Private equity portfolio company valuations



FW moderates a discussion focusing on private equity portfolio company valuations between Charles Lundelius at Berkeley Research Group, LLC, Michael Ryan at Hamilton Lane Advisors LLC, and Michael Athanason at KPMG LLC.

FW: Why are regulators now focusing more attention on private equity portfolio valuations?

Athanason: Increased regulation of the private equity industry is a global trend, and several factors are driving it, including the financial crisis, high profile cases against fund managers, new legislation, and limited partner complaints, amongst other reasons. The Securities and Exchange Commission (SEC) has increased its scrutiny of the private equity industry, by growing headcount of personnel that concentrate on fund managers and are themselves industry specialists. Regulators are particularly focused on risk areas such as valuation, investor reporting, fee structures, expense calculations/allocations, and conflicts of interest. Robert Kaplan, Co-Chief of the SEC’s Asset Management Group, recently affirmed at a conference that the SEC is squarely focused on the private equity industry. “I think that private equity law enforcement is where hedge fund law enforcement was five or six years ago,” Kaplan said, according to The Wall Street Journal. Reuters also recently quoted Carlo Di Florio, Director of SEC Office of Compliance Inspections and Examinations, who was speaking at the Private Equity Analyst Outlook Conference 2012, as commenting, “A significant percentage of new [Private Equity] registrants will face coordinated examinations focused on the highest risk areas of their business.”

Lundelius: There are no market prices for private companies. Valuing a private company is a complex and imprecise task because it often requires the use of estimates, forecasts, and models. Assume a 2006 valuation of a new start-up that proves to be dramatically higher than the actual value realised by investors in 2009. Did investors lose because of a faulty valuation or did the financial crisis play a role in the loss? In this example, regulators may investigate the 2006 valuation as well as the write-downs taken between 2006 and 2009. Regulators will investigate the periodic valuation assessments to ensure that the estimates were prepared in good faith and in accordance with regulatory and industry standards. In the US, the SEC has taken a keen interest in valuation issues related to private equity and has recently initiated several enforcement actions against PE funds that are publicly traded.

FW: How can general partners achieve portfolio valuation results that are robust, fully independent and functionally segregated from the investment team?

Lundelius: The Private Equity Industry Guidelines Group (PEIGG) has provided managers with a framework for valuing their private companies. The framework recommends that written valuation parameters be established and periodically reviewed by an oversight committee. In addition, some valuations may benefit from review by external valuation experts. An external valuation is especially useful if the portfolio company is operating in a difficult business environment where its solvency or high value may be challenged. The benefits of a robust process can be significant. For example, if the portfolio company has a complex capital structure where, under certain conditions, one class of third-party shareholders may receive additional shares of stock and dilute the PE fund’s investment, a robust process would evaluate the potential impact of such an event and inform limited partners to avoid rude surprises. 

Athanason: General partners are able to achieve independent valuations by focusing on three key areas. First, develop a formal valuation policies and procedures document that is clear to investors in the offering memoranda or partnership agreements. Second, be consistent in the adherence to these policies and procedures. And third, develop a fully segregated valuation team, contract with an external third party reviewer, or use a combination of the two. A key question at middle market and small funds is how to assure CFO independence. One way for them to enhance independence controls is to use independent third party reviewers to augment their own staff, which is a common practice of large funds for regulatory, limited partner and auditor reporting. 

FW: Why is having a written, detailed and independent valuation process in place important and how can general partners maintain compliance discipline?

Lundelius: Subjective judgments play a significant role in private company valuations. Therefore, investors or regulators may perceive bias in a non-independent valuation performed by a private equity fund’s manager. For instance, the SEC recently accused a major investment adviser of overstating the value of two portfolio companies in order to generate higher investment advisory fees. The SEC believed that because the companies were kept on a tight leash with regard to capital contributions, the companies’ ability to fund future operations was in doubt and that they were effectively insolvent. The PE manager valued them at tens of millions of dollars. This dispute could have been avoided if the manager had a written, detailed and independent valuation process to ensure that the investment team is not inappropriately influencing the valuation process.

Athanason: Rigorous valuation policies are a ‘must have’ these days. The ability to demonstrate the existence of and compliance with valuation policies provides investors, regulators and auditors with the comfort that the private equity manager is diligent and strives to follow IPEV and EVCA Guidelines. A documented process with proper controls also provides a framework to help the PE manager maintain investment and reporting discipline for compliance purposes. The document should be comprehensive, updated annually and rigorously followed. Both the SEC and the European Union view the valuation policies and procedures document as a fundamental component of an independent valuation process.

FW: How are regulators scrutinising valuations and analysing them vis-a-vis marketing material and investor communications?

Athanason: Regulators assess portfolio company valuation methodology, consistency of approach, and conclusions to form opinions on the quality of valuations. They also cross check with performance data and marketing material for inconsistencies. Key focus areas include handling of conflicts of interest, internal controls and compliance programs, and valuation practices. How are placement agents or other third party consultants used and under what terms? To what extent are preferential side letters used? What marketing claims are made, regarding returns? Is there a consistent approach to portfolio company valuations? Is there selective sampling and weighting of portfolio returns to show better performance?

