Summary
The practice of valuing companies has little guidance and much room for interpretation. If the SEC is going to start looking into how the private equity industry is formulating their calculations, GAAP must do a better job at defining the requirements.
Analysis
If the SEC is going to start looking at valuation practices at equity and VC firms, GAAP must do a better job at defining the calculation. The search for misguided valuations can expand to strategic acquisitions where companies have bought other companies to expand their market or product-line. Under an asset valuation, the guide-lines are broad with several areas of interpretation. Furthermore, company valuation, traditionally using discounted cash flow and multiples on EBITDA or revenue, have little guidance.
Under asset impairment testing, the owner must come to the realization that the asset has lost value before taking a write-down. During the annual audit, past performance is compared to expected performance. If this is below expectations, then the company is required to book the valuation difference. Factors in the calculation include expected performance, discount rates and terminal values. As long as the numbers are supported with reasoning, the valuation is accepted. The private equity market doesn’t different significantly from this exercise. This is where the SEC is going to have problems in their search. As long as the VC firms can support their forward-looking valuations, there won’t be too much weight to this argument.
Unfortunately, this will add work and cost to the VC practices and could take attention away from potential investments.
This author consults with leading institutions through GLG
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
