Benoît Theunissen: Kroll, formerly Duff & Phelps, launched its valuation practice in Luxembourg in December 2021. What were the reasons for this?
Armand Kantar: Kroll has historically supported our Luxembourg client base through our global Portfolio Valuation practice which includes 300 valuation professionals across Europe, and based in London. However, based on the simple observation that there is a high density of funds in Luxembourg, in particular AIFs [alternative investment funds], which are growing rapidly, making Luxembourg an important place for valuation consulting activities, Kroll inaugurated our valuation consulting activities in Luxembourg in 2021. Indeed, AIFs hold illiquid and often difficult to value assets, commonly called ‘hard to value assets’. They therefore require rigorous valuation methodologies specific to each asset.
Hard to value assets are also illiquid assets. Some of these assets are even more difficult to value because they do not yet generate income, such as early stage investments in the venture capital field.
So AIFs include ‘hard to value assets’. What makes them so difficult to value?
These are assets for which there is no direct reading of the price in the market, as opposed to listed stocks, for example. Hard to value assets are also illiquid assets. Some of these assets are even more difficult to value because they do not yet generate income, such as early stage investments in the venture capital field. In addition, investments may be in new industries or niche technologies that make them difficult to compare with other similar companies.
What is the industry’s approach to the valuation of hard to value assets?
Because of the challenges they represent, Limited Partners are increasingly pushing investment advisors and their AIFMs – many of whom are based in Luxembourg – to have their NAVs validated by a reputable independent third party, such as ourselves. This practice brings independent credibility to the NAVs [net asset values], gives regulators and investors confidence in the governance around valuations, and helps AIFMs to reduce their own valuation risk profile.
So that’s where you come in as a consulting firm. How do you fit into your clients’ processes?
Our role is that of an ‘independent cross-check’ of the client’s own valuation process – whether that’s in the form of a fully independent corroborative valuation, or an opinion of ‘positive assurance.’ Our business model is to support the valuation processes of funds, by being in constant dialogue with them. They provide us with their information so that we can then carry out the valuations. This is not a one-off exercise, it requires several iterations. To do this, we have the methodological and technical know-how to value the full range of assets held by funds, including private equity, private debt, venture capital and derivatives.
Our methodology must be robust enough to take into account all the elements that affect the value of a company.
In practice, how do you go about valuing these types of assets?
We implement a methodological approach and a valuation framework that incorporates recognised best practices and the IPEV [International Private Equity and Venture Capital Valuation] guidelines and IFRS [International Financial Reporting Standards] reference frameworks. Our technical analysis includes financial analysis based on financial models, complemented by an overall view of the business to identify any elements that have an impact on value. Our starting point is naturally the business plan, which reflects the future expectations of the companies under analysis. Our methodology must be robust enough to take into account all the elements that affect the value of a company. It is also essential that both the framework and the methodology are flexible to accommodate the shocks and volatilities of a crisis, for example.
How have the crises of the last two years affected the valuation methodologies and models in place?
Depending on the industry, certain valuation approaches have been put to the test over the last two years due to the volatility of the markets. If we take the example of the year 2020, this could concern industries such as tourism, catering or transport, where funds have had to question the forecasting of companies. Our role then is to support our clients in setting up a valuation framework adapted to this challenge, and a methodological approach that must remain consistent over time.
If it is important to maintain consistency of frameworks and methodologies over time, how do you meet the challenge of anticipation and change?
Where there is significant uncertainty in forecasting, several methodological approaches are possible, including the creation of several scenarios by funds based on their understanding of possible future states of the world. This may include, for example, exiting the covid-19 pandemic period and making assumptions about the timing of a return to normal industrial activity. Other more complex approaches, simulating a large number of scenarios, such as Monte Carlo modelling [an analytical method that can reduce uncertainty and complexity by integrating multiple data sources], are also possible.
The core of our work is to ensure that funds have a robust, flexible valuation process that takes into account the key elements affecting value.
What kind of information do you feed into your models?
Our valuations are all bespoke, both for each client and each investment. They incorporate the qualitative and quantitative elements provided by our client that have an impact on the valuation. Our approach is not simply a desktop valuation exercise, as we discuss with our clients their views on what are sometimes qualitative and subjective issues such as ESG aspects. We therefore advise our clients to take into account such qualitative elements, as they can become a valuation risk. The company will be more resilient in the event of a crisis if it has previously identified these elements and integrated them into its valuation model.
As you mention, qualitative elements include an element of subjectivity. Isn’t this opening the door to too much room for error?
Subjectivity is inherent in the valuation of ‘hard-to-value’ assets. To attempt to remove the subjectivity would inevitably result in mis-valuation. This creates reputational risk, not just for our clients, but for ourselves as well as the broader industry. The core of our work is to ensure that funds have a robust, flexible valuation process that takes into account the key elements affecting value. Valuation approaches, while rigorous and demanding, can indeed sometimes seem more of an art than an exact science. But for Kroll it is an art that is supported by strong technical and sector expertise, and by the know-how of valuation professionals whose experience spans the full range of assets and industry sectors.
This article was published for the Paperjam + Delano Finance newsletter, the weekly source for financial news in Luxembourg. Subscribe using this link. Read the original French version of this interview on the Paperjam website.