One of the biggest challenges for private equity professionals today is the lack of clarity surrounding how to value their portfolio companies. And if they were hoping that recent announcements from accounting bodies would help to disperse the fog, they have been left disappointed.
On 30 September, the Financial Accounting Standards Board (FASB) made an announcement that was interpreted by some as relaxing the requirement to mark private equity portfolio investments to market in circumstances where the market is “disorderly”.
Because it could be argued that markets today are generally in a disorderly state, some assumed that marking to market has been effectively suspended (this appeared to be the conclusion of a report in UK newspaper the Sunday Times, for example).
On 10 October, the FASB issued a follow-up statement, FAS 157-3, apparently designed to clarify that an alternative to marking to market should only be considered where the market price of an individual asset or specific asset class has become distressed. It stated: “Even in times of market dislocation, it is not appropriate to conclude that all market activity represents forced liquidations or distressed sales”.
FAS 157-3 did not address the question of what happens when many or most market prices have become distressed.
The waters became further muddied when another UK newspaper, the Financial Times, on 13 October ran a story that the International Accounting Standards Board was considering adjusting its rules to allow banks to return to the old practice of cost accounting. This, according to a commentary issued by investment bank Houlihan Lokey, “begs the question on how non-bank investors should be treated, and risks a proliferation of different valuations of identical assets as a function of the vehicle in which they are held”.
Says Max Ziff, co-head of UK financial advisory services at Houlihan Lokey: “Given the inevitable scepticism of investors to valuations in distressed and illiquid markets, there needs to be a code of best practice where private equity firms deviate from valuations based on inputs derived from market prices. The consequences of a “free-for-all” basis of valuation would be a further lack of investor confidence which would negatively impact future fundraising opportunities.”
Fortunately, there is some good news. For those firms offering independent valuation services such as Houlihan Lokey, business has rarely been better.