The International Private Equity and Venture Capital valuation guidelines aim to establish “best practice where private capital investments are reported at ‘fair value’” and “to help investors in private capital funds make better economic decisions,” as described in its December 2022 publication.
“A key purpose of the revised edition of the IPEV guidelines is to provide a framework for consistently determining valuation for the type of investments held by private capital funds,” explained Antoine Boggini, vice president of the LVPA and moderator of the webinar. Almost four years have passed between the two editions of the guidelines--the previous guidelines were published in 2018--and part of the aim of the webinar was to “consider what has happened during those four years.”
There was, of course, the covid-19 pandemic, but also dislocation of the public and private markets and the significant development of early-stage venture capital companies. “The intention today is to focus on these edits, on these changes, to the guidance provided by the IPEV guidelines, and not to comment or to discuss about the overall guidelines,” said Boggini.
At the webinar, the changes were divided in six categories.
1. Adjustment to enterprise value, with a focus on early stage, pre-revenue companies
“According to the guidelines, considerations should be given to performance--at, above or below expectation--cash burn, market acceptance, and how close is an exit and who would be the potential buyer,” said Boggini.
So how is it possible to get “comfortable” with a fair value? “It’s not easy,” replied Elena Moisei, strategy and transactions senior manager at EY Luxembourg. From her experience, when one is analysing or evaluating a startup, there are two important things to determine. The first is what stage of development the company is in--valuation methods and key performance indicators (KPIs) will differ, depending on where the company’s at.
It’s also important to pay attention to the “structure of a capital,” she noted. Is a company financed only by its founders, or have different investment rounds been financed by external investors? Common KPIs can include financial, technical and market metrics.
Talat Kadret, an audit partner at PwC Luxembourg, mentioned the importance of setting qualitative and quantitative milestones. Milestones need to be set, “and then at every single measurement date, you also assess where you are with this milestone, whether you have reached your objectives or not, and then consequently impact your valuation positively or negatively.”
2. Known and knowable information at measurement date
“Known or knowable information pertains to facts, conditions, or observable information which exists as of the measurement date and is available to the valuer or would reasonably be available to the valuer through routine inquiry or due diligence,” said Boggini, quoting from the IPEV guidelines. Could the spread of the pandemic be reasonably available to value, to consider, at the end of 2019?
This is an important question, but it’s not only covid that raises this question--the question could be applicable to many other situations, said Daniele Arcidiaco, corporate finance partner at KPMG Luxembourg. These could include “a market which is changing, new players, new products, economic obsolescence, these are all items which could potentially impact the evolution of the financials of a company,” he said.
“But the valuation date is really the point in time at which a potential valuer would have considered acquiring this asset,” said Arcidiaco. So it’s important to refer to identifiable, quantifiable information as at valuation date that could impact the value of the company, whether it’s covid, technology or another element.
Moisei echoed this point, saying that “especially in a volatile environment, it’s very important to fix on a valuation date,” and not to deviate.
3. ESG and integration into valuation models
On the topic of ESG and its integration into valuation, Arcidiaco sees two trends: attempts to create a common framework and quantification.
ESG might seem “pretty easy,” but implementing it in valuation is “not an easy exercise,” Moisei cautioned. It’s important to avoid giving a “double premium or a double penalty.”
4. Discounts on contractual restrictions
“In the new IPEV 2022, the discount which was applicable to a contractual restriction applicable to security was removed,” said Kadret, but “any specific legal or government restriction is still applicable.”
In addition, “the FSAP [Financial Sector Assessment Program] has taken the same direction as the IPEV in removing the application of discount for a contractual restriction applicable to security.” This means there’s a “convergence” between the IPEV and the FSAP, though Kadret also noted that there’s “still the possibility” to apply a discount under IFRS 13 [International Financial Reporting Standards].
5. Dislocation of markets
Something that has happened more frequently over the past four years is market dislocation, said Boggini. But there could be “some subjectivity” around what can be seen as “highly or excessively volatile.” So what does it mean to talk about market dislocation?
“From a valuation standpoint, we define a dislocated market where there is a lot of volatility and uncertainty, in relation to potential future development,” replied Arcidiaco. “It’s a market that is altered, I would say, starting from the normal condition.” It’s a “very challenging” situation that requires a lot of “professional judgement.”
But valuation should follow a few steps to ensure that fair value is “defendable,” said Arcidiaco. The first point is that fair value is not a “fire sale.” Instead, value creation should be monitored during the long run. Second, “different companies in different sectors behave in a different way under a crisis”, so it’s important to focus on the company in the context of its sector. And the third point is related to “the selection of the appropriate valuation methodology,” he concluded.
6. Data quality
The webinar concluded with a brief discussion on data--the “raw materials,” as Boggini called it. Benjamin Franck, senior manager in the valuation department at Deloitte Luxembourg, emphasised the importance of spending more time to gather the information necessary for the valuation process.