Posted: 20 Aug. 2020 10 min. read

Valuation of the family office investment portfolio – harder to value assets just got harder to value

Introduction

In the current uncertain environment, family offices are challenged to consider the impact COVID-19 has had on the value of their unlisted investments. No one can say with certainty what the course of the pandemic will be, much less its impact on businesses in the long or even medium-term. The uncertainty poses significant challenges. What might the landscape look like once the pandemic passes? What if the pandemic lasts longer than we are expecting? While the answers are not available, a well-considered approach to assessing the impact is required.

The investment governance frameworks of family offices would likely not have accounted for such a unique and unprecedented disruptive event. As such, a thorough, swift and robust re-assessment of the frameworks may be needed by management as they continue to respond to the crisis. Additionally, any framework that included the use of third-party valuers may need to amend its reporting requirements to reflect updated terms and conditions with their vendors as the need to incorporate and reflect COVID-19 considerations and its inherent uncertainties become pivotal to all stakeholders.

As the market compression continues to change the inherent nature of the underlying assets within the investment portfolio – previously liquid investments become less liquid due to the decreased trading activity – management will need to consider the adequacy of its current investment governance framework to respond to an intrinsically more risky portfolio than the targeted portfolio envisaged from its strategic asset allocation framework.

When attempting to determine fair value in these uncertain times we should consider the increasingly broad effects on the financial condition of portfolio companies as a result of the pandemic’s impact on the country, industry, and major financial markets. It is also important to be aware that such conditions can change significantly over relatively short periods.

Valuation in uncertain times - Is there guidance?

International Private Equity & Venture Capital (IPEV) Valuation Guidelines were updated on 31 March 2020 and provide useful considerations when valuing your portfolio, some of which are detailed below.

  • Care should be taken not to “double-dip” – i.e. in the case of a Discounted Cash Flow (DCF) if future cash flows have been adjusted to consider COVID-19, then any increase in the discount rate should be lower than if cash flows had not been adjusted. Market participant views matter – greater uncertainty may translate into greater required returns.
  • It may no longer be appropriate to rely on recent transaction prices as an indication of fair value.
  • Appropriate multiples must be determined, which reflect the current market environment.
  • The percentage change in market capitalisation of comparable public companies may provide a good proxy for the magnitude of the change to be expected in the multiple.
  • Revenue and earnings metrics must be evaluated in the context of market participant perspectives. Generally, market participants focus on maintainable earnings or maintainable revenue. Therefore, one-time impacts would be excluded from the metric to which the multiple is applied.
  • Notwithstanding the previous point, expected adverse performance in Q1 and Q2 2020 and beyond, if deemed one-time, would still affect cash balances and would be reflected as a deduction from enterprise value in estimating fair value.
  • Liquidity needs must be evaluated.

Operational Disruption

As the impact of the pandemic unfolds, a holistic assessment of every investment in a portfolio is critical. This should extend to the portfolio company’s revenue, customers, supply chain, and operations to determine the extent of any operational disruption.

Understanding the extent of operational disruption because of COVID-19 will be a key driver in adjusting any performance metrics and factoring in market participant’s considerations.

The below factors are important in assessing the threat of COVID-19 and thus should drive any forecasts used as part of the valuation of portfolio companies:

  • Is the business able to supply what it is trying to sell? Are staff available; are the supply chain and distribution channels functioning adequately?
  • How does this situation affect demand? Does anyone want what the business is selling now?
  • Are there single point of failure risks in the supply chain?
  • What is the company’s active business continuity/contingency planning in respect of COVID-19, how does the board assess the ability of the business to withstand disruption from both an operational and a financial standpoint, and what are the actions taken to mitigate actual or potential issues?
  • Geographical implications of group operations – how diverse are group operations. Could the business face a protracted shock, as COVID-19 spreads?

Upside Potential

There is a possibility that profitable investments may exist under this unique market climate. For example, investors looking at primary investments could benefit from lower entry multiples and diminished competition, while favourable secondary investments could arise as economic turbulence caused by COVID-19 create buying opportunities. Finally, the impact of COVID-19 may create long-lasting behavioural changes to consumer habits which result in the strengthening of well-positioned companies or companies which have successfully managed to adapt to the new economic environment.

The last few months have been challenging, and so too will be the coming months, the decisions businesses make in the near term will most likely drive sustainability in the long term and that includes how it communicates with its stakeholders. It is too soon to tell how we will emerge, but resilient leaders are preparing now for what the future may hold and reporting responsibly to their stakeholders.

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Key contacts

Barry Christoforou

Barry Christoforou

Director

Barry is a Director within Deloitte’s Investment Management and Private Equity practice with over eleven years of industry experience focusing on Alternative Asset Managers. Barry leads our Private Equity assurance offerings. He and his team help firms and their funds navigate complex accounting, enhance their governance and controls and assist with regulatory change.

Ceile Bird

Ceile Bird

Senior Manager

Ceile is a Senior Manager in the Investment Management and Private Equity practice at Deloitte London. Ceile is a leading member of the Private Equity assurance service proposition in London, with many years of experience in leading audits and assurance engagements for a portfolio of Private Equity and Investment Management entities including muti-national large scale asset managers.