11 - Private equity fund managers do not overvalue their company investments

Abstract

This chapter presents a study on the valuation behavior of private equity fund managers, using a European private equity fund investor's database. It not only has complete cash-flow information from all 2,500 indirect company investments of their funds, but also all of its 15000 valuations by the fund managers. The study finds that private equity fund managers do not overvalue and they value conservatively in line with valuation guidelines. The average observed valuation of the company investments is close to at-cost value over the first two years of investment life. Over the following years, the valuation reflects a fairer value and is strongly influenced by the valuation year. This effect is due to the early write-off of bad investments combined with the inability to recognize or write-up top performing investments. In fact, the largest underestimation comes from exceptionally well-performing company investments. Moreover, little evidence has been found that factors such as fund manager's experience, market segment, or fund size strongly influence the valuation behavior.