Friday Letter: Future looks fair

Fair value is here to stay. This method of valuation, deemed inappropriate for private equity by so many general partners, is gaining unmistakable momentum within the industry and looks likely to take over the entire world.  

Such were the observations on the first day of the 2006 North American Private Equity COOs and CFOs Forum, held this week in New York and sponsored by sister publications Private Equity International and Private Equity Manager. On a panel discussing the state of standards in private equity, Arlett Tygesen, the executive director of the Institutional Limited Partners Association, noted that some members of the trade association for LPs have begun asking GPs to live by PEIGG standards as part of the partnership negotiations during fundraising. According to Tygesen, many GPs continue to “push back” on the issue.

PEIGG standards are the voluntary guidelines on valuation and reporting put forth by the Private Equity Industry Guidelines Group, a temporary body created specifically to draft the standards. The valuation standards put forth by PEIGG use fair value as the core methodology. Most GPs prefer a hold-at-cost method, writing up valuations only upon follow-on financings or material events like IPOs.

It is unknown how many LPs are applying pressure on standards, and how hard they are pushing. Trying to get into an oversubscribed fund, after all, is not a position of strength from which to drive a hard bargain. A member of the conference audience noted that in raising her firm’s most recent fund, no LPs had brought up the issue of fair value or other standards. The results of an audience poll at the event revealed that only 22 percent of GPs had received “pressure” from LPs on this issue.

From the audience, David Larsen, a partner at accounting firm KPMG, described great progress on an effort to harmonize the PEIGG standards with standards issued last year by the private equity trade associations of Britain and France and the European Private Equity and Venture Capital Association, called the International Private Equity and Venture Capital Guidelines. Larsen noted that the two standards are roughly 90 percent to 95 percent “the same” and that what once seemed to some to be an impossibility – true international guidelines – is now well within reach.

But if you build a global standard, will GPs adopt it? Another audience survey indicated impressive headway has been made by standards among private equity firms – 50 percent of GP groups in the audience said their respective firms had adopted one of the various fair-value standards as a method of valuation. Perhaps there is more demand for standards on the GP side than has previously been acknowledged.