Our View of the News: Private Equity Firms Need to Examine Methods Used to Value Holdings
2/15/2012
As the Securities and Exchange Commission (“SEC”) increases its focus on private equity, particularly valuations, private equity firms need to look closely at the methods they use to value their holdings.
Media outlets have recently reported on the SEC’s increased focus on private equity. In The Wall Street Journal article, “SEC Launches Inquiry Aimed at Private Equity,” Gregory Zuckerman writes that the SEC enforcement division in December sent letters to private equity firms as part of an informal inquiry about how firms value their investments, among other matters. Due to the limited number of registered investment advisers among private equity funds as compared to hedge fund managers, the SEC has historically had limited interaction with the private equity world. However, this will be changing given the requirement for these managers to register along with the hedge fund managers by the end of March 2012.
Valuations of investments in private companies are much more subjective than the valuations of listed securities that are traded by most hedge funds. Private company valuations are typically based on certain information regarding the results of the portfolio company, coupled with estimates and comparable information based on market conditions related to the specific industry. The process is subject to interpretation of the available information by the valuation preparers, who may at times derive different results. While private equity fund managers receive their ultimate compensation based on realized events and not these estimates, the estimates are used for interim reporting purposes and in marketing to investors.
It is critical that the process for preparing valuations be documented by the fund manager and applied consistently across the portfolio as well as in accordance with the accounting standards generally accepted in the United States. Since the valuation is an estimate, we believe that the process and the ultimate documentation is indeed as important to the private equity fund manager as the ultimate result.
If you are interested in best practices related to documentation for private equity valuations and would like additional information, please contact Dom Esposito, partner and Private Equity/Venture Capital Services Practice leader, at desposito@jhcohn.com or 646-254-7414.