The International Private Equity and Venture Capital Valuation Board published its revised valuation guidelines for the industry in December.
Dislocation of markets, distressed transactions and the impact of ESG on valuations are some of the key themes in the guidelines, which “set out best practice where private capital investments are reported at ‘fair value’” and aim to “help investors in private capital funds make better economic decisions”.
Private Equity International caught up with Paul Cunningham, chairman of the IPEV Board and CFO of Helios Investment Partners, to discuss the industry’s reaction to the December update, how LPs are evaluating GPs’ valuation in a highly uncertain time and why hard-and-fast rules for valuations do not work in PE.
How did the industry respond to IPEV’s updated guidelines?
The response has been mixed, which in some respects means that we’ve probably pitched the guidelines just about right. There are certain areas – such as the impact of ESG – where some GPs or other industry bodies might have preferred that [we’d] gone further and produced more detailed guidance. There were also areas where other practitioners… thought that we were in danger of becoming too prescriptive.
We cannot always satisfy all interested parties, so a mixed response in this manner is probably the best that we can hope for. A significant proportion will sit in the middle, being reasonably comfortable with what we put out.
There is a lot of pressure to include more examples and more specific guidance, but as a board, we’ve made a very deliberate decision that these will remain as guidelines, not fixed rules.
We don’t want to lose sight of the fact that we are there to give guidance and guard rails that industry practitioners can work within. We don’t want to be seen to be telling people how they have to value a particular asset, because the people who are best placed to determine the appropriate methodology are the people managing that asset themselves.
Which areas did industry practitioners want further guidance on?
ESG is a clear example. As an industry, we’re probably still too early in our ESG journey to be able to give clear and detailed guidance on how it might impact valuation.
What we tried to do is highlight certain areas that GPs should consider as part of the valuation and how those areas would impact the value of a particular asset. What people shouldn’t be doing is looking to the IPEV Board to actually drive ESG practice. It was by no means an oversight on the part of the board: it was debated quite extensively when we were drafting the guidelines and came up a number of times in the consultation process.
As an industry, we haven’t even got to a position where there is a workable set of guidelines or requirements around what needs to be reported on ESG, never mind how it impacts valuations. There are various bodies, from the EU down, that are putting out requirements, but even those have yet to hit the full picture.
Looking ahead, what updates are being considered for the next version of the guidelines? Could increasing access to individual investor capital play a role in valuations?
We’re not due another set of guidelines for another three years.
We have been particularly active with the covid special guidance, followed by the Ukraine war guidance. We took those two and built that into the main body of the 2022 guidelines and expanded areas such as ESG.
It’s very difficult to say today what the next guidelines are going to cover. It will be based on what we hear in late 2024 and early 2025 [are] the hot topics that are causing some degree of concern.
I would be very surprised if we didn’t include more on ESG at that point. Because I think if we didn’t, it would mean that the industry’s thinking around ESG hasn’t progressed in that three-year period.
In terms of focusing on specific types of investor, I’m not sure that that warrants any changes in the guidelines. From where we are today, I’m not sure that I see any need. If that changes over time, we will address that need.
The fair value is the fair value – it doesn’t matter who’s looking at that. Whether there are some changes that might be necessary in terms of guidance on how it gets reported is a different matter. But the pure fair value itself should not be influenced by who your investor is.
We’re in a highly uncertain macro environment at the moment. Should LPs push back more on GPs that might be too aggressive in terms of how they value their assets?
There is definitely scope for LPs that have concerns to raise those concerns with their GPs. Most LPAs – if not to all LPs, certainly to the advisory committee members – give them the right to challenge valuations if they see fit.
From my understanding, that is not a right that is exercised particularly frequently. But if there is a genuine concern that certain GPs are manipulating their values, then the correct forum is through the terms of the LPA.
I don’t think any guideline will ever be able to correct that risk because there will always have to be an element of judgement in a private market valuation, for the simple reason that there is no public price for those assets. You can’t get away from the fact that there will always be some degree of judgement.
At the end of the day, if a GP has a long track record of overvaluing the asset, and as a result their performance is not good, the real punishment there will be that LPs will not re-up into their next fund. There are sufficient LP levers to hold the GPs to account.
To try to fix that within the IPEV guidelines again means turning them… from guidelines… into hard-and-fast rules. And the one thing about private capital investments is [that] no deal is exactly like another. Hard-and-fast rules won’t necessarily work in that environment.
Paul Cunningham is chairman of the International Private Equity and Venture Capital Valuation Board and partner and chief financial officer of Helios Investment Partners