Few readers will need reminding that the valuation of private equity portfolios has become a hot topic. Much of the recent debate that has arisen around the process of valuing private companies in a private equity fund's portfolio stems from the broader debates that have centred on transparency. Regulators and investors alike have been pushing for better disclosure on the part of any entity into which an investor can commit capital and in this context the limited partnership structure of a private equity fund has been put under close scrutiny. As these groups began to better acquaint themselves with a closed end investment product with a ten-year life span, so the relative opacity throughout the fund's life cycle became a source of concern.
Limited partners are today much more keen on seeing more granular information on a fund's composition, and as more mainstream institutional investors invest in private equity, so the expectation that private equity will conform in no small part to other more mainstream asset classes in terms of information quality, frequency and – crucially – accuracy – increases. And this mantra of consistency and clarity seems pretty hard to rebut – especially if you are a general partner.
But there are some significant reasons to at least pause before embracing a set of reporting and valuation guidelines – whether you are an LP or a GP. If you are the latter, there are both strategic and operational concerns. For one, the regular revaluation of portfolio companies using a fair value model, rather than holding at cost (or subsequent financing round), means a fund's performance profile is going to fluctuate – with possibly negative implications for not just fund raising but also secondary sales and general LP sentiment. A private equity firm is also going to have to build the capacity to regularly capture, collate and distribute the required information. That means investment in people and systems.
Likewise, if you are an LP you are going to find that your allocation models are going to have to accommodate far more volatile private equity metrics – not only obliging greater maintenance and supervision but also prompting greater scrutiny from trustees and investment committees (not a bad thing in itself, but an issue nonetheless).
Which all perhaps serves as a useful reminder that the key people who need to know how a fund's portfolio is performing are the limited partners who invest in it and the general partners who manage it. So long as these two groups have agreed a set of rules by which the value of the portfolio is calculated (and that these are then adhered to) and that the LPs have the means to monitor these valuations (reviewing, not approving, each quarter in an audit-style committee) then surely the key part of the valuation mission has been accomplished. VDO: valuation debate over.