Private Equity Valuations Research Articles

The Impact of COVID-19 Pandemic on the Private Equity Valuation

The Impact of COVID-19 Pandemic on the Private Equity Valuation

The Impact of COVID-19 Pandemic on the Private Equity Valuation

As the downward pressure on the world economy increases, the financial industry continues to suffer, especially private equity funds. In recent years, the frequent occurrence of major special events and hot news around the world cannot help but make people doubt whether these special events will have an impact on the valuation of private funds. This paper takes COVID-19, the most typical and influential special event in recent years, as an example, combined with various data during COVID-19, to discuss the impact of the epidemic on private equity valuation models and the private equity market. This paper finds that the COVID-19 pandemic has severely affected the valuation accuracy of discounted cash flow method and made the valuation of the market method lower than the true value of the company. While sectors such as real estate, tourism and hospitality and logistics have been severely negatively impacted by COVID-19, the pandemic has boosted sectors such as fintech, healthcare, pharmaceuticals and biotechnology. After the test of this epidemic, investors and management teams need to make timely adjustments to valuation models, while taking into account long-term market trends and industry changes, more prudently evaluate investment opportunities, and make sound investment decisions.

Private Equity Valuation and IRR Algorithm

An algorithm is developed that calculates the IRR for various private equity entities within a private equity leveraged transaction. The algorithm calculates the total anticipated value for a transaction and then produces the associated IRRs based on the exit EBITDA, the EBITDA multiple, and the available cash. The benefits of the algorithm are that multiple programming formats become available, insights emerge that are difficult to perceive using an equivalent spreadsheet pro forma analysis, and other types of analyses become possible for examining individual parameters.

Private equity valuation under time-inconsistent preferences

Our research expands on the private equity (PE) valuation theory by incorporating the limited partner’s (LP) time-inconsistent preferences. Our findings show that time inconsistency has a detrimental impact on the LP’s certainty-equivalent valuation, which is dependent on the duration of investment and the value of PE asset. Through a comparative static analysis of the risk-attitude parameter and the future self arrival intensity, we have determined that the negative effects of time inconsistency can be mitigated by a more conservative attitude on the part of LP, while a higher future self arrival intensity exacerbates the impact of LP’s time inconsistency on their certainty-equivalent valuation.

Sustainable development for private equity: Integrating environment, social, and governance factors into partnership valuation

AbstractGeneral partners (GPs) of private equity (PE) are facing increasing pressure from limited partners (LPs) to make investments that meet environmental, social, and governance (ESG) targets. We develop a tractable model to analyze an LP's valuation of participating in PE investment when the ESG factors are objectives. Integrating the ESG factors makes the LP commit to investing capital in ESG demand spending and choosing sustainable PE, which has an inverted U‐shaped effect on the LP's certainty‐equivalent wealth. At the optimal ESG demand spending, the LP tends to choose more consumption but less public equity investment due to his or her positive expectation about higher certainty‐equivalent wealth from PE investment. However, an endogenous risk‐aversion attitude and exogenous idiosyncratic risk will have an adverse effect and make the LP less eager to integrate the ESG factors for sustainable development. Thus, the optimal ESG demand decreases, and the LP requires a higher break‐even excess return. Our analysis provides new theoretical insights for both PE partners and regulators when integrating ESG factors and sustainable concepts into PE valuation and management.

The Rebalancing Conundrum: Private Equity Valuations and Market Dislocations

The Rebalancing Conundrum: Private Equity Valuations and Market Dislocations

Practical Applications of Private Equity Valuations and Public Equity Performance

<h3>Practical Applications Summary</h3> In <b>Private Equity Valuations and Public Equity Performance</b> from the Summer 2019 issue of <b><i>The Journal of Alternative Investments</i></b>, authors <b>Megan Czasonis</b> (of <b>State Street Associates</b>), <b>Mark Kritzman</b> (of <b>Windham Capital Management</b> and the <b>MIT Sloan School of Management</b>), and <b>David Turkington</b> (also of <b>State Street Associates</b>) demonstrate that private equity (PE) managers introduce positive bias into their quarterly investment valuations. Managers tend to overprice their shares by overstating how well their investments performed during the quarter. These optimistically high valuations are induced by public market gains that happen after quarter end; PE managers raise their share valuations when the public equity market goes up during the reporting delay after quarter end—but they do not lower valuations if the market declines. This uneven response to market gains and losses after quarter-end means that valuations are often unrealistically high. The underlying driver confirmation bias, the tendency of managers to only cite evidence that shows their investments did well. But since managers tend not to do this in the fourth quarter, when investment valuations are independently audited, PE funds appear to gain more in Q1 through Q3 than in Q4. This introduces artificial volatility in performance over the year and has serious implications for investors and advisors. <b>TOPICS:</b>Private equity, security analysis and valuation, performance measurement

