1. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA LVA L U AT I O N G U I D E L I N E S Edition August 2010

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These guidelines have been developed by the IPEV Board with the valuable input and endorsementof the following associations:AFIC - Association Franaise des Investisseurs en Capital*AIFI - Italian Private Equity and Venture Capital AssociationAMEXCAP - Mexican Private Equity AssociationAMIC - Moroccan Private Equity and Venture Capital AssociationAPCRI - Portuguese Private Equity and Venture Capital AssociationAPEA - Arab Private Equity AssociationASCRI - Spanish Private Equity and Venture Capital AssociationATIC - Tunisian Venture Capital AssociationAVCA - African Venture Capital AssociationAVCAL - Australian Private Equity and Venture Capital AssociationAVCO - Austrian Private Equity and Venture Capital OrganizationBVA - Belgian Venturing AssociationBVCA - British Venture Capital Association*BVK - German Private Equity and Venture Capital Association e.V.CVCA - Canadas Venture Capital and Private Equity AssociationCVCA - China Venture Capital AssociationCVCA - Czech Venture Capital and Private Equity AssociationDVCA - Danish Venture Capital AssociationEMPEA - Emerging Markets Private Equity AssociationEVCA - European Private Equity and Venture Capital Association*FVCA - Finnish Venture Capital AssociationGVCA - Gulf Venture Capital AssociationHKVCA - Hong Kong Venture Capital AssociationHVCA - Hungarian Venture Capital and Private Equity AssociationILPA - Institutional Limited Partners AssociationIVCA - Irish Venture Capital AssociationLAVCA - Latin American Venture Capital AssociationLPEQ - LPEQ Listed Private EquityLVCA - Latvian Venture Capital AssociationNVCA - Norwegian Venture Capital & Private Equity AssociationNVP - Nederlandse Vereniging van Participatiemaatschappijen (Dutch Private Equity andVenture Capital Association)NZVCA - New Zealand Private Equity & Venture Capital AssociationPPEA - Polish Private Equity AssociationRseau Capital - Qubec Venture Capital and Private Equity AssociationRVCA - Russian Private Equity and Venture Capital AssociationSAVCA - Southern African Venture Capital and Private Equity AssociationSECA - Swiss Private Equity and Corporate Finance AssociationSLOVCA - Slovak Venture Capital AssociationSVCA - Singapore Venture Capital and Private Equity AssociationSVCA - Swedish Private Equity and Venture Capital Association(Endorsement as of 31 January 2011)* AFIC, BVCA and EVCA founded the IPEV Board in 2005. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 3 3. DisclaimerThe information contained within this paper has been produced with reference to the contributions of a numberof sources. The IPEV Board has taken suitable steps to ensure the reliability of the information presented.However, the IPEV Board nor other named contributors, individuals or associations can accept responsibilityfor any decision made or action taken, based upon this paper or the information provided herein.For further information please visit: www.privateequityvaluation.com 4. CONTENTSPRE FA CE 6IN T RODU CT ION7DE FIN IT ION S 8SE CT ION I: DE T E RM INING FAIR VALUE101. The Concept of Fair Value 112. Principles of Valuation 113. Valuation Methodologies 14 3.1. General14 3.2. Selecting the Appropriate Methodology14 3.3. Price of Recent Investment 15 3.4. Multiples17 3.5. Net Assets 20 3.6. Discounted Cash Flows or Earnings (of Underlying Business) 21 3.7. Discounted Cash Flows (from the Investment)21 3.8. Industry Valuation Benchmarks22 3.9. Available Market Prices234. Valuing Fund Interests24 4.1. General24 4.2. Adjustments to Net Asset Value 24 4.3. Secondary Transactions 25SE CT ION II: A PPL ICATION G UIDANCE26Introduction 271. Specific Considerations 271.1. Insider Funding Rounds271.2. Distressed Market 271.3. Deducting Higher Ranking Instruments281.4. Bridge Financing281.5. Mezzanine Loans 281.6. Rolled up Loan Interest 291.7. Indicative Offers 291.8. Impacts from Structuring29E N DORSIN G A SSOCIATIONS 31 5. P R E FA C EThese Guidelines set out recommendations, intended to Where there is conflict between a recommendationrepresent current best practice, on the valuation of privatecontained in these Guidelines and the requirements ofequity and venture capital investments. The term private any applicable laws or regulations or accounting standardequity is used in these Guidelines in a broad sense to or generally accepted accounting principle, the latterinclude investments in early stage ventures, management requirements should take precedence.buyouts, management buyins and similar transactions andgrowth or development capital.No member of the International Private Equity and VentureCapital Valuation Guidelines (IPEV Guidelines) BoardThe recommendations are intended to be applicable across(IPEV Board), any committee or working party thereof canthe whole range of Private Equity Funds (seed and start-upaccept any responsibility or liability whatsoever (whether inventure capital, buyouts, growth/development capital, etc)respect of negligence or otherwise) to any party as a resultand financial instruments commonly held by such Private of anything contained in or omitted from the GuidelinesEquity Funds. They also provide a basis for valuing nor for the consequences of reliance or otherwise oninvestments by other entities, including Funds-of-funds,the provisions of these Guidelines.in such Private Equity Funds.These Guidelines should be regarded as supersedingThe recommendations themselves are surrounded byprevious Guidelines issued by the IPEV Board with effecta border and set out in bold type, whereas explanations,for reporting periods post 1 July 2009.illustrations, background material, context and supportingcommentary, which are provided to assist in theinterpretation of the recommendations, are set outin normal type.6I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 6. INTRODUCTIONPrivate equity managers may be required to carry outThe requirements and implications of financial reportingperiodic valuations of Investments as part of the reporting standards and in particular International Financialprocess to investors in the Funds they manage.Reporting Standards and US GAAP have been consideredThe objective of these Guidelines is to set out best practice in the preparation of these Guidelines. This has been done,where private equity Investments are reported at Fairin order to provide a framework for Private Equity FundsValue, with a view to promoting best practice and hencefor arriving at a Fair Value for Investments which ishelping investors in Private Equity Funds make better consistent with accounting principles.economic decisions.It is not a requirement of accounting principles thatThe increasing importance placed by international these Guidelines are followed. However compliance withaccounting authorities on Fair Value reinforces the needthese accounting principles can be achieved by followingfor the consistent use of valuation standards worldwide the Guidelines.and these Guidelines provide a framework for consistentlydetermining valuations for the type of Investments held These Guidelines are intended to represent current bestby Private Equity Funds.practice and therefore will be revisited and, if necessary,revised to reflect changes in international regulation orPrivate Equity Funds are typically governed by a combinationaccounting standards.of legal or regulatory provisions or by contractual terms.It is not the intention of these Guidelines to prescribe or These Guidelines are concerned with valuation fromrecommend the basis on which Investments are included ina conceptual standpoint and do not seek to addressthe accounts of Funds. The IPEV Board confirms fair value best practice as it relates to investor reporting, internalas the best measure of valuing private equity portfolio processes, controls and procedures, governance aspects,companies and investments in private equity funds.Committee oversights, the experience and capabilitiesThe boards support for fair value is underpinned byrequired of the Valuer or the audit or review of valuations.the transparency it affords investors in funds, which usefair value as an indication of the interim performance of A distinction is made in these Guidelines between the basisa portfolio. In addition, institutional investors require fairof valuation (Fair Value), which defines what the carryingvalue to make asset allocation decisions, and to produceamount purports to represent, a valuation methodologyfinancial statements for regulatory purposes. (such as the earnings multiple technique), which details themethod or technique for deriving a valuation, and inputsused in the valuation methodology (such as EBITDA).I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 7 7. DEFINITIONSThe following definitions shall apply in these Guidelines.Fair ValueThe Fair Value is the price at which an orderly transactionActive Marketwould take place between Market Participants at theA financial instrument is regarded as quoted in an active Reporting Date (measurement date).market if quoted prices are readily and regularly availablefrom an exchange, dealer, broker, industry group, pricing Fund or Private Equity Fundservice or regulatory agency, and those prices representThe Fund or Private Equity Fund is the generic term usedactual and regularly occurring market transactions onin these Guidelines to refer to any designated pool ofan arms length basis.investment capital targeted at all stages of private equityInvestment from start-up to large buyout, including thoseA market is considered active when transactions are takingheld by corporate entities, limited partnerships andplace regularly at an arms length basis with sufficientother investment vehicles.volume and frequency to determine a price on an ongoingbasis. The necessary level of trading required to meet theseFund-of-Fundscriteria is a matter of judgement.Fund-of-Funds is the generic term used in these GuidelinesAttributable Enterprise Value to refer to any designated pool of investment capitaltargeted at investment in underlying Private Equity Funds.The Attributable Enterprise Value is the Enterprise Valueattributable to the financial instruments held by the FundInvestee Companyand other financial instruments in the entity that rankalongside or beneath the highest ranking instrument The term Investee Company refers to a single business orof the Fund.group of businesses in which a Fund is directly invested.Distressed or Forced TransactionInvestmentA forced liquidation or distress sale (i.e., a forced An Investment refers to all of the financial instrumentstransaction) is not an orderly transaction and is not in an Investee Company held by the Fund.determinative of Fair Value. An entity applies judgementin determining whether a particular transaction Liquidityis distressed or forced.Liquidity is defined as the relative ease and