Lundelius: Once regulators suspect a problem, they comb through everything. For instance, the SEC charged an investment adviser for fraudulently overstating the value of its portfolio companies. In its complaint, the SEC noted that the investment adviser directed both the investment decisions and the valuation recommendations. Before filing the complaint, the SEC thoroughly investigated the investment adviser’s communications to investors, the board of directors, and the independent auditors. In those communications, the SEC found discussions that cast doubt on the values presented in the financial statements, and once the auditors were shown those communications, they resigned. The SEC then filed suit and alleged that the investment adviser failed to disclose financial difficulties and misrepresented the financial performance of the portfolio companies.

FW: What percentage of the audit test work surrounds valuation and how can that be made more efficient and less time consuming?

Athanason: Valuation is a vital part of the audit process, many times making up a sizeable portion of the total audit fees. The valuation component of the audit depends heavily on the complexity of assets, extent of documentation, and the skill set of the private equity manager. As importantly, it also depends on the skill set and experience of the audit team. After FASB’s 157 – which became ‘ASC 820’ in the 2010 updated FASB Codification – private equity funds began to improve their internal valuation capabilities, sometimes supplementing in-house staff with external third party reviewers. This helped strengthen independence and streamline the audit process. Funds have also been adopting valuation practices economically to address transparency, including the following. First, developing detailed valuation policy and procedure documents. Second, creating templates and streamlined valuation models. Third, standardising the valuation process. Fourth, focusing on valuation documentation support for audit. Fifth, utilising data management solutions. Finally, leveraging third party review work as support for the valuation. We are also seeing in the marketplace that fund auditors are escalating reviews of fund investments in order to satisfy the greater level of scrutiny desired by regulators and investors. 

Lundelius: The percentage of time spent auditing valuations depends on how well prepared is the PE fund manager. Audit test work can be extensive if a valuation is based on unsupported or undocumented estimates, if a valuation contains internal inconsistencies, or if a valuation is not prepared in accordance with the firm’s valuation guidelines. Those conditions indicate weak internal controls and will require the auditor to implement extensive additional procedures to gain assurance as to the values presented in the financial statements. Alternatively, internal controls that demonstrate a robust valuation process will allow the auditor to place reliance on those controls and not spend as much time auditing specific valuations. Also, private company valuations supported by a review report from an independent valuation expert will result in less time consuming audit test work.

FW: How are technology solutions playing a more important role in the reporting, monitoring and valuation processes?

Ryan: We have made a substantial investment in our internal IT systems to provide our clients with best-in-class reporting and portfolio analytics. As a limited partner, we continually evaluate technology solutions to shorten the reporting time lag and reduce data errors in a resource-efficient manner.

Lundelius: Technology provides better access to data that are critically important to the valuation process. For example, private companies are frequently valued using price/earnings multiples derived from comparable public companies. Technology presents a larger universe of comparables and better information about those companies to help a valuation expert discern which public companies should or should not be included in the peer group. With regard to reporting and monitoring valuations, technology allows the PE fund manager to frequently reassess initial values based on changes in market conditions. This information not only provides better and more timely updates to valuations, it also helps the PE fund manager better determine that critical time to exit the investment and liquidate the fund’s investment.

Athanason: Innovative private equity managers are adopting technology solutions to manage portfolio company data. These managers are also using IT solutions to support their valuation process. Select service providers are creating automated reporting templates that integrate data management and valuation to allow for customised portfolio company/asset reports on a real time basis. This accomplishes a number of important goals. First, it improves operational management of funds and portfolio companies. Second, it satisfies regulatory and investor inquiries efficiently. Finally, it improves internal reporting and audit processes, while minimising labour costs.

FW: How are limited partners looking to shape the reporting volume, quality and depth of their existing and potential general partners? 

Lundelius: The Institutional Limited Partners Association (ILPA) established best practices for reporting that include not only financial information, with extensive footnotes, but also supplemental management reports. Those supplemental reports include information on the fund manager’s other assets under management, information on commitments and drawdowns made by the PE fund, key valuation metrics, historical performance and portfolio breakdown by country or region. The best practices also call for a supplemental schedule of investments that include a discussion of valuation drivers and performance metrics on each individual portfolio company. The performance metrics detail the change in company value and cost and include a ‘movement summary’ that discusses important events, whether internal or external to the portfolio company, that impact value.

Athanason: Limited partners and the trade organisations that serve them have begun to exert more influence on the volume and quality of information they are requesting. The ILPA has recently released capital call templates that the California Public Employees Retirement System (CalPERS) customised and adopted. While the ILPA reporting package mentioned above is a start, limited partners are continuing to customise their reporting requests or adopt internal templates. Even though standardisation may be a way off, the consistent theme is that limited partners are asking for quarterly reporting along with portfolio company/asset detail, in addition to fund-level information. Within the current fundraising cycle, limited partners are asking their general partners for items including a summary discussion and analysis of management activities, firm and fund management reports, and portfolio company detail, including valuation support.

