Whether you are preparing or using a valuation of a private equity or venture capital fund’s portfolio company investment, it is helpful to be knowledgeable about these industries and how the professionals who prepare these valuations apply and support professional judgment.
To help you, the AICPA has published the Accounting and Valuation Guide – Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies (the guide) to provide guidance to preparers of financial statements, independent auditors, and valuation specialists on the accounting for and valuation of portfolio company investments of venture capital funds, private equity funds and other investment companies.
How might the material in the guide be useful to me?
Although the guide is nonauthoritative, it was designed to provide investment companies, auditors, and valuation specialists with tools to address some of the key challenges that arise in valuing investments for this industry. FASB Accounting Standards Codification (ASC) 820, Fair Value Measurement, requires informed judgment, and applying judgment when valuing illiquid investments with unobservable inputs requires careful consideration of the facts and circumstances. Therefore, this guide is extensive, providing technical material and examples showing how judgment may be applied in many situations.
The guide is intended to be user-friendly, with examples that demonstrate the concepts discussed in the chapters and illustrate the way these concepts apply to real situations faced by management, valuation specialists, and auditors. Users may focus on the guidance and examples that are most relevant to their investments. As always, an entity's specific situation should be considered when applying the guidance or examples in valuing a given investment.
Do I need to know everything in this guide to be able to perform valuations for this industry?
The guide includes material that is relevant for management, valuation specialists, and auditors in understanding key issues relating to valuations for this industry. However, given the breadth of the guide, some of the material may not be relevant to your situation. For example, practitioners who work primarily with venture capital (VC) investments may not need to consider chapter 6, "Valuation of Debt Instruments," and practitioners who work primarily with leveraged buyouts (LBOs) may not need to consider chapter 8, "Valuation of Equity Interests in Complex Capital Structures." You may also want to consider the examples in appendix C, "Valuation Case Studies," to see how judgment may be applied in selecting valuation methodologies and assumptions in specific situations that are most like the types of investments made in your funds.
I am a preparer at a mid-sized VC fund. I am concerned that given the size of this guide and the extensive discussion of so many technical issues and valuation techniques, the workload for preparing my fund's financial statements will be significantly greater following the publication of this guide. In addition, I am concerned that the documentation my auditors will now require will be considerably greater. Has the task force considered these factors in developing this guide?
This guide does not promulgate new requirements; instead, it describes what is required by U.S. generally accepted accounting principles (GAAP) and explains best practices for complying with those requirements. The complexity of the valuation issues discussed in this guide reflects the level of judgment required in estimating fair value in accordance with FASB ASC 820. The specific facts and circumstances for each investment matter. The extensive discussion in the guide will help to educate those who need to understand the valuations prepared by VC and private equity (PE) funds about the complexity of this industry and the inherent estimation uncertainty associated with these estimates.
As a practitioner who is new to the PE and VC industry, how do I best use the guide to get up to speed on the issues that are most critical to valuing my portfolio?
A practitioner new to this industry might first review chapters that cover broad industry issues: chapter 1, "Overview of the Private Equity and Venture Capital Industry and Its Investment Strategies," chapter 3, "Market Participant Assumptions," chapter 4 "Determining the Unit of Account and the Assumed Transaction for Measuring the Fair Value of Investments," and chapter 10, "Calibration," will be particularly beneficial. These chapters provide context for more specific examples. The general valuation chapters provide an overview of the valuation methodologies that are appropriate for valuing these types of investments and provide details that may be relevant to a current need, such as chapter 6.
The examples in appendix C illustrate a broad spectrum of situations, covering different investment strategies (for example, LBO, early-stage VC investments, and business development companies) and industries (for example, real estate, biotech, software, cleantech, oil and gas, and medical devices, among others; including capital intensive and low capital growth businesses). The introduction to the appendix provides a summary to assist practitioners in quickly identifying those examples that are most relevant for a specific valuation need. However, practitioners are recommended to read through all examples that are at all similar to investments in the portfolio.
Finally, practitioners are encouraged to review chapter 11, "Backtesting," and chapter 12, "Factors to Consider at or Near a Transaction Date," for additional examples addressing commonly encountered issues for this industry, as well as chapter 13, "Special Topics," for less frequently encountered situations, and chapter 14, “Frequently Asked Questions” for general guidance.
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Leveraged from Chapter 14 of the AICPA Accounting and Valuation Guide: Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies.