EVCA international company valuation guidelines

I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D
V E N T U R E C A P I TA L VA L U AT I O N G U I D E L I N E S
Edition October 2006

These guidelines have been developed by the Association Française des Investisseurs en Capital (AFIC),
the British Venture Capital Association (BVCA) and the European Private Equity and
Venture Capital Association (EVCA) with the valuable input and endorsement of the following associations:

AIFI - Italian Private Equity and Venture Capital Association HVCA - Hungarian Venture Capital and Private Equity Association
APCRI - Portuguese Private Equity and Venture Capital Association ILPA - Institutional Limited Partners Association
APEA - Arab Private Equity Association IVCA - Irish Venture Capital Association
ASCRI - Spanish Private Equity and Venture Capital Association LAVCA - Latin American Venture Capital Association
ATIC - Tunisian Venture Capital Association LVCA - Latvian Venture Capital Association
AVCA - African Venture Capital Association NVCA - Norwegian Venture Capital & Private Equity Association
AVCAL - Australian Private Equity and Venture Capital Association NVP - Nederlandse Vereniging van Participatiemaatschappijen
AVCO - Austrian Private Equity and Venture Capital Organization (Dutch Private Equity and Venture Capital Association)
BVA - Belgian Venturing Association PPEA - Polish Private Equity Association
BVK - German Private Equity and Venture Capital Association e.V. Réseau Capital - Québec Venture Capital and
CVCA - Canada’s Venture Capital and Private Equity Association Private Equity Association
CVCA - China Venture Capital Association RVCA - Russian Private Equity and Venture Capital Association
CVCA - Czech Venture Capital and Private Equity Association SAVCA - Southern African Venture Capital and
DVCA - Danish Venture Capital Association Private Equity Association
EMPEA - Emerging Markets Private Equity Association SECA - Swiss Private Equity and Corporate Finance Association
FVCA - Finnish Venture Capital Association SLOVCA - Slovak Venture Capital Association
GVCA - Gulf Venture Capital Association SVCA - Swedish Private Equity and Venture Capital Association
HKVCA - Hong Kong Venture Capital Association (Endorsement as of 2nd January 2007)

I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A LUAT I O N G U I D E L I N E S W W W . P R I VAT E EQ U I T Y VA LU AT I O N . CO M
These guidelines have been developed by AFIC, BVCA and EVCA with
the valuable input and endorsement of the following associations:

AIFI, APCRI, APEA, ASCRI, ATIC, AVCA, AVCAL, AVCO, BVA, BVK, CVCA, CVCA, CVCA, DVCA, EMPEA, FVCA, GVCA,
HKVCA, HVCA, ILPA, IVCA, LAVCA, LVCA, NVCA, NVP, PPEA, RÉSEAU CAPITAL, RVCA, SAVCA, SECA, SLOVCA, SVCA

(Endorsement as of 2nd January 2007)

P L EA S E N OT E
The information contained within this paper has been produced with reference to
the contributions of a number of sources. AFIC, BVCA and EVCA have taken suitable
steps to ensure the reliability of the information presented. However, neither AFIC,
BVCA, EVCA nor other named contributors, individuals or associations can accept
responsibility for any decision made or action taken, based upon this paper or
the information provided herein.
For further information please visit: www.privateequityvaluation.com

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I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D
V E N T U R E C A P I TA L V A LUAT I O N G U I D E L I N E S


P R E FAC E
These Guidelines set out recommendations, intended to represent current best
practice, on the valuation of private equity and venture capital investments. The term
“private equity” is used in these Guidelines in a broad sense to include investments
in early stage ventures, management buyouts, management buy-ins and similar
transactions and growth or development capital.
The recommendations are intended to be applicable across the whole range of
investment types (seed and start-up venture capital, buy-outs, growth/development
capital, etc) and financial instruments commonly held by private equity funds.
The recommendations themselves are set out in bold type, whereas explanations,

