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The importance of open relationships16/05/2006. Source: SJ Berwin. Simon Witney 
The industry took a huge step forward last year when the European Private Equity and Venture Capital Association, and the French and British national associations, published a single set of valuation guidelines, says SJ Berwin. It's making it harder to criticise the PE industry for lack of transparency. These were designed to be compatible with International Accounting Standards, and to have application across all types of private equity fund anywhere in the world. Since publication a year ago, the valuation guidelines have been endorsed by over 30 industry associations worldwide, and are becoming an accepted methodology to report valuations of portfolios.
That is important not just from an investor relations perspective, but also because it helps with public relations. It is harder to criticise the industry for lack of transparency if most private equity funds are valuing their investments on a consistent and internationally accepted basis.
But valuation is only part of the picture, and the method and frequency of reporting to investors is also important. This is determined by the contract between the fund manager and the investors, usually in the limited partnership agreement, but it is very helpful to have a point of reference identifying best practice.
A number of industry associations have set such standards in the past, and these have been widely used - but EVCA’s standards were in need of an overhaul (in particular, to cater for the new valuation standards). Last month, the European association announced that it was doing just that, and published for consultation (until the end of April) a draft set of revised reporting guidelines.
The draft guidelines set out some “requirements” - minimum standards for those who want to claim compliance with the standards - and “recommendations” - additional suggestions left to the discretion of the fund manager. For example, the guidance requires six-monthly reports, but suggests quarterly.
It requires a large amount of factual detail (including a fair value valuation) of every portfolio investment, but recommends inclusion of a budget or forecast for the current year, and a comparison of historic numbers with budget. These two compliance levels replace the “Level 1” and “Level 2” ranking in the existing guidelines, but have similar effect. However, some “Level 2” guidelines have been elevated to “requirements” in the revised publication, effectively making compliance a little tougher.
Most of the changes, though, are consequential on the radical change to valuation practice announced last year, and there are few other significant revisions.
A review of the sample fund report (reproduced at the end of the guidance) demonstrates that funds which comply with the guidelines - which is most of them - will be providing a regular and very detailed report to investors. That is an important feature of the asset class, and is something often misunderstood by those unfamiliar with it - the open relationship between GPs and LPs is a distinguishing mark of private equity. But for many that does not go far enough, and there are calls for more public disclosure.
Much of the information in the reports is commercially sensitive, and it is clear that it can only be provided if kept confidential by the investors. The EVCA guidelines themselves make the point that funds whose investors are subject to Freedom of Information Act rules, and therefore cannot keep the information confidential, may wish to restrict disclosure.
It is for statutory reporting and accounting requirements (to which private equity backed companies are subject, like all others) to control how much disclosure is made to the world at large. Fund performance information is a private matter between the fund and its investors, and detailed reporting would be impossible if it were not.
Simon Witney
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on our services to the private equity industry please contact Simon Witney in our London office 020 7533 2222 or visit our website at www.sjberwin.com
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