Need To Know

If prices fetched in the secondary market are any indication, general partners looking to comply with fair-value accounting standards should be prepared to record aggressive write-downs in their year-end financial statements. Either that or pray for a rally in stock prices.

The latest analysis of the secondary market from advisory firm Cogent Partners found that the average high bid for stakes in both buyout and venture capital funds dropped to 61.0 percent of net asset value, or NAV, in the second half of 2008, down from 84.7 percent in the first half of the year. The decline stems in part from the tumble in the U.S. public equity markets, which were all off roughly 40 percent for the year. But it also reflects the unwillingness of buyout firms to value their holdings at a loss.

“The secondary market corrects for these fantasy valuations reported by general partners,” Colin McGrady, a managing director and co-founder of Cogent, in a statement accompanying the study. He added later: “However, because sellers realize their funds have embedded losses and unrealistic valuation levels, portfolios continue to transact.”

Indeed, secondary deal volume in 2008 was projected to have reached a record $17 billion, according to data from secondary buyer Lexington Partners. And as Buyouts reported in mid-December, that annual figure is expected to come in between $20 billion and $30 billion per year for the next two to three years, based on Lexington Partners’s prediction that partnership interest turnover rate could go as high as 10 percent, up from the current rate of nearly 5 percent.

The study looked at first-round bids Cogent Partners received on a group of roughly 300 partnerships marketed from July through November. The breakdown of fund type: 56 percent buyout funds, 38 percent venture funds and 6 percent other funds. In a possible sign of growing urgency among sellers, the firm also saw more binding first-round bids requested for portfolios marketed in the second half of 2008, a big change from the past when first-round bids were almost exclusively non-binding.

Zeroing in on buyout funds, the study found the stakes were able to achieve substantially higher pricing than venture partnerships. The average high bid was 64.7 percent of NAV for buyout funds, compared to 55 percent for venture funds. The average median bid for buyout funds was 57.6 percent, compared to 50.6 percent for venture funds.

As Cogent Partners noted, only the most distressed limited partners would be willing to sell at a 40 percent discount to reported values. This is where the firm takes general partners to task on their valuations, saying the reported figures are “at best stale and at worst a fantasy.”

For a reality-check, Cogent Partners also reported a figure in its study adjusting the NAVs of the funds by the decline in the appropriate benchmarks (the S&P 500 for buyout funds) in the public markets since Sept. 30 to the low value seen in the two weeks prior to the bid date. Doing this improved pricing greatly in the secondary market, with the overall adjusted NAV coming in at 98.2 percent and the adjusted NAV for buyout funds rising to 101.5 percent. Those figures go a long way toward explaining the rationale of buyers in the secondary market. They also point the way to fair value for GPs. The question now is whether or not they’ll follow.