promptnesswith which an instrument may be sold when desired.Enterprise ValueThe Enterprise Value is the value of the financialMarket Participantsinstruments representing ownership interests inMarket Participants are potential or actual willing buyersan entity plus the net financial debt of the entity.or willing sellers when neither is under any compulsionto buy or sell, both parties having reasonable knowledgeof relevant facts and who have the ability to performsufficient due diligence in order to be able to make orderlyinvestment decisions related to the enterprise.8I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 8. Net Asset Value (NAV)Underlying BusinessNAV of a Fund is the amount estimated as being The Underlying Business is the operating entities in whichattributable to the investors in that Fund on the basisthe Fund has invested, either directly or through a numberof the Fair Value of the underlying Investee Companies of dedicated holding companies.and other assets and liabilities. ValuerOrderly Transaction The Valuer is the person with direct responsibility forAn orderly transaction is a transaction that assumes valuing one or more of the Investments of the Fundexposure to the market for a period prior to the Reporting or Fund-of-Funds.Date to allow for marketing activities that are usual andcustomary for transactions involving such assets or liabilities.Quoted InstrumentA Quoted Instrument is any financial instrument for whichquoted prices reflecting normal market transactions arereadily and regularly available from an exchange, dealer,broker, industry group, pricing service or regulatory agency.RealisationRealisation is the sale, redemption or repayment ofan Investment, in whole or in part; or the insolvency ofan Investee Company, where no significant return tothe Fund is envisaged.Reporting DateIs the date for which the valuation is being prepared,which equates to the measurement date.Secondary TransactionA Secondary Transaction refers to a transaction whichtakes place when a holder of an interest in unquoted orilliquid Funds trades their interest to another party.Unquoted InstrumentAn Unquoted Instrument is any financial instrument otherthan a Quoted Instrument. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 9 9. SECTION I:D E T E R M I N I N G F A I R VA L U E10 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 10. 1. T H E C O N C E P T OFF A I R VA L U EThe Fair Value is the price at which an orderly transaction would take place betweenMarket Participants at the Reporting Date.For Quoted Instruments, available market prices will be the primary basis forthe determination of Fair Value.For Unquoted Investments, the estimation of Fair Value requires the Valuer to assumethe Underlying Business is realised at the Reporting Date, appropriately allocated tothe various interests, regardless of whether the Underlying Business is prepared for saleor whether its shareholders intend to sell in the near future.The objective is to estimate the hypothetical Although transfers of shares in privateexchange price at which Market Participants businesses are often subject to restrictions,would agree to transact at the Reporting Date.rights of pre-emption and other barriers,it should still be possible to estimate whatFair Value is not the amount that an entity amount a willing buyer would pay to takewould receive or pay in a forced transaction, ownership of the Investment.involuntary liquidation or distressed sale.However the hypothetical exchange price musttake into account current market conditionsfor buying and selling assets.2. P R I N C I P L E S OFVA L U AT I O NThe Fair Value of each Investment In estimating Fair Value for anshould be assessed at each ReportingInvestment, the Valuer should apply aDate. methodology that is appropriate in lightof the nature, facts and circumstancesof the Investment and its materiality inIn the absence of an active market for athe context of the total Investmentfinancial instrument, the Valuer must estimateportfolio and should use reasonableFair Value utilising one or more of the valuationdata and market inputs, assumptionsmethodologies.and estimates. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 11 11. 2. P R I N C I P L E SOFVA L U AT I O NIn private equity, value is generally crystallised throughDue to the complex interaction of these factors anda sale or flotation of the entire Underlying Business,often the lack of directly comparable market transactions,rather than through a transfer of individual shareholdercare should be applied when using publicly availablestakes, the value of the business as a whole at information regarding other entities in deriving a valuation.the Reporting Date (Enterprise Value) will often provideIn order to determine the Fair Value of an Investment,a key insight into the value of investment stakes inthe Valuer will have to exercise judgement and makethat business.necessary estimates to adjust the market data to reflectthe potential impact of other factors such as geography,credit risk, foreign currency, rights attributable,The Fair Value is estimated by the Valuer,equity prices and volatility.whichever valuation methodologies are used,from the Enterprise Value, as follows:As such, it must be recognised that, whilst valuations(i) Determine the Enterprise Value of the do provide useful interim indications of the progressInvestee Company using the valuationof a particular Investment or portfolio of Investments,methodologies;ultimately it is not until Realisation that true performanceis firmly determined. A Valuer should be aware of reasons(ii) Adjust the Enterprise Value for surplus assetswhy realisation proceeds are different from their estimatesor excess liabilities and other contingenciesof Fair Value.and relevant factors to derive an AdjustedEnterprise Value for the Investee Company;Fair Value should reflect reasonable estimates and(iii) Deduct from this amount any financial assumptions for all significant factors that parties to aninstruments ranking ahead of the highestarms length transaction would be expected to consider,ranking instrument of the Fund in a including those which impact upon the expected cashliquidation scenario (e.g. the amount thatflows from the Investment and upon the degree of riskwould be paid) and taking into accountassociated with those cash flows.the effect of any instrument that maydilute the Funds Investment to deriveIn assessing the reasonableness of assumptions andthe Attributable Enterprise Value;estimates, the Valuer should:(iv) Apportion the Attributable Enterprise Value note that the objective is to replicate those thatbetween the companys relevant financial the parties in an arms-length transaction would makeinstruments according to their ranking;at the Reporting Date; take account of events taking place subsequent to the(v) Allocate the amounts derived according to Reporting Date where they provide additional evidencethe Funds holding in each financial of conditions that existed at the Reporting Date;instrument, representing their Fair Value. take account of current market conditions at the reporting date; andIt is important to recognise the subjective nature of take account of materiality considerations.private equity Investment valuation. It is inherently basedon forward-looking estimates and judgements about theUnderlying Business itself: its market and the environmentin which it operates; the state of the mergers andacquisitions market; stock market conditions andother factors that exist at the Reporting Date.12 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 12. Apportion the Attributable Enterprise ValueBecause of the uncertainties inherent in appropriatelyestimating Fair Value for private equity The apportionment should reflect the respective amountsInvestments, care should be applied in exercising accruing to each financial instrument holder in the eventjudgement and making the necessary estimates. of a sale or flotation at the Reporting Date. As discussedHowever, the Valuer should be wary of applying further in section II 1.8., where there are ratchets orexcessive caution. share options or other mechanisms (such as liquidation preferences, in the case of Investments in early-stagePrivate Equity Funds often undertake an Investment withbusinesses) in place which are likely to be triggereda view to build, develop and/or to effect substantialin the event of a sale of the company at the givenchanges in the Underlying Business, whether it is to its Enterprise Value at that date, these should be reflectedstrategy, operations, management, or financial condition.in the apportionment.Sometimes these situations involve rescue refinancing ora turnaround of the business in question. Whilst it mightThe estimation of Fair Value should be undertaken onbe difficult in these situations to determine Fair Value,the assumption that options and warrants are exercised,it should in most cases be possible to estimate the amount where the Fair Value is in excess of the exercise price anda Market Participant would pay for the Investmentaccordingly it is a reasonable assumption that these will bein question. exercised. The aggregate exercise price of these may result in surplus cash arising in the Underlying Business ifThere may be situations where: the aggregate exercise price is significant. the range of reasonable Fair Value estimates is significant; Differential allocation of proceeds may have an impact on the probabilities of the various estimates within the value of an Investment. If liquidation preferences exist, the range cannot be reasonably assessed; these need to be reviewed to assess whether they are the probability and financial impact of achieving a key expected to give rise to a benefit to the Fund, or a benefit milestone cannot be reasonably predicted; and to a third party to the detriment of the Fund. there has been no recent investment into the business. Where significant positions in options and warrants areWhile these situations prove difficult, the Valuer must held by the Fund, these may need to be valued separatelystill come to a conclusion as to their best estimate of from the underlying investments using an appropriatethe hypothetical exchange price between willing option based pricing model.Market Participants.Estimating the increase or decrease in Fair Value insuch cases may involve reference to broad indicatorsof value change (such as relevant stock market indices).After considering these broad indicators, in some situations,the Valuer might reasonably conclude that the Fair Valueat the previous Reporting Date remains the best estimateof Fair Value.Where a change in Fair Value is perceived to haveoccurred, the Valuer should amend the carrying valueof the Investment to reflect the estimated impact. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 13 13. 