W W W . P R I VAT E EQ U I T Y VA LU AT I O N . CO M
illustrations, background material, context and supporting commentary, which are
provided to assist in the interpretation of the recommendations, are set out in
normal type.
Where there is conflict between a recommendation contained in these Guidelines
and the requirements of any applicable laws or regulations or accounting standard
or generally accepted accounting principle, the latter requirements should take
precedence.
Neither the AFIC, BVCA, EVCA nor the endorsing associations nor the members
of any committee or working party thereof can accept any responsibility or liability
whatsoever (whether in respect of negligence or otherwise) to any party as a result
of anything contained in or omitted from the Valuation Guidelines nor for the
consequences of reliance or otherwise on the provisions of these Valuation Guidelines.
These Valuation Guidelines should be regarded as superseding previous guidelines
issued by the AFIC, BVCA or EVCA with effect for reporting periods post
1 January 2005.

I N T E R N AT I O N A L P R I VAT E E Q U I T Y A N D V E N T U R E C A P I TA L V A LUAT I O N G U I D E L I N E S W W W . P R I VAT E EQ U I T Y VA LU AT I O N . CO M



CO N T E N TS
INTRODUCTION 7
Definitions 7

SECTION I: DETERMINING FAIR VALUE 9
1 The Concept of Fair Value 9
2 Principles of Valuation 9
3 Valuation Methodologies 12
3.1 General 12
3.2 Selecting the Appropriate Methodology 13
3.3 Price of Recent Investment 14
3.4 Earnings Multiple 15
3.5 Net Assets 20
3.6 Discounted Cash Flows or Earnings (of Underlying Business) 21
3.7 Discounted Cash Flows (from the Investment) 22
3.8 Industry Valuation Benchmarks 23
3.9 Available Market Prices 23

SECTION II: APPLICATION GUIDANCE 25
Introduction 25
1 Selecting the Appropriate Methodology 25
2 Specific Considerations 27
2.1 Internal Funding Rounds 27
2.2 Bridge Financing 27
2.3 Mezzanine Loans 28
2.4 Rolled up Loan Interest 28
2.5 Indicative Offers 29
3 Events to Consider for their Impact on Value 29
4 Impacts from Structuring 31

WORKGROUP 33

INTRODUCTION

INTRODUCTION However, the requirements and A distinction is made in these Guidelines
implications of the Financial Reporting between a basis of valuation (such as
Private Equity Managers may be Standards and in particular International Fair Value), which defines what the
required to carry out periodic valuations Financial Reporting Standards and US carrying amount purports to represent,
of Investments as part of the reporting GAAP have been considered in the and a valuation methodology (such as
process to investors in the Funds they preparation of these guidelines. This has the earnings multiple technique), which
manage. The objective of these Guidelines been done, in order to provide a frame- details the method or technique for
is to set out best practice where private work for arriving at a Fair Value for deriving a valuation.
equity Investments are reported at “Fair private equity and venture capital
Value”, with a view to promoting best Investments which is consistent with
practice and hence helping investors in accounting principles.
DEFINITIONS
Private Equity Funds make better The following definitions shall apply in
These guidelines are intended to represent
economic decisions. these Guidelines.
current best practice and therefore will
The increasing importance placed by be revisited and, if necessary, revised to
international accounting authorities on reflect changes in international Enterprise Value
Fair Value reinforces the need for the regulation or accounting standards. The Enterprise Value is the value of
consistent use of valuation standards the financial instruments representing
It is not a requirement of accounting ownership interests in an entity plus
worldwide and these guidelines provide a
principles that these guidelines are the net financial debt of the entity.
framework for consistently determining
followed. However compliance with
valuations for the type of Investments
these accounting principles can be Fair Value
held by private equity and venture
achieved by following the guidelines. The Fair Value is the amount for which
capital entities.
These Guidelines are concerned with an asset could be exchanged between
The accounts of Private Equity Funds valuation from a conceptual standpoint knowledgeable, willing parties in an arm’s
are governed by legal or regulatory and do not seek to address best practice length transaction. This is congruent
provisions or by contractual terms. It is as it relates to investor reporting, in concept with alternately worded
not the intention of these Guidelines to internal processes, controls and definitions such as ‘Fair Value is the
prescribe or recommend the basis on procedures, governance aspects, price that would be received for an asset
which Investments are included in the Committee oversights, the experience or paid for a liability in a transaction
accounts of Funds. and capabilities required of the Valuer between market participants at the
or the audit or review of valuations. reporting date’. 7




Fund Marketability Quoted Instrument
The Fund, i.e. a private equity or Marketability is defined as the relative ease A Quoted Instrument is any financial
venture capital fund, is the generic term and promptness with which an instrument instrument for which quoted prices
used in these Guidelines to refer to any may be sold when desired. Marketability reflecting normal market transactions are
designated pool of investment capital implies the existence of current buying readily and regularly available from an
targeted at private equity Investment, interest as well as selling interest. exchange, dealer, broker, industry group,
including those held by corporate pricing service or regulatory agency.
entities, limited partnerships and other Marketability Discount
investment vehicles. Realisation
The Marketability Discount is the
consequence of the return Market Realisation is the sale, redemption or
Gross Attributable Enterprise Value
Participants demand to compensate repayment of an Investment, in whole or
The Gross Attributable Enterprise Value for the risk arising from the lack in part; or the insolvency of an Investee
is the Enterprise Value attributable to the of Marketability. Company, where no significant return to
financial instruments held by the Fund the Fund is envisaged.
and other financial instruments in the Market Participants
entity that rank alongside or beneath the Unquoted Instrument
Market Participants are potential or
highest ranking instrument of the Fund.
actual willing buyers or willing sellers An Unquoted Instrument is any financial
when neither is under any compulsion instrument other than a Quoted Instrument.
Investee Company
to buy or sell, both parties having
The term Investee Company refers to a reasonable knowledge of relevant facts Underlying Business
single business or group of businesses in and who have the ability to perform
The Underlying Business is the
which a Fund is directly invested. sufficient due diligence in order to be
operating entities in which the Fund has
able to make investment decisions
invested, either directly or through a
Investment related to the enterprise.
number of dedicated holding companies.
A Fund’s Investment refers to all of the
Net Attributable Enterprise Value
financial instruments in an Investee Valuer
Company held by the Fund. The Net Attributable Enterprise Value
The Valuer is the person with direct
is the Gross Attributable Enterprise
responsibility for valuing one or more
Value less a Marketability Discount.
of the Investments of the Fund.

S EC T I O N I: D E T E R M I N I N G F A I R V A LU E

1 THE CO N C E P T O F F A I R V A LU E 2 PRINCIPLES OF V A LU AT I O N
Fair Value is the amount for which an asset could be Investments should be reported at Fair Value at the
exchanged between knowledgeable, willing parties in an arm’s reporting date.
length transaction.
In the absence of an active market for a financial instrument,
The estimation of Fair Value does not assume either that the the Valuer must estimate Fair Value utilising one of the
Underlying Business is saleable at the reporting date or that valuation methodologies.
its current shareholders have an intention to sell their holdings
In estimating Fair Value for an Investment, the Valuer
in the near future.
should apply a methodology that is appropriate in light
The objective is to estimate the exchange price at which of the nature, facts and circumstances of the Investment
hypothetical Market Participants would agree to transact. and its materiality in the context of the total Investment
portfolio and should use reasonable data and market inputs,
Fair Value is not the amount that an entity would receive or
assumptions and estimates.
pay in a forced transaction, involuntary liquidation or
distressed sale. In private equity, value is generally crystallised through a sale
or flotation of the entire business, rather than a sale of an
Although transfers of shares in private businesses are often
individual stake. Accordingly the Value of the business as a
subject to restrictions, rights of pre-emption and other
whole (Enterprise Value) will provide a base for estimating
barriers, it should still be possible to estimate what amount a
the Fair Value of an Investment in that business.
willing buyer would pay to take ownership of the Investment.
The Fair Value is estimated by the Valuer, whichever
valuation methodologies are used, from the Enterprise
Value, as follows:
(i) Determine the Enterprise Value of the Investee
Company using the valuation methodologies;
(ii) Adjust the Enterprise Value for surplus assets, or
excess/unrecorded liabilities and other relevant factors;

9




(iii) Deduct from this amount any financial instruments As such, it must be recognised that, whilst valuations do provide
ranking ahead of the highest ranking instrument of useful interim indications of the progress of a particular
the Fund in a liquidation scenario and taking into Investment or portfolio of Investments, ultimately it is not
account the effect of any instrument that may dilute until Realisation that true performance is firmly apparent.
the Fund’s Investment to derive the Gross Attributable
Fair Value should reflect reasonable estimates and
Enterprise Value;
assumptions for all significant factors that parties to an arm’s
(iv) Apply an appropriate Marketability Discount to the length transaction would be expected to consider, including
Gross Attributable Enterprise Value to derive the Net those which impact upon the expected cash flows from the
Attributable Enterprise Value; Investment and upon the degree of risk associated with those
cash flows.
(v) Apportion the Net Attributable Enterprise Value
between the company’s relevant financial instruments In assessing the reasonableness of assumptions and estimates,
according to their ranking; the Valuer should:
(vi) Allocate the amounts derived according to the Fund’s • note that the objective is to replicate those that the parties in
holding in each financial instrument, representing their an arm’s-length transaction would make;
Fair Value.
• take account of events taking place subsequent to the
It is important to recognise the subjective nature of private reporting date where they provide additional evidence of
equity Investment valuation. It is inherently based on conditions that existed at the reporting date; and
forward-looking estimates and judgments about the
• take account of materiality considerations.
Underlying Business itself, its market and the environment in
which it operates, the state of the mergers and acquisitions Because of the uncertainties inherent in estimating Fair
market, stock market conditions and other factors. Value for private equity Investments, a degree of caution
should be applied in exercising judgment and making the
Due to the complex interaction of these factors and often the
necessary estimates. However, the Valuer should be wary
lack of directly comparable market transactions, care should be
of applying excessive caution.
applied when using publicly available information in deriving a
valuation. In order to determine the Fair Value of an Investment, Private Equity Funds often undertake an Investment with
the Valuer will have to exercise judgement and make necessary a view to effecting substantial changes in the Underlying
estimates to adjust the market data to reflect the potential Business, whether it be to its strategy, operations, management,
impact of other factors such as geography, credit risk, foreign or whatever. Sometimes these situations involve rescue
currency and exchange price, equity prices and volatility. refinancing or a turnaround of the business in question.


Whilst it might be difficult in these situations to determine In situations where Fair Value cannot be reliably measured
Fair Value based on a transaction involving a trade purchaser, the Valuer may reasonably conclude that the Fair Value
it should in most cases be possible to estimate the amount a at the previous reporting date remains the best estimate of
Private Equity Fund would pay for the Investment in question. Fair Value, unless there is evidence that the Investment has
since then been impaired. In such a case the carrying value
The Valuer will need to assess whether, in the particular
should be reduced to reflect the estimated extent of
circumstances of a specific Investment, he is able reliably
impairment.
to measure Fair Value by applying generally accepted
methodologies in a consistent manner based on reasonable In respect of Investments for which Fair Value cannot be
assumptions. reliably measured, the Valuer is required to consider whether
events or changes in circumstances indicate that an
There may be situations where:
impairment may have occurred.
• the range of reasonable Fair Value estimates is significant
Where an impairment has occurred, the Valuer should reduce
• the probabilities of the various estimates within the range the carrying value of the Investment to reflect the estimated
cannot be reasonably assessed extent of impairment. Since the Fair Value of such
Investments cannot be reliably measured, estimating the
• the probability and financial impact of achieving a key
extent of impairment in such cases will generally be an
milestone cannot be reasonably predicted
intuitive (rather than analytical) process and may involve
• there has been no recent Investment into the business. reference to broad indicators of value change (such as relevant
stock market indices).
In these situations, the Valuer might conclude that Fair Value
cannot be reliably measured.

