A new set of guidelines has been devised to help reduce inconsistencies in the measurement of private equity fund performance. The question now is whether or not the proposals will even be adopted by most buyout and VC firms, let alone be effective.
Developed by a two-year-old consortium called the Private Equity Industry Guidelines Group (PEIGG), the guidelines urge general partners to evaluate portfolio company valuations by using the best estimate of fair market value. In other words, value a portfolio company based on the amount that an independent party would be willing to pay for the company today, rather than on the valuation from its previous equity infusion. Moreover, firms are being asked to report valuations on a quarterly basis to their limited partners, and also to create semi-independent valuation committees that would establish valuation guidelines for their respective general partnerships (although the general partner would still calculate the actual valuation). Finally, firms that follow the guidelines would be encouraged to confer with one another if they have a shared portfolio company.
“A common value system agreed on by both limited and general partners is an important step in the growth and maturation of the private equity industry,” said Bill Franklin, a managing director with Bank of America Capital and PEIGG board member.
Stephen Holmes, general partner and chief financial officer of firm InterWest Partners, added: “We were very pleased by the feedback we received on the earlier drafts from a broad range of constituencies… We believe that this broad industry participation will help us enormously as we seek to build consensus around our recommendations.”
What Holmes conceded, however, was that PEIGG was unable to secure National Venture Capital Association (NVCA) approval prior to releasing the guidelines. He suggested that the early release was caused by fears over press leaks, but some market sources suggest that the true fear was that NVCA ultimately would not adopt the measures in full.
Jim Breyer, the NVCA’s incoming chairman, already has expressed reservations. Breyer, a general partner with Accel Partners, says that his firm only plans to partially adopt the new guidelines.
“To carry an investment at cost when the general partners know that cost is unfairly high is irresponsible, and standards to move the industry to more aggressive write-downs from cost, or from previous write-ups, is very positive,” Breyer said. “The troubling issue is the suggestion that, on a quarterly basis or an annual basis, there should be write-ups of portfolio company valuations without third-party validation. That’s a slippery slope because it just leads to more arbitrary valuations when it comes to write-ups.”
Even if the NVCA does adopt the guidelines in full, it’s unclear what impact it would have. Kevin Delbridge, a managing director with HarbourVest Partners and a PEIGG board member, acknowledged that HarbourVest would not summarily reject potential investments in firms that do not adopt the guidelines. Another limited partner, who wishes to remain anonymous, concurred, adding that the reduced inconsistencies caused by the guidelines still would not safeguard against inaccuracies.
“What good does it do me if two firms agree on a valuation, but they are both wrong?” he asked. “Also, I’m getting so much less information now from general partners that it may not really matter much one way or the other.”