3 . VA L U AT I O N M E T H O D O L O G I E S3.1. General Movements in rates of exchange may impact the value of the Funds Investments and these should be takenA number of valuation methodologies that may be into account.considered for use in estimating the Fair Value ofUnquoted Instruments are described in sections 3.3. to3.8. below. These methodologies should be amended asWhere the reporting currency of the Fundnecessary to incorporate case-specific factors affecting Fair is different from the currency in whichValue. Methodologies for valuing Quoted Instruments are the Investment is denominated, translationdescribed in section 3.9. below.into the reporting currency for reporting purposesshould be done using the bid spot exchange rateFor example, if the Underlying Business is holding surplusprevailing at the Reporting Date.cash or other assets, the value of the business shouldreflect that fact. 3.2. Selecting the AppropriateBecause, in the private equity arena, value is generallyMethodologycrystallised through a sale or flotation of the entireUnderlying Business, rather than through a transferThe Valuer should exercise their judgement toof individual shareholder stakes, the value of the businessselect the valuation methodology that is the mostas a whole at the Reporting Date will often provide a keyappropriate for a particular Investment.insight into the value of investment stakes in that business.For this reason, a number of the methodologies describedbelow involve estimating the Enterprise Value as anThe key criterion in selecting a methodology is that itinitial step.should be appropriate in light of the nature, facts and circumstances of the Investment and its materiality in theThere will be some situations where the Fair Value willcontext of the total portfolio of Investments. The Valuerderive mainly from the expected cash flows and riskmay consider utilising further methodologies to checkof the relevant financial instruments rather than from the Fair Value derived, if appropriate.the Enterprise Value. The valuation methodology usedin these circumstances should therefore reflect this fact. When selecting the appropriate methodology each Investment should be considered individually. Where an immaterial group of Investments in a portfolio are similar inIn determining the Fair Value of an Investment, terms of risk profile and industry, it is acceptable to applythe Valuer should use judgement. This includes a the same methodology across all Investments in thatdetailed consideration of those specific terms of immaterial group. The methodology applied should bethe Investment which may impact its Fair Value. consistent with that used for material investments withIn this regard, the Valuer should consider the a similar risk profile in that industry.substance of the Investment, which may takepreference over the strict legal form.14I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 14. An appropriate methodology will incorporate availableMethodologies should be applied consistently from periodinformation about all factors that are likely materially toto period, except where a change would result in betteraffect the Fair Value of the Investment. estimates of Fair Value.The Valuer will select the valuation methodology thatThe basis for any changes in valuation methodologiesis the most appropriate and consequently make valuationshould be clearly understood. It is expected that thereadjustments on the basis of their informed and experienced would not be frequent changes in valuation methodologiesjudgement. This will include consideration of factors such as: over the course of the life of an investment. the relative applicability of the methodologies used The table below identifies a number of the most widely given the nature of the industry and current market used methodologies conditions; the quality, and reliability of the data used in each METHODOLOGY methodology; Price of Recent Investment the comparability of enterprise or transaction data; Multiples the stage of development of the enterprise; Net assets the ability of the enterprise to generate maintainable Discounted cash flows or earnings (of Underlying Business) profits or positive cashflow; and Discounted cash flows (from the Investment) any additional considerations unique to the enterprise. Industry valuation benchmarksIn assessing whether a methodology is appropriate, theValuer should be biased towards those methodologies that 3.3. Price of Recent Investmentdraw heavily on market-based measures of risk and return. Where the Investment being valued was itself madeFair Value estimates based entirely on observable market recently, its cost may provide a good indication of Fairdata should be of greater reliability than those based on Value. Where there has been any recent Investment inassumptions. In some cases observable market data may the Investee Company, the price of that Investment willrequire adjustment by the Valuer to properly reflect provide a basis of the valuation.the facts and circumstances of the entity being valued.This adjustment should not be automatically regarded The validity of a valuation obtained in this way is inevitablyas reducing the reliability of the Fair Value estimation. eroded over time, since the price at which an Investment was made reflects the effects of conditions that existedMethodologies utilising discounted cashflows and industry on the date that the transaction took place. In a dynamicbenchmarks should rarely be used in isolation of the market- environment, changes in market conditions, the passagebased measures and then only with extreme caution. of time itself and other factors will act to diminish theThese methodologies may be useful as a cross-check of appropriateness of this methodology as a means ofvalues estimated using the market-based methodologies. estimating value at subsequent dates.Where the Valuer considers that several methodologies In addition, where the price at which a third party hasare appropriate to value a specific Investment, the Valuer invested is being considered as the basis of valuation,may consider the outcome of these different valuation the background to the transaction must be taken inmethodologies so that the results of one particular method to account.may be used as a cross-check of values or to corroborateor otherwise be used in conjunction with one or moreother methodologies in order to determine the Fair Valueof the Investment. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 15 15. 3. VA L U AT I O N M E T H O D O L O G I E SIn particular, the following factors may indicate that the price The Price of Recent Investment methodology is commonlywas not wholly representative of the Fair Value at the time: used in a seed, start-up or an early-stage situation, where there are no current and no short-term future different rights attach to the new and existing earnings or positive cash flows. For these enterprises, Investments; typically, it is difficult to gauge the probability and financial disproportionate dilution arising from a new investor; impact of the success or failure of development or research a new investor motivated by strategic considerations; activities and to make reliable cash flow forecasts. the transaction may be considered to be a forced sale or rescue package; or Consequently, the most appropriate approach to determine the absolute amount of the new Investment is relatively Fair Value is a methodology that is based on market data, insignificant. that being the Price of a Recent Investment.This methodology is likely to be appropriate for all private If the Valuer concludes that the Price of Recent Investment,equity Investments, but only for a limited period after the unadjusted, is no longer relevant, and there are nodate of the relevant transaction. Because of the frequency comparable companies or transactions from which towith which funding rounds are often undertaken for seed infer value, it may be appropriate to apply an enhancedand start-up situations, or in respect of businesses engaged assessment based on an industry analysis, sector analysisin technological or scientific innovation and discovery, and/or milestone analysis.the methodology will often be appropriate for valuingInvestments in such circumstances. In such circumstances, industry-specific benchmarks/ milestones, which are customarily and routinely usedThe length of period for which it would remain in the specific industries of the Investee Company,appropriate to use this methodology will depend on can be used in estimating Fair Value where appropriate.the specific circumstances of the Investment and In applying the milestone approach, the Valuer attemptsis subject to the judgement of the Valuer. to ascertain whether there has been a change in the milestone and/or benchmark which would indicateIn stable market conditions with little change in the entity that the Fair Value of the investment has changed.or external environment, the length of period for whichthis methodology is likely to be appropriate will be longer For an investment in early or development stages,than during a period of a rapidly changing environment. commonly a set of agreed milestones would be established at the time of making the investment decision. These willIn applying the Price of Recent Investment vary across types of investment, specific companies andmethodology, the Valuer uses the initial cost of industries, but are likely to include;the Investment itself or, where there has beensubsequent investment, the price at which aFinancial measures:significant amount of new Investment into the revenue growth;company was made, to estimate the Enterprise profitability expectations;Value, but only for a limited period following cash burn rate;the date of the relevant transaction. During the covenant compliance.limited period following the date of the relevanttransaction, the Valuer should in any case assess at Technical measures:each Reporting Date whether changes or eventssubsequent to the relevant transaction would phases of development;imply a change in the Investments Fair Value. testing cycles; patent approvals.16I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 16. Marketing and sales measures: However, the necessity and magnitude of the adjustmentsare relatively subjective and require a large amount of customer surveys;judgment on the part of the Valuer. Where deterioration in testing phases;value has occurred, the Valuer should reduce the carrying market introduction;value of the Investment reported at the previous Reporting market share.Date to reflect the estimated decrease.In addition, the key market drivers of the Investee Company,If there is evidence of value creation, such as those listedas well as the overall economic environment are relevant toabove, the Valuer may consider increasing the carryingthe assessment.value of the Investment. Caution must be applied sothat positive developments are only valued when theyIn applying the milestone analysis approach, the Valuercontribute to an increase