11




3 V A LU AT I O N M E T H O D O LO G I E S In determining the Fair Value of an Investment, the
Valuer should use judgement. This includes a detailed
3.1 General consideration of those specific terms of the Investment
which may impact its Fair Value. In this regard, the
A number of valuation methodologies that may be considered
Valuer should consider the substance of the Investment,
for use in estimating the Fair Value of Unquoted
which takes preference over the strict legal form.
Instruments are described in sections 3.3 to 3.9 below.
These methodologies should be amended as necessary to It is important conceptually to distinguish the value that
incorporate case-specific factors affecting Fair Value. may be ascribed to an Investment from the value that may
For example, if the Underlying Business is holding surplus be ascribed to the Underlying Business. For example, in
cash or other assets, the value of the business should reflect valuing the Underlying Business one may seek to estimate
that fact. the amount a buyer would pay for the business at the
reporting date. In valuing an Investment stake in that
Because, in the private equity arena, value is generally
business, one would not merely take the relevant share of
crystallised through a sale or flotation of the entire
the business’s value, since that would fail to recognise the
Underlying Business, rather than through a transfer of
uncertainty and risk involved in actually selling the business
individual shareholder stakes, the value of the business as a
and crystallising the Investment value, and particularly the
whole at the reporting date will often provide a key insight
risk that value may be eroded before a sale can be achieved
into the value of investment stakes in that business. For this
under the current market conditions.
reason, a number of the methodologies described below
involve estimating the Enterprise Value as an initial step. The estimation of Fair Value should be undertaken on the
assumption that options and warrants are exercised, where
There will be some situations where the Fund has little
the Fair Value is in excess of the exercise price. The exercise
ability to influence the timing of a Realisation and a
price of these may result in surplus cash arising in the
Realisation is not likely in the foreseeable future, perhaps
Underlying Business if the exercise price is significant.
because the majority shareholders are strongly opposed to
it. In these circumstances (which are expected to be rare in Other rights such as conversion options and ratchets, which
private equity), Fair Value will derive mainly from the may impact the Fair Value of the Fund’s Investment, should
expected cash flows and risk of the relevant financial be reviewed on a regular basis to assess whether these are
instruments rather than from the Enterprise Value. likely to be exercised and the extent of any impact on value
The valuation methodology used in these circumstances of the Fund’s Investment.
should therefore reflect this fact.


Differential allocation of proceeds may have an impact on it is also important to consider the stage of development
the value of an Investment. If liquidation preferences exist, of an enterprise and/or its ability to generate maintainable
these need to be reviewed to assess whether they will give profits or positive cashflow.
rise to a benefit to the Fund, or a benefit to a third party to
The Valuer will select the valuation methodology that is
the detriment of the Fund.
the most appropriate and consequently make valuation
Further examples of specific matters for consideration that adjustments on the basis of their informed and experienced
may impact valuations are set out in section II, 3 . judgment. This will include consideration of factors such as:
Movements in rates of exchange may impact the value of • the relative applicability of the methodologies used given
the Fund’s Investments and these should be taken in the nature of the industry and current market conditions;
account.
• the quality, and reliability of the data used in each
Where the reporting currency of the Fund is different methodology;
from the currency in which the Investment is denominated,
• the comparability of enterprise or transaction data;
translation into the reporting currency for reporting
purposes should be done using the bid spot exchange rate • the stage of development of the enterprise; and
prevailing at the reporting date.
• any additional considerations unique to the subject
enterprise.
3.2 Selecting the Appropriate Methodology
In assessing whether a methodology is appropriate,
The Valuer should exercise her or his judgement to select the Valuer should be biased towards those methodologies
the valuation methodology that is the most appropriate that draw heavily on market-based measures of risk and
for a particular Investment. return. Fair Value estimates based entirely on observable
market data will be of greater reliability than those based
The key criterion in selecting a methodology is that it
on assumptions.
should be appropriate in light of the nature, facts and
circumstances of the Investment and its materiality in Methodologies utilising discounted cashflows and industry
the context of the total Investment portfolio. benchmarks should rarely be used in isolation of the
market-based measures and then only with extreme caution.
An appropriate methodology will incorporate available
These methodologies may be useful as a cross-check of
information about all factors that are likely materially to
values estimated using the market-based methodologies.
affect the Fair Value of the Investment. In this context,
13




