The valuation revolution

“2017 and 2018 are likely to be the biggest years of impact on valuation in the alternative assets space in the last decade,” according to David Larsen, a managing director at Duff & Phelps.

Larsen, speaking at a roundtable discussion at the firm’s New York offices earlier this month, was referring to the raft of frameworks, guidelines and standards recently introduced or set to go live in 2018 that will transform the valuations landscape for private fund managers.

Here’s what’s coming up:

The American Institute of Chartered Professional Accountants Private Equity & Venture Capital Accounting and Valuation Guide

When delegates at Duff & Phelps’ 11th annual alternative investment conference in New York this month were asked what they thought would have the biggest impact on the valuation process, the most popular choice was the in-development AICPA guide. A draft is expected to be released in April or May.

The guide – set to be more than 650 pages – is expected to offer examples of exercising valuation judgments, providing more in-depth industry-wide guidance leading to greater global consistency.

The Public Company Accounting Oversight Board auditing standards proposals

While the PCAOB’s new auditing standards proposals don’t technically apply to the private fund world, “practically they do because auditors have difficulty auditing one set of companies one way and a different set of companies a different way”, Larsen said.

These proposals – the second most popular choice for “biggest impact” among Duff & Phelps’s audience – force the auditor to do more work unless it concludes the fund manager has a good process to come to fair value estimates.

This means that in order to prevent an increase in audit costs, fund managers will need to demonstrate they have a robust valuations process. As the extra work undertaken – and charged for – by the auditor will likely not result in more relevant and reliable financial information, that money would be better spent improving the rigor of the firm’s own valuation processes.

These new standards are likely to bring greater regulatory scrutiny on pricing services and broker quotes as they call for fund managers to be able to demonstrate the information given is based on contemporaneous and actionable transactions – in other words, the broker would be willing to transact for the given quantity at the given price, without any caveats.

The Mandatory Performance Framework

The global Mandatory Performance Framework is designed to enhance consistency and transparency in fair value measurement methodology. It is part of the Certified in Entity and Intangible Valuations certification, an optional qualification established by the industry body and accountancy firms in response to the SEC’s concerns over inconsistency in valuations methodologies.

Those choosing to become CEIV-certified have to comply with the framework, but it will likely be extended to those that are not certified anyway to create a “gold standard” in valuations.

Despite the fact the CEIV credential has been active since early 2017, 40 percent of the audience at the Duff & Phelps conference hadn’t heard of it. Fewer than 10 people had the actual credential.

Around a third of the audience said the new valuation framework would impact their documentation but wouldn’t change their fair value estimates, while a third indicated it would impact both their documentation and their fair value estimates.

A quarter said they expect to comply with the MPF in 2018; half said they would start to comply when their auditors forced them; 10 percent when their investors forced them; and 10 percent said they would hope never to have to comply.