in value of the Underlyingattempts to assess whether there is an indication of changeBusiness when viewed by a Market Participant.in Fair Value based on a consideration of the milestones.When considering these more subtle indicators of valueThis assessment might include considering whether:enhancement, in the absence of additional financing there has been any significant change in the resultsrounds or profit generation, the Valuer should consider of the Investee Company compared to budget planwhat value a purchaser would place on these indicators, or milestone;taking into account the potential outcome and the costs there have been any changes in expectation that and risks to achieving that outcome. technical milestones will be achieved; there has been any significant change in the market In the absence of significant revenues, profits or positive for the Investee Company or its products or potentialcash flows, other methodologies such as the earnings products;multiple are generally inappropriate. The DCF methodologies there has been any significant change in the global may be utilised, however the disadvantages inherent in economy or the economic environment in which these, arising from the high levels of subjective judgement, the Investee Company operates; may render the methodology inappropriate. there has been any significant change in the observable performance of comparable companies, or in the 3.4. Multiples valuations implied by the overall market;This methodology involves the application of an earnings any internal matters such as fraud, commercial disputes,multiple to the earnings of the business being valued in litigation, changes in management or strategyorder to derive a value for the business.If the Valuer concludes that there is an indication thatThis methodology is likely to be appropriate for anthe Fair Value has changed, they must estimate theInvestment in an established business with an identifiableamount of any adjustment from the last Price of Recentstream of continuing earnings that are considered to beInvestment. By its very nature such adjustment will bemaintainable.subjective. This estimation is likely to be based on objectivedata from the company, and the experience of theThis section sets out guidance for preparing valuations ofinvestment professionals and other investors.businesses on the basis of positive earnings. For businessesthat are still in the development stage and prior to positiveearnings being generated, multiples of revenue may beused as a basis of valuation.I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 17 17. 3. VA L U AT I O N M E T H O D O L O G I E SA revenue multiple is commonly the product of an Guidance on the interpretation of the terms in boldassumption as to the normalised level of earnings that is given below.can be generated from that revenue. The methodologyand considerations set out here for earnings multiples Appropriate multipleequally apply if a multiple of revenue is utilised. A number of earnings multiples are used, including price/ earnings (P/E), Enterprise Value/earnings before interestThis methodology may be applicable to companies with and tax (EV/EBIT) and depreciation and amortisationnegative earnings, if the losses are considered to be (EV/EBITDA). The particular multiple used should betemporary and one can identify a level of normalised appropriate for the business being valued. (N.B: The multiplesmaintainable earnings. of revenues and their use are presented in 3.8. Industry Valuation Benchmarks).This may involve the use of adjusted historic earnings,using a forecast level of earnings or applying a sustainable In general, because of the role of financial structuringprofit margin to current or forecast revenues. in private equity, multiples should be used to derive an Enterprise Value for the Underlying Business. Where EBITDAThe most appropriate earnings to use in this methodology multiples are available, these are commonly used.would be those likely to be used by a prospective When unavailable, P/E multiples may be used since thesepurchaser of the business. are more commonly reported. For a P/E multiple to be comparable, the two entities should have similar financingIn using the Earnings Multiple methodology structures and levels of borrowing.to estimate the Fair Value of an Investment,the Valuer should: Therefore, where a P/E multiple is used, it should generally be applied to an EBIT figure which is adjusted for finance(i) Apply a multiple that is appropriate and costs relating to operations, working capital and tax.reasonable (given the risk profile and earnings These adjustments are designed to eliminate the effect ongrowth prospects of the underlying company) the earnings of the acquisition finance on the Enterpriseto the maintainable earnings of the company; Value since this is subsequently adjusted.(ii) Adjust the Enterprise Value for surplus assetsor excess liabilities and other contingenciesBy definition, earnings multiples have as their numeratorand relevant factors to derive an Adjusted a value and as their denominator an earnings figure.Enterprise Value for the Investee Company; The denominator can be the earnings figure for any specified period of time and multiples are often defined as historical,(iii) Deduct from this amount any financial current or forecast to indicate the earnings used. It isinstruments ranking ahead of the highest important that the multiple used correlates to the periodranking instrument of the Fund in a and concept of earnings of the company being valued.liquidation scenario (e.g. the amount thatwould be paid) and taking into account the Reasonable multipleeffect of any instrument that may dilute theFunds Investment to derive the Attributable The Valuer would usually derive a multiple by reference toEnterprise Value;current market-based multiples, reflected in the market valuations of quoted companies or the price at which(iv) Apportion the Attributable Enterprise Value companies have changed ownership. This market-basedappropriately between the relevant financial approach presumes that the comparator companies areinstruments. correctly valued by the market.18I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 18. Whilst there is an argument that the market capitalisation When considering adjustments to reported multiples,of a quoted company reflects not the value of the companythe Valuer should also consider the impact of thebut merely the price at which small parcels of shares aredifferences between the liquidity of the shares being valuedexchanged, the presumption in these Guidelines is that and those on a quoted exchange. There is a risk associatedmarket based multiples are indicative of the value ofwith a lack of liquidity or marketability. The Valuer shouldthe company as a whole.consider the extent to which a prospective acquirer of those shares would take into account the additional risksWhere market-based multiples are used, the aim isassociated with holding an unquoted share.to identify companies that are similar, in terms of riskattributes and earnings growth prospects, to the company In an unquoted company the risk arising from the lackbeing valued. This is more likely to be the case where of marketability is clearly greater for a shareholder whothe companies are similar in terms of business activities, is unable to control or influence a realisation process thanmarkets served, size, geography and applicable tax rate. for a shareholder who owns sufficient shares to drive a realisation at will. It may reasonably be expected that aIn using P/E multiples, the Valuer should note thatprospective purchaser would assess that there is a higherthe P/E ratios of comparator companies will be affectedrisk associated with holding a minority position than forby the level of financial gearing and applicable tax ratea control position.of those companies. The multiple at the date of acquisition should be calibratedIn using EV/EBITDA multiples, the Valuer should note against the market comparable multiples. Differences, ifthat such multiples, by definition, remove the impact on any, should be understood and similar differences may bevalue of depreciation of fixed assets and amortisation ofexpected or need to be understood at subsequentgoodwill and other intangibles. If such multiples are used valuation dates.without sufficient care, the Valuer may fail to recognisethat business decisions to spend heavily on fixed assets orFor example, the reasons why the comparator multiplesto grow by acquisition rather than organically do have realmay need to be adjusted may include the following:costs associated with them which should be reflected the size and diversity of the entities and, therefore,in the value attributed to the business in question.the ability to withstand adverse economic conditions; the rate of growth of the earnings;It is important that the earnings multiple of each the reliance on a small number of key employees;comparator is adjusted for points of difference between the diversity of the product ranges;the comparator and the company being valued. These points the diversity and quality of the customer base;of difference should be considered and assessed by the level of borrowing;reference to the two key variables of risk and earnings for any other reason the quality of earnings may differ; andgrowth prospects which underpin the earnings multiple. the risks arising from the lack of marketability ofIn assessing the risk profile of the company being valued,the shares.the Valuer should recognise that risk arises from a range ofaspects, including the nature of the companys operations, Recent transactions involving the sale of similar companiesthe markets in which it operates and its competitive are sometimes used as a frame of reference in seeking toposition in those markets, the quality of its management derive a reasonable multiple. It is sometimes argued, sinceand employees and, importantly in the case of private such transactions involve the transfer of whole companiesequity, its capital structure and the ability of the Fund whereas quoted multiples relate to the price for smallholding the Investment to effect change in the company. parcels of shares, that they provide a more relevant source of multiples. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 19 19. 