A One-Size-Fits-All Approach to Valuation May Not Be Optimal
By Frank Fumai, Deloitte & Touche LLP
As 2015 starts and private equity fund managers begin the process of closing the books on 2014, it is a good time to consider how best to establish valuation policies and procedures that are both useful and effective. Recently, Deloitte’s investment management practice launched its second annual Private Equity Fair Value Pricing Survey. The survey is timely, particularly in light of the SEC’s recent comments regarding the private equity valuation process, including the appropriateness of making changes in methodology or inputs used without a logical reason for doing so, and on how such changes were being disclosed to investors. Perhaps the key lies in the overall architecture of the policies and procedures.
Ninety-four percent of the private equity survey’s participants indicated that their policies and procedures provide general principles as opposed to prescriptive requirements for valuations. Clearly, there is a view held among most private equity fund managers that valuation policies and procedures should provide more of a framework which those preparing and reviewing fair values should use, as opposed to a detailed document that covers every potential scenario that may be faced. In fact, the survey found that a clear majority of survey participants use multiple valuation methodologies at least some of the time, while only 33 percent of survey participants rarely or never use multiple valuation methodologies. This approach provides maximum flexibility and can make the valuation process more nimble.
This year’s survey revealed broad agreement among private equity fund managers that a one-size-fits-all approach to valuation may not be optimal for every situation. Fund managers want the flexibility that a broad framework for valuation provides.
The SEC’s comments regarding changes made in methodologies may raise concerns that, in some instances, less prescriptive policies and procedures may lead to a greater ability to manipulate methodologies to achieve desired valuation outcomes. This could, in turn, expose the private equity fund manager to greater (and unwanted!) scrutiny relating to the rationale behind the change, the internal controls and documentation surrounding the change, and the disclosure, if any, of such change to investors.
The level of standardization in the valuation process that exists for managers of other asset classes may never occur for private equity, but attempts to make the valuation process more consistent, both in appearance and in fact, to better document the rationale behind approaches taken and inputs used, and to tighten internal controls may all be forthcoming. The questions asked by regulators and the results of their recent examinations may drive some of these changes. In some instances, investors may read comments made by regulators and decide to ask more questions relative to investment valuations. Some evidence of that may already be occurring, as 40 percent of survey participants indicated that they have received more valuation inquiries from investors over the last year.
An interest in internal controls has also grown in the U.S., to some extent, as a result of changes made in 2013 to the Committee of Sponsoring Organizations of the Treadway Commission Framework, which created a more formal structure for the design and evaluation of the effectiveness of internal controls. With expectations high in the U.S. that organizations, especially those that are public, will adopt the new framework, there is every reason to believe that firms will re-evaluate their internal controls relating to valuation and determine whether they require a fresh look.
Frank Fumai is a partner with Deloitte & Touche LLP, where he leads the national private equity audit practice. Detailed results of the survey are available to survey participants. For those interested in participating in the survey’s next edition or for more information about Deloitte’s private equity practice, you can e-mail Frank at ffumai@deloitte.com. Deloitte is a PEGCC Associate Member firm.
