The National Venture Capital Association (NVCA), the industry group representing venture capital firms in the US, yesterday chose not to endorse proposed valuation guidelines issued by the Private Equity Industry Guidelines Group (PEIGG) back in December.
The move – or lack thereof – is another setback for the US private equity industry’s attempts to standardise portfolio company valuations according to a “fair value” approach to reporting. Since the technology market collapse earlier this decade, many investors have been clamouring for valuation methods that would more accurately reflect current company values rather than relying on static initial investment figures.
According to The Wall Street Journal, the NVCA, whose board of directors met yesterday, chose not to adopt the guidelines, instead issuing a statement recommending that its members “create, follow and communicate clearly the specific procedures and methodologies used for valuing their portfolios.” The board did state that any valuation methods should be accepted by limited partners and adhere to Generally Accepted Accounting Principles (GAAP), laying “ultimate responsibility” for proper valuation in the hands of general partners. Finally, the NVCA did recommend that venture capital firms consider the PEIGG guidelines when determining their own valuation methods.
The PEIGG, formed in February 2002, is a volunteer group of industry-wide representatives formed to debate and establish reporting guidelines for the industry. As such, the group’s guidelines are also voluntary. It relies on endorsements from general and limited partners and funds of funds, and industry organizations such as the NVCA, the Institutional Limited Partners Association and the Venture Capital Bean Counters for legitimisation.
Currently, many private equity entities use the historical costs of company purchases in their ledgers to approximate value. However, as the amount of time spent in the investment increases, that value obviously changes, fluctuating above or below the initial investment level. Unfortunately, even though GAAP rules require “fair value” reporting to adjust for cost over time, many firms keep costs at historical levels, especially firms whose investments have drooped, thus overstating the current values of companies in the view of many market participants. In choosing not to accept the PEIGG guidelines, the NVCA argued that fair market valuations would also force firms to write up the value of private companies without input from a third party, which would double-check any increases.
The issuance of valuation guidelines is also seen as a way to get the US private equity industry in line with Europe. The NVCA’s overseas counterpart, the European Venture Capital Association (EVCA), for example, has its own set of recommended valuation standards.
The PEIGG is not the only organization to make a push for industry-wide standards in valuation. In January, the Association for Investment Management and Research (AIMR), a US-based non-profit association that issues investment reporting and valuation standards, added its own private equity valuation principles to its standards handbook. Like the PEIGG, the AIMR also advocates adopting a “fair value” method for pricing investments, though again, its guidelines are strictly voluntary.