3. VA L U AT I O N M E T H O D O L O G I E SHowever, their appropriateness in this respect is often 3.5. Net Assetsundermined by the following:This methodology involves deriving the value of a business the lack of forward looking financial data and otherby reference to the value of its net assets. information to allow points of difference to be identified and adjusted for; This methodology is likely to be appropriate for a business the generally lower reliability and transparency of whose value derives mainly from the underlying Fair Value reported earnings figures of private companies; andof its assets rather than its earnings, such as property the lack of reliable pricing information forholding companies and investment businesses (such as the transaction itself.Funds-of-funds as more fully discussed in 4. ValuingFund Interests).It is a matter of judgement for the Valuer as to whether,in deriving a reasonable multiple, they refer to a singleThis methodology may also be appropriate for a business thatcomparator company or a number of companies oris not making an adequate return on assets and for whichthe earnings multiple of a quoted stock market sector ora greater value can be realised by liquidating the businesssub-sector. It may be acceptable, in particular circumstances,and selling its assets. In the context of private equity,for the Valuer to conclude that the use of quoted sectorit may therefore be appropriate, in certain circumstances,or sub-sector multiples or an average of multiples fromfor valuing Investments in loss-making companies anda basket of comparator companies may be appropriate.companies making only marginal levels of profits.Maintainable earnings In using the Net Assets methodology to estimateIn applying a multiple to maintainable earnings, it is the Fair Value of an Investment, the Valuer should:important that the Valuer is satisfied that the earningsfigure can be relied upon. Whilst this might tend to favour(i) Derive an Enterprise Value for the companythe use of audited historical figures rather than unauditedusing appropriate measures to value its assetsor forecast figures, it should be recognised that value is byand liabilities (including, if appropriate,definition a forward-looking concept, and quoted markets contingent assets and liabilities);more often think of value in terms of current and forecast (ii) Deduct from this amount any financialmultiples, rather than historical ones. In addition, there is instruments ranking ahead of the highestthe argument that the valuation should, in a dynamic ranking instrument of the Fund in aenvironment, reflect the most recent available information. liquidation scenario (e.g. the amount thatThere is therefore a trade-off between the reliability and would be paid) and taking into account therelevance of the earnings figures available to the Valuer. effect of any instrument that may dilute theOn balance, whilst it remains a matter of judgementFunds Investment to derive the Attributablefor the Valuer, he should be predisposed towards using Enterprise Value; andhistorical (though not necessarily audited) earnings figures (iii) Apportion the Attributable Enterprise Valueor, if he believes them to be reliable, forecast earnings appropriately between the relevant financialfigures for the current year. instruments.Whichever periods earnings are used, the Valuer shouldsatisfy himself that they represent a reasonable estimate ofmaintainable earnings, which implies the need to adjustfor exceptional or non-recurring items, the impact ofdiscontinued activities and acquisitions and forecastmaterial changes in earnings.20 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 20. 3.6. Discounted Cash Flows or Earnings (of Underlying Business)In using the Discounted Cash Flows or Earnings (of Underlying Business) methodology to estimateThis methodology involves deriving the value of a business the Fair Value of an Investment, the Valuer should:by calculating the present value of expected future cashflows (or the present value of expected future earnings, (i) Derive the Enterprise Value of the company,as a surrogate for expected future cash flows). The cash using reasonable assumptions and estimationsflows and terminal value are those of the Underlying of expected future cash flows (or expectedBusiness, not those from the Investment itself.future earnings) and the terminal value, and discounting to the present by applying theThe Discounted Cash Flows (DCF) technique is flexibleappropriate risk-adjusted rate that quantifiesin the sense that it can be applied to any stream of cashthe risk inherent in the company;flows (or earnings). In the context of private equity (ii) Deduct from this amount any financialvaluation, this flexibility enables the methodology to be instruments ranking ahead of the highestapplied in situations that other methodologies may be ranking instrument of the Fund in aincapable of addressing. While this methodology may liquidation scenario (e.g. the amount thatbe applied to businesses going through a period of great would be paid) and taking into accountchange, such as a rescue refinancing, turnaround, strategic the effect of any instrument that may diluterepositioning, loss making or is in its start-up phase, the Funds Investment to derive thethere is a significant risk in utilising this methodology. Attributable Enterprise Value;The disadvantages of the DCF methodology centre around (iii) Apportion the Attributable Enterprise Valueits requirement for detailed cash flow forecasts and the appropriately between the relevant financialneed to estimate the terminal value and an appropriate instruments.risk-adjusted discount rate. All of these inputs requiresubstantial subjective judgements to be made, and thederived present value amount is often sensitive to small3.7. Discounted Cash Flows (from thechanges in these inputs. Investment)This methodology applies the DCF concept and techniqueDue to the high level of subjectivity in selecting inputsto the expected cash flows from the Investment itself.for this technique, DCF based valuations are useful asa cross-check of values estimated under market-basedWhere Realisation of an Investment or a flotation ofmethodologies and should only be used in isolation ofthe Underlying Business is imminent and the pricingother methodologies under extreme caution.of the relevant transaction has been substantially agreed,the Discounted Cash Flows (from the Investment)In assessing the appropriateness of this methodology,methodology (or, as a surrogate, the use of a simplethe Valuer should consider whether its disadvantagesdiscount to the expected Realisation proceeds or flotationand sensitivities are such, in the particular circumstances,value) is likely to be the most appropriate methodology.as to render the resulting Fair Value insufficiently reliable.I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 21 21. 3. VA L U AT I O N M E T H O D O L O G I E SThis methodology, because of its flexibility, is capable ofIn circumstances where a Realisation is not foreseeable,being applied to all private equity Investment situations. the terminal value may be based upon assumptions ofIt is particularly suitable for valuing non-equity Investments the perpetuity cash flows accruing to the holder of thein instruments such as debt or mezzanine debt, since the Investment. These circumstances (which are expected to bevalue of such instruments derives mainly from instrument-rare in private equity) may arise where the Fund has littlespecific cash flows and risks rather than from the value ofability to influence the timing of a Realisation and/or thosethe Underlying Business as a whole.shareholders that can influence the timing do not seek a Realisation.Because of its inherent reliance on substantial subjectivejudgements, the Valuer should be extremely cautious ofIn using the Discounted Cash Flows (from theusing this methodology as the main basis of estimatingInvestment) methodology to estimate the FairFair Value for Investments which include an equity element.Value of an Investment, the Valuer should derivethe present value of the Investment, usingThe methodology will often be useful as a sense-checkreasonable assumptions and estimations ofof values produced using other methodologies.expected future cash flows and the terminal valueand date, and the appropriate risk-adjusted rateRisk and the rates of return necessary to compensate forthat quantifies the risk inherent to the Investment.different risk levels are central commercial variables in themaking of all private equity Investments. Accordingly thereexists a frame of reference against which to make discount 3.8. Industry Valuation Benchmarksrate assumptions. A number of industries have industry-specific valuationHowever the need to make detailed cash flow forecastsbenchmarks, such as price per bed (for nursing-homeover the Investment life may reduce the reliability andoperators) and price per subscriber (for cable televisioncrucially for equity Investments, there remains a need companies). Other industries, including certain financialto estimate the terminal value.services and information technology sectors and some services sectors where long-term contracts are a key feature,Where the Investment comprises equity or a combination use multiples of revenues as a valuation benchmark.of equity and other financial instruments, the terminalvalue would usually be derived from the anticipated valueThese industry norms are often based on the assumptionof the Underlying Business at Realisation. This will usually that investors are willing to pay for turnover or marketnecessitate making assumptions about future business share, and that the normal profitability of businesses inperformance and developments and stock market andthe industry does not vary much.other valuation ratios at the assumed Realisation date.In the case of equity Investments, small changes in theseThe use of such industry benchmarks is only likelyassumptions can materially impact the valuation. In theto be reliable and therefore appropriate as thecase of non-equity instruments, the terminal value willmain basis of estimating Fair Value in limitedusually be a pre-defined amount, which greatly enhancessituations, and is more likely to be useful as athe reliability of the valuation.sense-check of values produced using othermethodologies.22I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 22. 3.9. Available Market Prices In determining the level of discount to apply, the Valuer should consider the extent of compensation a holderPrivate Equity Funds may be holding Quoted Instruments, would require when comparing the Investment in questionfor which there is an available market price. with an identical but unrestricted holding.Instruments quoted on an active stock market A Valuer may consider using an option pricing modelshould be valued at their bid prices on theto value the impact of this restriction on realisation,Reporting Date. If bid price is not required however in practice for restrictions which only coverby accounting regulation and not deemed to bea limited number of reporting periods, this is simplifiedappropriate, the most representative point to a simple mathematical discount to the quoted price.estimate in the bid/ask spread may be used.The Valuer should consistently use either the bidThe discount applied should appropriately reflect the timeprice or the most representative point estimatevalue of money and the enhanced risk arising from thein the bid/ask spread. reduced liquidity. The discount rate used is a matter of judgement influenced by expected volatility which should reduce to zero at the end of the period.For certain Quoted Instruments there is only one marketprice quoted, representing, for example, the value at whichthe most recent trade in the instrument was transacted.For other Quoted Instruments there are two market pricesat any one time: the lower bid price quoted by a marketmaker, which he will pay an investor for a holding (i.e.the investors disposal price), and the higher ask price,which an investor can expect to pay to acquire a holding.However, as an alternative to the bid price (where notrequired by regulation), is the mid-market price (i.e. theaverage of the bid and ask prices), where this is consideredthe most representative point estimate in the bid/ask spread.This methodology should apply when the prices are set onan Active Market.Discounts should not be applied to prices quotedon an Active Market, unless there is somecontractual, Governmental or other legallyenforceable restriction that would impactthe value realised at the Reporting Date. