The evolution of private equity valuations over the past 12 months

March 2020 - Special guidance

In March 2020 the IPEV Board issued special guidance in estimating fair value at valuation date in these unprecedented times. Key highlights from this guidance were:

• A “fire sale” is not representative of an investments fair value.
• Fair value represents the amount that would be received in an orderly transaction using market participant assumptions in the current market environment.
• Fair value is based on known and knowable data at the measurement date.
• Ensure that the effects of COVID-19 are not taken into account in multiple inputs in the valuation model, resulting in ‘double dipping’, which could result in a very prudent value.
• The greater the risk, the greater the returns, which may result in lower fair values.

Since issuing the March 2020 guidance, asset managers were challenged by the limited amount of data available, the volatility in the public markets and the sudden decrease in activity within the private equity sector. In practice, we found that asset managers embraced these guidelines to support their valuation methodology, the significant level of judgements applied to assumptions and the use of various calibration techniques to ‘sense-check’ their valuations.
 

December 2020 - Special guidance

Fast forward nine months and the IPEV Board issued further guidance in terms of 31 December 2020 fair value estimates, where they confirmed that:

• The March 2020 special guidance remains relevant.
• A potential buyer would exercise prudence when determining the price they would pay, and it may be challenging to determine which metric to use.
• Public company multiples may need to be adjusted to reflect differences in terms of COVID-19 impact, operational performance and other adjustments to reflect market participant perspectives.

In practice, asset managers are considering the following to support their 31 December 2020 valuations:

• Recent failed sales provided an understanding of the multiple / discount rate range between buyer and seller; the adjustments made to earnings and cash flows; and the specific reasons why the sale failed. All of these supported the calibration of the asset managers assumptions.
• Similarly, current exit negotiations also support the calibration of the asset managers valuation assumptions around the movement in the multiple / discount rate; and the adjustments made to earnings and cashflows.
• Maintained the level of discount / premium to the comparable company basket where a portfolio company had been performing better than expected and better than that of the market.
• Exercised a level of prudence by maintaining multiples at a constant value while the comparable company basket multiple had increased (i.e. the discount has increased).
• The use of Next Twelve Months (‘NTM’) earnings adjusted for the historical accuracy of management achieving budget.
• Growth rates used in the valuation model were supported by the most recent performance of the portfolio company and the sector growth expectations.
   

Looking ahead

The challenges during 2020 have not gone away, however the increased activity within the private equity sector is reducing the level of uncertainty around private equity valuations when compared to those private equity valuations performed in March 2020.

Asset managers should remain cautious in assessing the integrity of the information used in the valuation model and calibration testing remains vital in supporting private equity valuations for the foreseeable future.

Both the special guidance issued in March 2020 and December 2020 remain particularly relevant to asset managers conducting private equity valuations for future reporting periods.

For more information or to discuss further insights in the investment management and private equity sector In the Channel Islands please contact either of the key contacts below.