Private equity funds continue to play a prominent role in the investment arena. Not surprisingly,  regulators, investors and other stakeholders are increasingly interested in the valuation of the funds’  portfolio investments — sometimes in the context of enforcement actions and litigation.

Portfolio valuation can be difficult because market prices aren’t available for privately owned  companies such as those often held by private equity funds. But appraisal experts have several  methodologies to accurately value such investments.

Not the only factor

Historically, private equity funds used the cost or value of the most recent round of financing to  estimate the fair value of investments, without taking into account other facts and circumstances. But  the transaction price might not represent fair value if, for example, it was between related parties or  transacted under duress. That means that the transaction’s surrounding circumstances must be taken  into account. And the more time that passes, the less reliable the latest round of financing becomes  as an estimate of fair value.

The Private Equity Industry Guidelines Group (PEIGG) has published valuation guidelines that deem  the cost approach incompatible with the concept of fair value. Although the value of the latest round of financing for a company (excluding transaction costs) is a factor in determining fair value, it’s not the only factor.

Alternative Approaches

Several alternative approaches can be used to make adjustments to cost method appraisals and accurately determine the fair value of private equity fund portfolio companies. These methods include:

Looking at comparable companies. A business is valued by selecting similar companies and researching transactions involving them to determine value. Comparables are adjusted for control premiums and other benefits or detriments that accrue to the owner. This method requires that the subject company has achieved marketplace acceptance for its product or service. Otherwise, it’s unlikely that truly comparable companies with determinable fair value can be identified.

Applying a performance multiplier. This approach applies a relevant multiplier (based on the  company’s size, risk profile and earnings growth prospects) to the company’s maintainable  performance. The multiplier is derived from comparable companies or recent private transactions involving comparable companies. Options for multipliers range from price/earnings to enterprise value / earnings before interest and taxes (EV/EBIT) and enterprise value / earnings before interest, taxes, depreciation and amortization (EV/EBITDA).

The multiplier approach is most applicable to businesses with a positive and sustainable operating  performance. It’s important that transaction multipliers be carefully selected to help ensure accuracy.  Transactions during the recent recession, for example, were biased toward those involving the highest quality companies.

Using discounted cash flow (DCF). The DCF method estimates a business’s value by calculating the:

  1. Present values of its expected future cash flows or earnings, and
  2. Terminal value (a company’s value at a future date beyond the projected cash flows period).

The method is flexible, so it may prove applicable when other methods aren’t well suited to the subject business. But the DCF method requires significant forecasts of cash flow, terminal value and other  highly subjective judgments, making the present value sensitive to minor changes in these inputs.

Often, the approach is used by experts as a cross-check on values produced by other methods.

Estimating net asset value.
In its most basic form, net asset value equals a company’s assets less its liabilities. Net asset valuation can be used for appraising investments in companies whose value comes largely from the underlying value of their tangible assets (as opposed to their performance). This method may also suit businesses that generate only marginal profits or that operate at a loss.

Multiple is most reliable.
All of these methods have strengths and weaknesses, depending on the subject company and circumstances surrounding the valuation. The most reliable appraisal usually involves multiple approaches to reach an estimate — rather than reliance on only one method.

If you have questions about this, or any other matter, visit to learn more  about our Business Valuation services, as well as Forensic, Valuation and Litigation Support Services.