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 23 23. 4 . VA L U I N G F U N D I N T E R E S T S4.1. General 4.2. Adjustments to Net Asset ValueFund-of-Funds and investors in Private Equity Funds mustvalue their Interest in an underlying Fund at regular intervals After the Valuer determines that the reportedto support their financial reporting. Historically, the Net NAV is an appropriate starting point, it may beAsset Value (NAV) based on the underlying Fair Value of necessary to make adjustments based on the bestthe Investments, as reported by the Manager, has been available information at the Reporting Date.used as the basis for estimating the Fair Value of an Although the Valuer may look to the Fundinterest in an underlying Fund. Manager for the mechanics of their Fair Valueestimation procedures, the Valuer needs to haveappropriate processes and related controls inIn estimating the Fair Value of an interest in a Fund,place to enable the Valuer to assess andthe Valuer should base their estimate on theirunderstand the valuations received.attributable proportion of the reported Fund NAV. Factors which might result in an adjustment to theFair Value for an underlying Fund interest is, at its most reported NAV would include the following:basic level, equivalent to the summation of the estimatedvalue of underlying investments as if realised on the significant time elapsing between the Reporting Date ofReporting Date. The proceeds from such a realisationthe Fund NAV and the Valuer entitys Reporting Date.would flow through to the investor in an amount equal toThis would be further exacerbated by:NAV. This concept makes particular sense for closed-end - the Fund making additional investments or achievingFund investors who realise cash returns on their investment realizations;when realisation events occur through the sale of the - the Valuer becoming aware of subsequent changesunderlying portfolio companies. in the Fair Value of underlying investee companies;- market changes or other economic conditionsAs an investor in a Fund, reliance on a reported NAVchanging to impact the value of the Funds portfolio;provided by the investee Fund manager can only be used information from an orderly Secondary Transaction ifby the investor to the extent that they have evidence thatsufficient and transparent;the reported NAV is appropriately derived using proper Fair the appropriate recognition of potential performanceValue Principles as part of a robust process. Typically, evidence fees or carried interest in the Fund NAV;as to the Fair Value approach, procedures and consistency any features of the Fund agreement that may affectof application is gathered via initial due diligence, ongoing distributions but which are not captured in the NAV;monitoring, and review of financial reporting and materially different valuations by GPs for commongovernance of the investee Fund by the investor entity. companies and identical securities; and any other facts and circumstances which might impactTherefore, NAV when rigorously determined in accordance underlying Fund value.with the principles of Fair Value and these Guidelines providesthe best estimate upon which to base the Fair Value of NAV should be adjusted such that it is equivalent to thean Interest in a Fund. amount of cash that would be received by the holder of the interest in the Fund if all underlying Investee Companies were realised as at the Reporting Date.24I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 24. 4.3. Secondary TransactionsLimited Secondary Transactions exist for Private EquityFunds. External market transactions for a Fund are typicallyinfrequent, opaque and information extremely limited.Secondary prices are negotiated, influenced by factorsbeyond Fair Value and based on assumptions and returnexpectations that are often unique to the counter parties.In addition, information relevant to specific transactionsmay not be deemed orderly and any pricing data availablemay no longer be current.When a Valuer of an interest knows the relevantterms of a Secondary transaction in that particularFund and the transaction is considered orderly,the Valuer should consider the transaction priceas one component of the information used todetermine the Fair Value.In the event that the investor in the Private Equity Fund hasdecided to sell their interest in that fund, then data knownfrom orderly Secondary Transaction prices is likely to bebetter evidence of Fair Value.Any use of a Secondary Transaction price requiresconsiderable judgement. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 25 25. SECTION II:A P P L I C AT I O N G U I D A N C E26 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 26. IntroductionSection I sets out the Guidelines and principles which represent best practice for the valuation ofprivate equity and venture capital Investments. This section sets out further practical guidance tothe application of those principles and methodologies to specific cases.1. S P E C I F I C C O N S I D E R AT I O N S1.1. Insider Funding Roundsnumber of shares (share consolidation) or even cancelling all outstanding shares beforeThe price at which a funding round takes place a capital increase.may be a clear indicator of Fair Value at that date.When using the Price of Recent Investment 1.2. Distressed Marketmethodology, the Valuer should consider whetherthere are specific circumstances surrounding Markets from which transaction data may bethat round of Investment which may reduce theextracted may be viewed by Valuers to bereliability of the price as an indicator of Fair Value.distressed markets. A distressed market does not mean that all transactions within that marketWhere there is a round of financing that may be deemed to be distressed and invalidinvolves only existing investors of the Underlying for use as comparative purposes, howeverBusiness in the same proportion to their existingan individual transaction may be distressed.Investments (insider round), the commercial need In these situations significant judgement isfor the transaction to be undertaken at Fair needed when determining whether individualValue may be diminished. The Valuer needs to transactions are indicative of Fair Value.assess whether the transaction was appropriatelynegotiated and reflected the Enterprise ValueWhen considering whether a transaction mayat that date.be deemed to be distressed or forced (e.g. not orderly), the Valuer may include such matters asNevertheless, a financing with existingthe following indicators in their consideration:investors that is priced at a valuation that a legal requirement to transact, for exampleis lower than the valuation reported at the a regulatory mandate;previous Reporting Date (insider down round) a necessity to dispose of an asset immediatelymay indicate a decrease in value and should and there is insufficient time to markettherefore be taken into consideration. the asset to be sold; the existence of a single potential buyerInsider down rounds may take various forms, as a result of the legal or time restrictionsincluding a corporate reorganisation, i.e. imposed; anda significant change in the common equity there was not adequate exposure to thebase of a company such as converting all market to allow for usual and customaryoutstanding shares into equity, combining marketing activities.outstanding preferred shares into a smallerI N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 27 27. 1. S P E C I F I C C O N S I D E R AT I O N S1.3. Deducting Higher Ranking Instruments If the bridge finance is provided to an existing InvesteeCompany in anticipation of a follow on Investment,Many acquisition structures include third party debtthe bridge finance should be included, together withwhich ranks higher than the interests of the Fund,the original Investment, as a part of the overall packagewhich is deducted from the Enterprise Value toof investment being valued.estimate the Attributable Enterprise Value.1.5. Mezzanine LoansFor certain transactions, this debt is actively traded andmay be acquired by the Investee Company or the Fund inMezzanine loans are one of the commonly used sourcesthe market at a price which is at a discount to the par value.of debt finance for Investments. Typically these will rankbelow the senior debt, but above shareholder loans orIn calculating the Attributable Enterprise Value, the Valuerequity, bear an interest rate appropriate to the level ofshould deduct from the Enterprise Value the amountrisk being assumed by the loan provider and may havewhich is expected to be repaid in settlement of this debt additional potentially value enhancing aspects, such asat the Reporting Date. Typically this is the par value sincewarrants.the debt is repayable at the time of disposal of the InvesteeCompany and the Enterprise Value has been estimated onOften these are provided by a party other than the equitythe basis of disposal at the Reporting Date.provider and as such may be the only instrument held bythe Fund in the Underlying Business. In these situations,Where the debt is trading at a discount to par, this lowerthe mezzanine loan should be valued on a standaloneamount would not normally be deducted from the Enterprise basis. The price at which the mezzanine loan was issuedValue until the Investee Company or the Fund has acquired is a reliable indicator of Fair Value at that date.that debt in the market at that value and intends to cancelthe debt rather than seek repayment at par. The Valuer should consider whether any indications ofdeterioration in the value of the Underlying Business exist,1.4. Bridge Financing which suggest that the loan will not be fully recovered.The Valuer should also consider whether any indicationsFunds, or related vehicles, may grant loans to anof changes in required yield exist, which suggest thatUnderlying Business pending a new round of financingthe value of the loan has changed.