US industry group issues ‘fair value’ guidelines

The international harmonisation of reporting standards in the private equity market has come a step closer with new ‘fair value’ guidelines from an industry body in the US.

The Private Equity Industry Guidelines Group (PEIGG), a group of private equity market participants dedicated to bringing standards to valuations and reporting in the US private equity market, has released a set of guidelines that promote the use of ‘fair value’ in determining the worth of portfolio companies.

PEIGG, which has 18 board members comprised of general partners, limited partners and some service providers, says it spent nearly two years seeking comments for and revising drafts of the guidelines. The body sought the advice of other US industry groups such as the Institutional Limited Partners Association and the National Venture Capital Association. It also reviewed valuation guidelines sponsored by overseas industry groups such as the European Venture Capital Association and the British Venture Capital Association.

The focus of PEIGG’s efforts is to persuade general partners to move towards fair value when reporting valuations, which means the assigning of value to a portfolio company that would reflect its price if sold in the current market. General partners have been criticized in recent years for holding investments at cost in the face of market changes that would significantly affect the value of portfolio companies if sold.

Specifically, some limited partners have expressed frustration at fund managers that have reported investments at cost years after the initial investment, even as the market for those companies steadily worsened. The problem is compounded by the fact that no two private equity firms follow the same valuation practices, which, in co-investment situations, has meant different GPs reporting varying valuations for the same company.

In a conference call, Stephen Holmes, general partner and chief financial officer of venture capital firm InterWest Partners and a member of PEIGG’s valuation subcommittee, said the guidelines did not ‘mandate change’ but rather sought to affect change through consensus building. He expressed hope that the industry would gradually adopt the guidelines, noting that it might be a slow process – three of PEIGG’s 18 board members have not yet succeeded in persuading their own firms to adopt the guidelines.

In addition to suggesting guidelines for when and using what process a company’s value should be written up or down, the PEIGG is also ‘strongly suggesting’ that fund managers form valuation committees comprised of both GPs and LPs, said Kevin Delbridge, a managing director at fund of funds firm HarbourVest Partners. Delbridge also said he hoped to see GPs invested in the same company effectively collaborate on the valuation process to ensure consistency.

PEIGG members stressed the guidelines would continue to encourage GPs to use their best judgment in determining values. “While the managers’ judgment will result in different, but supportable, views on valuation, we expect that applying these guidelines will narrow the range,” a PEIGG press release stated.

In the conference call, Delbridge said PEIGG still had a number of goals it wanted to accomplish before disbanding. The group hopes to issue guidelines on how much information a GP should share with its LPs with regard to underlying portfolio companies; guidelines on whether IRR information in fund-marketing materials should be consistently presented on a net or gross basis; and the formulation of a ‘reporting template’, or standard format by which GPs report to investors.

The coming year should see ‘tangible progress’ in advancing these remaining goals, Holmes said, adding that PEIGG had ‘no interest’ in becoming a permanent industry group.