what any good manager is going to know.

You kind of know who the stars are in your portfolio are and you know who the dogs potentially are going to be. You don't necessarily broadcast that, but that gut feeling is very, very important and critical in valuations because valuations are effectively an expectations-setting process. And if you get it wrong, you'll be setting a set of expectations you won't be able to live up to. And the one thing limited partners don't like is surprises. The don't mind positive surprises, but they look very dimly on negative ones.

IN WHAT OTHER WAYS ARE VALUATION STANDARDS CHANGING THINGS FOR EUROPEAN BUYOUT FIRMS?
There is an issue at the moment, particularly with what's gone on with the credit crunch, because the basis on which a lot of the deals were done has fundamentally changed and whether as part of the fair value process you need to ask if you did this deal today, what would it look like.

And you probably couldn't do it. You couldn't put as much leverage into it, and potentially the deal might look very, very differently. So does that, by definition, undermine its value on the basis that the person coming in potentially might not be able to structure the deal in a similar way? Or should the basis on which the deal was done, and continues to exist, be the basis for the fair value? And if you're valuing against comparables and they've all been done pre-credit-crunch, is that a reasonable set of comparables? So there are a lot of issues around the credit crunch.

DO YOU SEE OTHER PROBLEMS WITH THE VALUATION PROCESS?
Fair value, sort of almost by underlying principal, assumes that you're going to sell the business. It's kind of like your house. If the housing market goes down significantly, and your house decreases in value by 25 percent, that's an important piece of information. But if you have no intention of selling your house for the next 10 years, it's not really that important. What is important is probably the fundamental structure of your house: Is it going to fall down anytime soon? Are you doing the appropriate maintenance? Can you continue to pay the mortgage? Those are critical issues that aren't necessarily factored into the valuation process. So I think it kind of draws a line in the sand and says what's the business worth today, as opposed to saying what's the business worth today but really does it matter, because we're not thinking of selling it today and we're not under any pressure to do so.