(Bridge financing). This may be provided in anticipationof an initial Investment by the Fund, or ahead ofThere are generally limited market opportunities for thea proposed follow on Investment.holders of mezzanine loans to trade. There are agencieswhich regularly quote prices on these types of loans,In the case of an initial Investment, where the Fundhowever transactions cannot always be undertaken atholds no other investments in the Underlying Business,the indicative prices offered. Prices reported of transactionsthe Bridge loan should be valued in isolation. In theseshould be considered by the Valuer as to whether thesesituations and if it is expected that the financing will occurare a reasonable indication of Fair Value.in due course and that the Bridge loan is merely ensuringthat funds are made available early, cost is likely to beSince the cash flows associated with a mezzanine loanthe best indicator of Fair Value.may be predicted with a reasonable amount of certainty,typically these are valued on the basis of a DCF calculation.If it is anticipated that the company may have difficultyarranging the financing, and that its viability is in doubt,the Valuer should reassess Fair Value.28 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 28. Warrants attached to mezzanine loans should be consideredHowever, before using the offer as evidence of Fair Value,separately from the loan. The Valuer should select a the Valuer should consider the motivation of the party inmethodology appropriate to valuing the Underlyingmaking the offer. Indicative offers may be made deliberatelyBusiness and apply the percentage ownership that high for such reasons as, to open negotiations, gain accessthe exercised warrants will confer to that valuation.to the company or made subject to stringent conditions or future events.In the event that the warrant position is significant,the Valuer may consider utilising one of the sophisticated Similarly they may be deliberately low if the offeroroption and warrant pricing models. believes that the vendor may be in a forced sale position, or to take an opportunity to increase their equity stakeIn the event that the mezzanine loan is one of a numberat the expense of other less liquid stakeholders.of instruments held by the Fund in the UnderlyingBusiness, then the mezzanine loan and any attached In addition, indicative offers may be made on the basiswarrants should be included as a part of the overall of insufficient detailed information to be properly valid.package of investment being valued. These motivations should be considered by the Valuer,1.6. Rolled up Loan Interest however it is unlikely that a firm conclusion can be drawn.Many financial instruments commonly used in private Accordingly, typically indicative offers will provide usefulequity Investments accumulate interest which is only realised additional support for a valuation estimated by one ofin cash on redemption of the instrument (e.g. deep the valuation methodologies, but are insufficiently robustdiscount debentures or Payment-in-Kind Notes). to be used in isolation.In valuing these instruments, the Valuer should assess the 1.8. Impacts from Structuringexpected amount to be recovered from these instruments.The consideration of recoverable amount will also includeFrequently the structuring of a private equity Investmentthe existence of any reasonably anticipated enhancements is complex with groups of stakeholders holding differentsuch as interest rate step increases.rights which either enhance or diminish the value of their interests, depending on the success or otherwise of theIn a typical financing package, these are inseparable from Underlying Business.the underlying equity investment and will be realised aspart of a sale transaction.Valuations must consider the impact of future changes in the structure of the Investment which may materiallyThe difference between the estimated recoverable impact the Fair Value. These potential impacts may takeamount (if in excess of the original cost) should be several different legal forms and may be initiated atspread over the anticipated life of the note so as the Funds option, automatically on certain eventsto give a constant rate of return on the instrument. taking place, or at the option of another party. Common clauses include, but are not limited to:1.7. Indicative Offers stock options and warrants;Indicative offers received from a third party for the anti-dilution clauses;Underlying Business may provide a good indication of Fair ratchet clauses;Value. This will apply to offers for a part or the whole convertible debt instruments;Underlying Business as well as other situations such as liquidation preferences;price indications for debt or equity refinancing. commitments to take up follow-on capital Investments. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 29 29. 1. S P E C I F I C C O N S I D E R AT I O N SThese rights should be reviewed on a regular basis toassess whether these are likely to be exercised and theextent of any impact on value of the Funds Investment.At each Reporting Date, the Valuer should determinewhether these rights are likely to be exercised.In assessing whether rights are likely to be taken up bystakeholders, the Valuer may limit their consideration to acomparison of the value received by the exerciser againstthe cost of exercising. If the exerciser will receive anenhancement in value by exercising, the Valuer shouldassume that they will do so.The estimation of Fair Value should be undertaken onthe basis that all rights that are currently exercisable andare likely to be exercised (such as options), or those thatoccur automatically on certain events taking place (such asliquidation preferences on Realisation, or ratchets basedon value), have taken place.Consideration should also be given to whetherthe exercise price will result in surplus cash arisingin the Investee Company.Notwithstanding the above, when considering the impactof liquidation preferences, the Valuer should include intheir assessment the likelihood of the Fund receiving theirfull contractual right under the preference. In practice fullvalue for the preference may not be achieved, particularlywhen this would result in other investors who are integral tothe sale process (such as a continuing management team)receiving a significantly reduced value for their investment.30 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 30. E N D O R S I N G A S S O C I AT I O N SAFIC In order to carry out the above-mentioned(Association Franaise des Investisseurs activities, AIFI can rely both on its permanenten Capital)staff and on different Technical Committees established with the task to carry out activitiesEstablished in 1984, AFIC has 280 active of study on specific matters and projects.members covering all types of private equityactivities in France. In addition, AFIC has 200associate members from a wide range of related AMEXCAPprofessions who support and advise investors (Asociacin Mexicana de Capital Privado, AC)and entrepreneurs in the structuring and The Mexican Private Equity Association (AMEXCAP)management of their partnerships. is a non for profit organization, created in 2003,By virtue of its responsibilities in the areas ofrepresenting venture capital/private equity fundscompliance, controlling and establishing that actively invest in Mexico. Additionally, othergenerally accepted practices, AFIC is one of two affiliates that play an important role in the sectorassociations recognized by the French Financialare members of the Association such as topMarket Authority (AMF). Management companies consulting and law firms that are active in Mexico.must be AFIC members in order to be certified bythe AMF. AFIC is the only professional association AMICfocused on the private equity business. (Association Marocaine des Investisseurs en Capital)AIFI AMIC is an independent non-profit association(Italian Private Equity and Venture Capital which was created in 2001 in order to:Association) Develop the private equity and venture capitalAIFI was founded in May 1986 in order to industry in Morocco;promote, develop and institutionally represent Promote best practices, transparency andthe private equity and venture capital activity in responsibility amongst professionals;Italy. The Association is a non-profit organisation Create the most favourable legal and fiscalwhose main activities are: to create a favourable environment by lobbying policymakers;legal environment for the private equity and Represent and defend its membersventure capital investment activity, to analyse professional interests;the Italian private equity market collecting Liaise with key industry players, entrepreneursstatistical data, to organize business seminars and media;and specialized courses addressed to institutional Provide research and information on the industry;investors and to people interested in operating Educate and train practitioners;within the industry, to publish research papers Foster networking between membersregarding specific topics about the private equity and stakeholders.market, to build up stable and solid relationshipswith other National Venture Capital Associations Based in Casablanca, AMIC with its 10 membersand key players in the international private represents the vast majority of private equityequity market. and venture capital actors in Morocco.I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 31 31. E N D O R S I N G A S S O C I AT I O N SAPCRI ASCRI(Portuguese Private Equity and Venture Capital(Spanish Private Equity and Venture Capital Association)Association)ASCRI is a non-profit making association that was set upAPCRI was established in 1989 and is based in Lisbon. in 1986, to promote and develop the venture capital andAPCRI represents the Portuguese private equity andprivate equity activity in Spain and represent, manage andventure capital sector and promotes the asset class.defend its members professional interests.APCRIs role includes representing the interests of the The Association stimulates the promotion and informationindustry to regulators and standard setters; developing analysis in the venture capital/private equity sector in Spain,professional standards; providing industry research;and provides the contact between Official Organisations,professional development and forums, facilitating investors, professional advisers, business schools and otherinteraction between its members and key industryrelevant institutions. At the end of May 2005, ASCRI hadparticipants including institutional investors, 84 full members and 28 associate members.entrepreneurs, policymakers and academics.The ASCRIs main activities are: Research activity, OrganisationAPCRIs activities cover the whole range of private equity: of different events such as: Annual General Assembly, ASCRIventure capital (from seed and start-up to developmentCongress, Training Seminars and Conferences/Workshops,capital), buyouts and buyins. Communication of investment opportunities betweenASCRI members, and Institutional and lobbying activity.APCRI represents the vast majority of private equity andventure capital in Portugal. APCRI has 16 full members and5 associate members. Full members are active in makingATICequity investments primarily in unquoted companies. (Tunisian Venture Capital Association)The associate membership can include those firms whoATIC (Association Tunisienne des Investisseurs en Capital) isinvest directly in private equity but for whom this is nota professional association founded in April 2004, by moretheir principal activity, advisory firms experienced in dealing than 30 companies operating in the field of private equitywith private equity and educational or research based and venture capital in Tunisia. Its main gaol is to playinstitutions closely associated with the industry.the vis-a-vis with the Tunisian authorities to introducethe appropriate legal and fiscal measures to ease thedevelopment, and solve the problems of the privateAPEAequity and venture capital industry in Tunisia.