Ryan: We seek information from general partners in a timely and consistent fashion to allow us to assess the drivers of performance, determine the level of conservatism in valuation and spot potential trouble spots in a portfolio.

FW: How are limited partners testing the net asset values (NAVs) they receive?

Ryan: We examine the dispersion of individual investment returns as one proxy for risk and assess the health of the current portfolio. In fund selection, we adjust the performance of the manager in line with our view of valuation and benchmark their performance based on that.

Lundelius: Limited partners are testing NAVs by drilling down into the data. The ILPA, for example, sets a best practice for PE fund managers to disclose the key valuation drivers of portfolio companies. Limited partners, then, can evaluate whether those drivers are the most appropriate and, if so, monitor those drivers independently from the fund manager. From that analysis, limited partners can test valuations of the companies that determine NAV.

Athanason: Limited partners have traditionally used the Practical Expediency guidance set forth in the United States FASB’s Accounting Standards Update 2009-12, which set standards for the calculation of NAVs. But, to better understand private equity managers’ risk/return profiles for fundraising and monitoring purposes, limited partners have begun to seek better transparency into portfolios and performance data. Limited partners are using various techniques to assess performance data including developing custom benchmarks to assess the reasonableness of the reported NAV. For example, the ILPA has selected consultant Cambridge Associates, LLC to create a benchmark that will focus solely on the private markets investment performance data of its member funds. Limited partners and their advisers, including external valuation firms, are also tracking portfolio company data including investment cash flows, financial statements, and capital structure information. Given the current US SEC and European regulatory push, coupled with the trend within the limited partner community for greater levels of transparency, limited partner assessment of NAV performance will continue to grow and evolve.

FW: What is driving general partners to achieve independent, supportable and cost effective valuation results, and what techniques are being used?

Lundelius: The regulatory climate has changed, and limited partners are expecting more. First, the regulators who used to shy away from valuation enforcement because of subjectivity on valuations are now emboldened to challenge valuations because they have had some initial success and sense a need for more enforcement activity. Second, limited partners are demanding more, as demonstrated by the ILPA standards. Those standards encourage or require PE fund managers to provide extensive disclosures such that limited partners will be able to evaluate for themselves many of the key factors used to value portfolio companies. In short, if the general partners want to attract capital, they will have to implement supportable valuation practices that address both regulatory and limited partner demands.

Athanason: Developing independent valuations begins with a detailed written set of policies and procedures that provide the framework to determine valuation methodology, use of assumptions and procedural steps to calculate the per unit value. Adoption of next generation data management solutions has also been on the rise with many general partners implementing software solutions to increase their ability to extract data directly from portfolio companies/assets for analysis and reporting purposes. General partners are also leveraging external advisers to supplement valuation capabilities. Some of the areas where general partners are seeing improvements are in the streamlining of the audit process and limited partner valuation reporting by using enhanced data solutions. Another key area is the use of standardised templates and reports. Standardising the reporting process can save significant time and effort to the three major stakeholder groups: the regulators, the auditors and the investors.


Charles Lundelius is a director at Berkeley Research Group, LLC. He has consulted with and given expert testimony on behalf of clients in the areas of investment management and stock valuation matters. He specialises in Securities and Exchange Commission (SEC), National Association of Securities Dealers, and New York Stock Exchange market regulation investigations, securities valuation, share price modelling, and commodities trading, having testified in over 30 different cases. Mr Lundelius is a Certified Public Accountant and is Accredited in Business Valuation and Certified in Financial Forensics by the AICPA. He can be contacted by email:

Michael Ryan is the Head of Research at Hamilton Lane, an independent provider of discretionary and non-discretionary private asset management services to institutional investors worldwide. At Hamilton Lane, Mr Ryan’s team focuses on portfolio construction and quantitative analysis of private asset portfolios. In addition, he is active in due diligence for primary fund investment opportunities. Previously, Mr Ryan was a Principal at Capital Z Investment Partners, where he was responsible for sourcing, evaluating and structuring Capital Z’s hedge fund and private equity fund investments. Prior to joining Capital Z in 2001, Mr Ryan worked in the Technology Investment Banking and Real Estate Investment Banking groups at Merrill Lynch. He can be contacted by email:

Michael Athanason is a principal in KPMG’s Alternative Investments Valuation Group in New York. Mr Athanason is responsible for working with PE/HF sponsors and limited partners. He also oversees the portfolio valuation service line and executes on transaction-related and other valuation engagements. He has over 25 years of valuation and corporate finance advisory experience and specialises in advising on valuation and value management of alternative assets. He has worked for many of the largest global private equity, hedge and sovereign funds in establishing fair market valuation standards, procedures and best practices in financial reporting. He can be contacted by email:

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Charles Lundelius

Berkeley Research Group, LLC


Michael Ryan

Hamilton Lane Advisors LLC


Michael Athanason


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