Covid-19: Valuing private equity portfolios

Posted on: 14 April, 2020 at 5:51 PM

By John Bellew (Head of Private Equity, Bowmans), Paola Samuel (Senior Associate, Bowmans) and Andrea Jekkels (Associate, Bowmans)

For many private equity investors, a crisis is not uncharted territory. What experienced investors know all too well is that the world of investing is filled with risk and uncertainty. The Covid-19 outbreak is, however, fundamentally unique, having impacted more people and more businesses more rapidly than any crisis in recent history. And it is having a profound effect on portfolio company valuations.

The International Private Equity and Venture Capital Valuation (IPEV) guidelines are the most widely adopted standard used in valuing inter alia private equity investments. The objective of the guidelines is to provide standardised and principle-based valuation guidelines for private equity practitioners, especially during and after M&A transactions.

‘Fair value’ is the fundamental benchmark. During the 2008 global financial crisis, the IPEV board stated that ‘fair value [is] the best measure of valuing private equity portfolio companies and investments in private equity funds’. Fair value represents the amount that would be received in an orderly transaction using market participant assumptions in the prevailing market environment.

Historic valuations of portfolio companies may need to be revisited given the current market volatility we are faced with. Any movement in fair value is an important factor to be taken into account in the true assessment of a portfolio company’s risk.

If fair value is not accurately determined, risk assessments will be misinformed, potentially having a significant impact on investment decisions for both GPs* and LPs* alike. Amidst the Covid-19 pandemic, LPs have a critical need for their GPs to report on the fair value of underlying investments in a timely, consistent and robustly determined manner.

In response to the global Covid-19 pandemic, the IPEV board on 31 March 2020, issued special valuation guidance (Special Guidance) to assist GPs in their valuations of portfolio companies (both debt and equity investments) and LP interests during this time.

The Special Guidance notes that in assessing investments, desperate times should not call for desperate measures and GPs should avoid basing valuations on fire sale prices. The principle remains one of determining fair value, representing the amount that would be received in an orderly transaction using market participation assumptions in the current market environment, and based on what is known or knowable at the valuation date.

The Special Guidance notes may no longer be appropriate for recent transaction prices, especially those from before the Covid-19 outbreak to receive significant, if any, weight in determining fair value.

Appropriate multiples must be determined and applied which reflect the current market conditions including risk and uncertainty in projections and historical results. GPs should ensure that there is a balance in the application of the valuation metrics applied to underlying investments taking into account:

– The impact of the crisis on revenues and customers, supply chains and operations, which need to be rigorously interrogated

– Lower than expected performances

– Avoiding the application of ‘far removed’ multiples attained by public companies that have not taken into account potential lower performances

– Avoiding ‘double-dipping’ such that the same set of valuation inputs is not effectively taken into account twice

– Any tangible government subsidies that may be available to the portfolio company or to companies generally.

These market conditions will be of paramount importance in determining the fair value of underlying investments and what LPs need now, more than ever, is transparency and engagement from their GPs in this respect.

In conclusion, GPs would be well served in actively engaging with their investors and providing timely, transparent and robust information as to the performance and financial condition of their underlying portfolio companies. The Special Guidance serves to provide some level of clarity amidst the current haze of market uncertainty.

For further information and more detail, the special valuation guideline is available here.

*A private equity firm is called a general partner (GP) and its investors who commit capital are called limited partners (LPs). Limited partners generally consist of pension funds, institutional investors and wealthy individuals.

Bowmans is a leading corporate law firm with a highly skilled team, track record and geographical footprint to provide both upstream and downstream services to the private equity sector in Africa. www.bowmanslaw.com/service/private-equity

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