Practical Applications of Private Equity Valuations and Public Equity Performance

Practical Applications of Private Equity Valuations and Public Equity Performance

Private Equity Valuations and Public Equity Performance

It is reasonable to expect that changes in private equity valuations should bear some correspondence to public equity performance because private assets and public assets both respond to common influences such as changes in discount rates. But it is also reasonable to recognize that changes in private equity valuations should depart to some extent from public equity performance owing to differences in risk, liquidity, and cash flow expectations. These differences affect the degree of correspondence. In this article, the authors explore an additional influence on private equity valuations that affects not the degree of correspondence, but rather the symmetry of the correspondence. The authors argue that because private equity managers are less constrained than public market participants by the forces of no-arbitrage pricing, they have greater discretion to introduce biases into their valuations. Based on an extensive sample of private equity valuations, the authors find persuasive evidence that private equity managers produce positively biased valuations that appear to be rationalized by information that should not be relevant. TOPICS:Private equity, performance measurement

Private Equity Valuation Before and After ASC 820

With $3.4 trillion invested in North America, private equity comprises a large segment of the capital markets. We examine the effect of ASC 820 (formerly known as SFAS 157) on the valuations reported by US private equity funds to their investors. In 2008, the FASB implemented ASC 820 to achieve more consistent measurement and increased transparency in fair value reporting. This new standard clarified the most critical accounting policy for private equity funds, which typically include highly illiquid investments. Exploiting a setting where we can observe all cash flows over a fund’s lifetime, we show that the reported net asset valuations (NAVs) of liquidated private equity funds more accurately predict future net distributions to investors following ASC 820 adoption, particularly for smaller funds, less experienced fund managers, and high-performing funds. Our findings shed light on financial reporting in an opaque industry and suggest that ASC 820’s enhanced fair value guidance improved the information environment in an economically significant cross-section of the financial markets.

CAPM Failure in Private Equity Valuation and the Alternative APT Method

The existing criticisms of CAPM in the financial economics literature in combination with the lack of new generalized risk pricing theories and methods in the private capital markets (PCM) valuation literature suggests there would likely be benefit from the introduction alternative asset pricing theories to the PCM valuation literature. In this connection, this article presents a simple test of CAPM using two publicly-traded securities suggesting that, while certain CAPM concepts are relevant and useful in asset pricing, CAPM theory and related methods are generally inadequate in PCM valuation practice. Again using publicly-traded securities, a method derived from arbitrage pricing theory (APT) is then presented to estimate the no-arbitrage required rate of return for one of the publicly-traded securities. Finally, the method is generalized to a hypothetical PCM valuation setting. The APT-based method presented in the article addresses the most problematic aspects of CAPM theory while providing a generalized risk pricing theory and method for use in PCM valuation practice.

Private Equity Valuations and Public Equity Performance

It is reasonable to expect that changes in private equity valuations should bear some correspondence to public equity performance because private assets and public assets both respond to common influences such as changes in discount rates. But it is also reasonable to recognize that changes in private equity valuations should depart to some extent from public equity performance owing to differences in risk, liquidity, and cash flow expectations. These differences affect the degree of correspondence. In this article, the authors explore an additional influence on private equity valuations that affects not the degree of correspondence, but rather the symmetry of the correspondence. The authors argue that because private equity managers are less constrained than public market participants by the forces of no-arbitrage pricing, they have greater discretion to introduce biases into their valuations. Based on an extensive sample of private equity valuations, the authors find persuasive evidence that private equity managers produce positively biased valuations that appear to be rationalized by information that should not be relevant. TOPICS:Private equity, performance measurement

Private Equity Fair Value Measurement: A Critical Perspective on IFRS 13

In this paper, we discuss IFRS 13 Fair Value Measurement with regard to private equity valuation. We raise issues on the fair value definition as an exit price and question the reliability of valuation techniques, which are categorised into Level 2 fair value hierarchy. Our paper questions whether fair value as defined by IFRS 13 is an appropriate measure for private equities and can contribute to enhancing transparency and comparability in financial statements, which is one of the purposes of the International Accounting Standards Board and the European Union Regulation 1606/2002.

Fair Value Measurement for Private Equities: A Plus or a Minus for Stakeholders?

In this paper, we discuss the potential economic consequences of IFRS 13 endorsement in the European Union. Our focus is on private equity valuation. We review prior research and perform a field-test in order to shed light on the possible effects of its adoption. Our paper questions whether fair value, as defined by IFRS 13, is an appropriate measure for private equities and can effectively contribute to enhance transparency and comparability in financial statement, which is one of the explicit purposes of both the IASB and the European Union Regulation 1606/2002. Our field-test supports this claim and shows that market-based valuation techniques fail to provide fair values which are a faithful representation of the economic real world phenomena they purport to represent. Consistently with previous research, we show that market and transaction multiples do a poor job and relevant entity-specific adjustments will be necessary.

