• Alexis Wolf, Partner |

Any professional involved in the valuation of private capital investments will agree that the International Private Equity and Venture Capital Valuation (IPEV) guidelines are an essential resource. Widely recognized as the industry standard for private capital valuation, these guidelines (issued by the IPEV board) and their recommendations have been adopted by many of the world's leading private equity and venture capital firms.

In December 2022, the board released a new set of guidelines, replacing those from 2018. So, what exactly has changed? Join as we take you through 10 key updates and the best course of action to ensure you’re all caught up!

1. Valuing early-stage companies

The revised guidelines emphasize that the headline valuation amount rarely takes into consideration the different rights and preferences of all the share classes, each of which have different risk and return expectations.

Qualitative factors such as actual versus budget performance metrics, cash burn rate, market acceptance of product/service, company strategy, the timing of the next financing round, exit timing and exit strategy should be considered. The fair value approach should consider the most likely exit strategy.

Take action:

Use multiple valuation methods to corroborate the value of early-stage companies (taking into account qualitative factors and adjustments for different rights of various classes of shares).

2. Valuing debt investments

In non-actively traded markets, the par value should not be considered fair value, even if there is sufficient enterprise value to cover the liability.

Take action

Base discounted cash flow (DCF) valuation on outflows per the repayment schedule, discounted with risk-free rate and credit spread (calculated based on a yield analysis).

3. Distressed or dislocated markets and transactions due to geopolitical, macroeconomic or other significant global or local events

So, what needs to be done? Several things: Analyze the operational environment, closely assess maintainable earnings, account for impact of market conditions on cash balances, and consider one-time cash demands including a possible covenant breach due to reduced cash flow.

In the case of distressed transactions, individual transactions should be ‘orderly’ to ensure that they are indicative of fair value.

Take action

Valuation techniques such as scenario analysis are likely to be necessary.

Use the income approach. That means carrying out DCF valuation with scenario analysis based on risk-adjusted cash flows, discounted by the corresponding risk-adjusted discount rate (including additional risk factors not captured within the cash flows).

4. Known and knowable information

The updated guidelines emphasize incorporating all known or knowable information that is available — or would easily be available — through inquiry or due diligence as of the measurement date. Transactions anticipated to sign or close after the measurement date may also indicate an estimate of fair value at the measurement date. The timing of a transaction closing or signing should be considered when making judgments about what was known or knowable at the measurement date.

Take action

Gather relevant information, including information on macro-economic uncertainties and investment specific uncertainties at the measurement date. 

5. Appropriate multiple

The updated guidelines provide additional clarifications on the selection of peer companies for multiples-based valuation and calibration, stating that peers may be direct competitors in the same industry, or have similar performance metrics. The comparability with peers ultimately defines the strength of the valuation conclusion.

Take action

Define comparable set of peers based on comparability against the target company’s business model, size, geographic focus and financial KPIs. Additional valuation techniques and adjustments may be necessary depending on the comparability of selected peers.

6. Contractual restrictions on securities

Discounts may be applied to actively traded securities if there is a “legal” restriction that would result in lower liquidity of the “security” itself (not the “holder”). That discount can be determined by comparing it with an identical unrestricted holding.

Contractual restrictions such as the underwriter’s lockup have been interpreted by some to be an attribute of the “security” and by others to be an attribute of the “holder”. Under the revised guidelines, such restrictions should not be considered as an attribute of the security.

Take action

Take a market view to determine the most advantageous market for security with contractual restrictions — most likely the public market where no discount would be allowed.

7. Enterprise value adjustments

The guidelines outline other adjustments that are to be made to the enterprise value to reflect surplus assets or excess liabilities.

Take action

  1. Identify steady state working capital, cash, surplus assets.
  2. Adjust for liabilities that may or may not be on the balance sheet such as deferred payments, incentive compensation, bonus, pension, taxes, deferred consideration etc.
  3. Adjust for ESG-related factors — decommissioning provisions and mandatory contributions, for example, by discounting the liability and including it in the enterprise value.

8. Net asset value adjustment

When it comes to fund of funds, the Net Asset Value (NAV) should be fair value based.

Take action

Ensure the NAV is consistent with the IPEV Guidelines and relevant GAAP. Adjustments to the last reported NAV may be required to account for subsequent changes or activity from the date of the reported NAV through to the current measurement date, to ensure it is based on fair value as at the measurement date. 

9. Indicative offers

Indicative offers may not be fully representative of fair value. However, more weight can be placed on signed contractual agreements.

Take action

In light of the uncertainty associated with closing or fair value determination, adjust the negotiated price for a transaction.

10. ESG integration

A newly added section of the guidelines focuses on integrating ESG factors in valuation, which can impact fair value quantitively and qualitatively. Quantitative factors that can be observed or measured include the impact of ESG actions on cash flows, changes in risk profile, and comparability with peer companies. Qualitative factors (that may not be quantifiable but can affect investment value) include: the proximity to coastal areas and potential flooding risks; the impact of a diverse workforce on the company's success; and the likelihood of a government action impacting the business model.

Take action

Identify measurable ESG metrics, analyze qualitative factors, and incorporate risks and opportunities from ESG initiatives and the ESG regulatory environment into the valuation analysis to the extent they are deemed known or knowable.

As an example, imagine a company with high carbon emissions is in the process of shifting towards carbon neutrality. The future investment/capital expenditure required for meeting ESG requirements should be included in the forecast cash flows, along with consequent expected reduction in carbon taxes. 

KPMG Expertise

Have you taken action? Do you have any specific questions? Reach out to the experts in our Corporate Finance team who can help you navigate your way through these important changes. 

This article was written in collaboration with Darshita Shah, Senior Manager, Advisory, KPMG Luxembourg.