PRINT THIS PAGE International valuation guidelines: a big step forward19/10/2005. Source: SJ Berwin. Jonathan Blake 
 Fund managers have to value their venture capital and private equity investments on a regular basis as part of the reporting process to investors. But, notes SJ Berwin, this valuation process is a complex matter: it involves ascribing values to illiquid companies.
Furthermore, fund managers are faced with inconsistent industry guidelines resulting in uncertainty for both fund managers carrying out these valuations and investors interpreting reports about their investments.
For example, although EVCA's valuation guidelines of March 2001 recommended two approaches for unquoted investments (a conservative value and a fair market value), the BVCA was already starting to move towards a fair value approach for all unquoted investments.
In view of the variety of valuation guidelines in circulation, the European Venture Capital Association (EVCA) and its French and British national counterparts (AFIC and BVCA) launched a consultation process in December 2004 based on their jointly drafted international valuation guidelines for venture capital and private equity investments.
Their aim was to encourage a consistent valuation methodology and practice across Europe for the benefit of both fund managers and investors. Final guidelines were published in March 2005 and are intended to be applicable across a whole range of investment types including seed and start-up venture capital, buy-outs and growth/development capital.
The guidelines adopt "fair value" as their starting point. The three venture capital associations opted for this concept as it has increasing currency in international accounting practice and takes account of International Accounting Standards, which have been in force for listed companies since January 2005.
At the heart of the new guidelines is an assumption that the valuation of investments will be based on the amount for which they could be sold, assuming knowledgeable, willing parties in an arm's length transaction.
This assumption, however, raises certain difficulties in respect of valuation methodology. The guidelines therefore seek to identify and describe ways of identifying fair value, including cost of investment, earnings multiples, net assets and, with some caution, discounted cash flow of either the underlying business or the investment.
The guidelines acknowledge that subjective judgements are necessary in estimating fair value and that sometimes fair value estimates will be unreliable. In such circumstances they recommend that the investment should be reported at its carrying value at the previous reporting date, unless there is evidence of impairment.
The joint guidelines also offer guidance on which valuation methodology is most appropriate for particular fair value investments, such as early stage enterprises or enterprises without or with insignificant revenues and without profits or positive cash flows; enterprises with revenue but without significant profits or positive cash flows; and enterprises with revenues, maintainable profits and/or maintainable positive cash flows. The guidelines also warn that methodologies should be used consistently from one period to another, unless a change would result in better fair value estimates.
This joint initiative is unique and a major step forward for the European private equity industry especially now that the guidelines have been endorsed by a wide range of other associations. Not only will this move us much closer towards uniform international standards on valuation and reporting, it also demonstrates the important role that EVCA and national venture capital associations play in the private equity and venture capital industry and their commitment to promoting best practice across Europe.
Jonathan Blake is Head of European Private Equity at SJ Berwin LLP. He advises on all aspects of private equity. He can be contacted on: T +44(0)20 7533 2222 or e-mailed at jonathan.blake@sjberwin.com
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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