Shedding Light on Microfinance Equity Valuation: Past and Present

Micro-finance institutions (MFIs) will certainly be affected by the financial crisis ricocheting across the globe, but the authors believe that the sector is fundamentally sound. Larger institutions, especially those with diversified funding sources, such as retail deposits, are best positioned to manage the effects of economic and financial contraction. Valuations may change, but the authors believe the long-term outlook for equity investment in microfinance is positive. Private equity valuations for MFIs have varied widely over the past few years. Investors should not value MFIs the same way they value traditional banks. The authors highlight five characteristics that differentiate MFIs from traditional banks, and justify a slightly different valuation approach: a double bottom line that aims for social and financial returns, excellent asset quality, high net interest margins (NIMs), high operating costs, and longer term funding available from developmental investors.

Valuation Guidelines for Private Equity and Venture Capital Funds

In March 2005, the most recent set of valuation guidelines produced by the Association Francaise des Investisseurs en Capital (AFIC), the British Venture Capital Association (BVCA) and the European Private Equity and Venture Capital Association (EVCA) were published following previous sets in 1991, 1993, 2001, and 2003. These new International Private Equity and Venture Capital Valuation (IPEV) guidelines were the result of increasing importance and acceptance of this asset class during the last decade, combined with the internationalization of the industry, the clear increase in the quality and availability of information, new applicable laws, regulations, and accounting standards. The IPEV guidelines took effect for all reporting periods after January 1, 2005. The European Investment Fund (EIF) asked the funds in its portfolio to produce their June 2005 reports in compliance with the IPEV guidelines. Using the 200+ funds in its portfolio, the EIF conducted a survey on the consequent adoption and accurate application of the IPEV guidelines. In this article, the results of that survey are presented.

A Contextual Analysis of Incomeand Asset-Based Approaches to Private Equity Valuation

The question of how to best value privately held businesses for purposes of taxation and other legal reasons remains open to debate. In general, valuation models are asset-based, income-based, or hybrid models that aggregate asset and income information. An example of the latter is the controversial excess earnings method recommended by IRS Rev. Rul. 68–609. In this research, we focus on the relative performance of the excess earnings method vis-a`-vis other widely used valuation models. We consider the valuation accuracy of each model in a general setting along with examining contextual performance under varying levels of intangible versus tangible assets and varying levels of business profitability. We show that the hybrid model provides superior valuation accuracy in general and more consistent valuation accuracy across the contexts examined. We also show that the inclusion of two capitalization rates in the excess earnings method, which is required in order to distinguish returns from tangible versus intangible assets, provides increasing relative valuation accuracy over that of the single-rate earnings capitalization model as the two rates diverge. In summary, we demonstrate that for privately held firms, which typically lack analyst following and independent earnings forecasts, the excess earnings method represents a viable valuation alternative.

Venture-backed Private Equity Valuation and Financial Statement Information

The relationship between (a) private and public equity market valuations and (b) financial statement information is examined for a sample of 502 venture capital backed companies from six different industries over the 1993-2003 period. Financial statement information explains a sizable component of the levels of and changes in valuation in both the Pre-IPO and Post-IPO periods. The findings support prior research for Post-IPO companies that revenues are value enhancing and costs are value diminishing. For the Pre-IPO period, we find that cost of sales; sales, marketing, general and administrative; and research and development are value enhancing - even when revenues are included in the analysis. This is consistent with costs incurred by early-stage, venture-backed companies having a strong "investment aspect" as the companies build a platform/infrastructure to grow revenue and validate their business model(s). We document the growth of early stage companies for revenues and costs in both calendar time (by round of private equity financing) and event time (relative to their eventual IPO).

Appropriate Pricing and Valuation of Portfolio Companies

Jonathan Boersma, CFA, of the CFA Centre for Financial Market Integrity, and William Franklin, of the Bank of America Capital Corporation and the Private Equity Industry Guidelines Group, each discuss their respective organization's progress in developing valuation guidelines for the private equity industry. They are then joined by Scott Brown, CFA, of State Street Corporation, for a panel question and answer session on private equity valuation guidelines.

Private Equity Valuation: A Riddle Wrapped in a Mystery inside an Enigma

This article addresses the following key points: Underlying measures of private equity value are cash flow, earnings, and assets. Valuation methodology depends on context — sale, financing, fair-value performance reporting. Competition for deals raises multiples. Proposed fair-value rules force regular valuations and promote consistency.