(Arab Private Equity Association)ATIC second objective is to offer its members the appropriateAPEA is the only pan-Arab industry association sponsoredspace for networking, information exchange and businessby the Economic Unity Council of the Arab League,development to upgrade the Tunisian industry by targetingthe APEA was formed to address the challenges faced byhigher value added technology projects, and strongerprivate equity firms as well as venture capitalists in thealliances with its North African and European Partners.Arab world. APEA believes that private equity and venturecapitalism can be important catalysts for the provision ATICs third objective no less important is to inculcateof economic opportunities, increased investment flows,the right private equity and venture capital culture to localand superior business performance for Arab industries.professionals, to enhance the creation of a new generationAPEAs core mission is to increase the role of this young of Funds managers and to reach strategic alliances with theirbut rapidly growing industry in the Arab world, and European or US counterparts. ATIC aims to reach that bystrengthen the performance of private equity investment enforcing the best practices of the profession according toin the emerging Arab market.international standards, through its planned training programs.32 I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 32. AVCA AVCO(African Venture Capital Association)(Austrian Private Equity and Venture Capital Organisation)AVCA represents the private equity and venture capitalindustry in Africa. AVCA was established in 2002 and its AVCO is the National Association of Austrias private equityhead office is in Yaound, Cameroon. AVCAs membership and venture capital industry, which covers more than 90%is drawn from across Africa and internationally. of the Austrian private equity market with its members.AVCAs objectives are to represent the industry within It works as a knowledgeable partner and independentAfrica and internationally, stimulate the growth andinformation point for journalists, entrepreneurs,expansion of the industry throughout Africa, stimulatepotential investors, private and public institutions as wellprofessional relationships and co-operation, provideas international bodies that are interested in Austriasopportunities for professional development of industryprivate equity industry, its development and structurepractitioners, research, publish and circulate industryas well as its activities and performance.information and insights, provide policymakers with It acts as the official representative of the industryproposals to improve the corporate, fiscal and legalactively engaged in improving the tax-related, legalenvironment for the industry, maintain high ethical andand economic policy environments in close connectionprofessional standards and contribute to the managementwith respective policy makers.development of investors, investees and other stakeholders. As a proactive networking institution it promotesAVCAs activities include an annual industry conference,co-operation inside the industry as well as interactiona quarterly newsletter, research, training and advocacywith complementary players from other fields in orderprograms. For more information visit the AVCA websiteto intensify information flows and create learning loops.www.avcanet.com. In addition it takes the role of an interface tointernational organisations exchanging experience,AVCAL information and knowledge with other Private Equity(Australian Private Equity and Venture Capitaland Venture Capital Associations in Europe, with theAssociation)European Commission and further relevant institutionsin order to put international best practice at workAVCAL represents the interests of Australias venturefor Austria.capital and private equity industry. Currently AVCO is engaged to initiate internationallyAVCALs 50 investor members have A$10 billion favourable private equity fund structures for Austria andunder management. AVCALs roles include: promotion recently AVCO has published Investor Relations Guidelinesof the industry, education of practitioners, public policy behavioural standards for its members vis--vis theirdevelopment, staging networking events, application of fund investors in order to raise transparency and faithvaluation & disclosure guidelines, benchmarking IRRs, in private equity as a professional asset class in Austria.development of industry standard Limited Partnership In line with these efforts AVCO welcomes the Internationalagreement. Private Equity and Venture Capital Guidelines and will beAVCAL conducts about 40 networking events annually eager to support their introduction and accurateacross Australia, and leverages its online presence at application by its members.www.avcal.com.au for maximum efficiency. I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 33 33. E N D O R S I N G A S S O C I AT I O N SBVABVK(Belgian Venturing Association)(Bundesverband Deutscher Kapitalbeteiligungs- gesellschaften German Private Equity and VentureBVA was founded in 1986 as a professional association. Capital Association e. V.)Its mission is to: BVK was founded in 1989. BVK represents most of the1. Animate the Belgian private equity and venture capital German private equity and venture capital firms as well as industry by deploying a series of activities for its the German branches of foreign private equity and venture members and for other stakeholders in the prosperity of capital firms. As per March 31, 2005, BVK represented the VC/PE sector in Belgium. The objectives of the main more than 180 private equity and venture capital firms. animation activities are: to foster active networking Apart from full membership BVK offers associate amongst members of the BVA and between members membership to companies and organizations working in of the BVA and other third parties, to provide extensive this particular business sector, i. e. accountants, lawyers, information to its members on all topics relevant to the consultants etc. VC/PE industry, to improve the quality of the operation of the sector.BVK serves as a link between government and business and represents its members views, needs and problems2. Promote the well being of the Belgian private equity while supplying information and discussing any particular and venture capital industry towards all relevant third political and economic subject with the relevant parties. The objectives of the promotional activities are: governmental institutions. to pro-actively represent the Belgian VC/PE industry to third parties as the industrys recognized spokesperson,Science and research are becoming more and more interested to conduct active lobbying for (i) improvements to or in private equity and venture capital issues. BVK supports (ii) the removal of obstacles from the structural context inuniversities, colleges and their students with their research which the Belgian VC/PE industry operates, to contributeactivities and problem solving. to the continuous development of business in our industry. On the international level BVK exchanges information with other national organizations in the economic sector and otherBVCA international private equity and venture capital associations.(British Venture Capital Association)The BVCA represents around 170 UK-based private equity CVCAand venture capital firms, the vast majority of all such firms (Canadas Venture Capital & Private Equity Association)in the UK. The BVCA is the public face of the industry The CVCA Canadas Venture Capital & Private Equityproviding services to its members, investors and Association, was founded in 1974 and is the sole nationalentrepreneurs as well as the Government and media. representative of Canadas venture capital and private equity industry. Its over 1800 members are firms and organizations which manage the majority of Canadas pools of capital designated to be committed to venture capital and private equity investments. CVCA members collectively manage over $75 billion. CVCAs members actively collaborate to increase the flow of capital into the industry and expand the range of profitable investment opportunities.34I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A L UAT I O N G U I D E L I N E S 34. This is accomplished by the CVCA undertaking a wide CVCAvariety of initiatives, ranging from developing comprehensive (Czech Venture Capital and Private Equity Association)performance and valuation statistics, education andCVCA is an association representing companies active innetworking activities to promoting the industrys intereststhe private equity and venture capital industry in the Czechwith governments and regulatory agencies.Republic. CVCA has full members (private equity andFor further information, please visit www.cvca.ca.venture capital fund managers) and associated members(companies providing advisory services to the private equityand venture capital industry). CVCA has 14 full membersCVCAand 16 associated members as of May 2005.(China Venture Capital Association)CVCAs priorities are: increasing the awareness aboutThe China Venture Capital Association (CVCA) is aprivate equity/venture capital among entrepreneurs, statemember-based trade organization established to promoteadministration and general public, promoting interests ofthe interest and the development of venture capital (VC)CVCA members in contact with the government and otherand private equity (PE) industry in the Greater Chinastate authorities, providing information on the privateRegion. Currently CVCA has close to 100 member firms,equity/venture capital industry in the Czech Republic,which collectively manage over US$100 billion in ventureproviding platform for discussion among memberscapital and private equity funds.of CVCA.C