Where the Valuer considers that several methodologies are 3.3 Price of Recent Investment
appropriate to value a specific Investment, the Valuer may
Where the Investment being valued was itself made recently,
consider the outcome of these different valuation
its cost will generally provide a good indication of Fair
methodologies so that the results of one particular method
Value. Where there has been any recent Investment in the
may be used as a cross-check of values or to corroborate
Investee Company, the price of that Investment will provide
or otherwise be used in conjunction with one or more other
a basis of the valuation.
methodologies in order to determine the Fair Value of
the Investment. The validity of a valuation obtained in this way is inevitably
eroded over time, since the price at which an Investment was
Methodologies should be applied consistently from
made reflects the effects of conditions that existed when the
period to period, except where a change would result
transaction took place. In a dynamic environment, changes in
in better estimates of Fair Value.
market conditions, the passage of time itself and other factors
This may occur for example in the case of a company will act to diminish the appropriateness of this methodology
becoming profitable and cash flow becoming positive on as a means of estimating value at subsequent dates.
a maintainable basis a few years after the start-up phase.
In addition, where the price at which a third party has
Any changes in valuation methodologies should be clearly
invested is being considered as the basis of valuation, the
stated. It is expected that there would not be frequent
background to the transaction must be taken in to account.
changes in valuation methodologies.
In particular, the following factors may indicate that the price
The table below identifies a number of the most widely used was not wholly representative of the Fair Value at the time:
methodologies.
• a further Investment by the existing stakeholders with
METHODOLOGY little new Investment;

Price of Recent Investment • different rights attach to the new and existing
Investments;
Earnings multiple
Net assets • a new investor motivated by strategic considerations;

Discounted cash flows or earnings (of Underlying Business) • the Investment may be considered to be a forced sale or
‘rescue package’; or
Discounted cash flows (from the Investment)
Industry valuation benchmarks • the absolute amount of the new Investment is relatively
insignificant.


This methodology is likely to be appropriate for all private service financial instruments, breaches of covenants
equity Investments, but only for a limited period after the and a deterioration in the level of budgeted or forecast
date of the relevant transaction. Because of the frequency performance;
with which funding rounds are often undertaken for seed
• there has been a significant adverse change either in
and start-up situations, or in respect of businesses engaged
the company’s business or in the technological, market,
in technological or scientific innovation and discovery, the
economic, legal or regulatory environment in which the
methodology will often be appropriate for valuing
business operates;
Investments in such circumstances.
• market conditions have deteriorated. This may be indicated
The length of period for which it would remain appropriate to
by a fall in the share prices of quoted businesses operating
use this methodology for a particular Investment will depend
in the same or related sectors; or
on the specific circumstances of the case, but a period of one
year is often applied in practice. • the Underlying Business is raising money and there is
evidence that the financing will be made under significantly
In applying the Price of Recent Investment methodology,
different terms and conditions from the original Investment.
the Valuer should use the cost of the Investment itself or
the price at which a significant amount of new Investment
into the company was made to estimate the Fair Value of 3.4 Earnings Multiple
the Investment, but only for a limited period following
This methodology involves the application of an earnings
the date of the relevant transaction. During the limited
multiple to the earnings of the business being valued in
period following the date of the relevant transaction, the
order to derive a value for the business.
Valuer should in any case assess whether changes or
events subsequent to the relevant transaction would This methodology is likely to be appropriate for an
imply a change in the Investment’s Fair Value. Investment in an established business with an identifiable
stream of continuing earnings that can be considered to be
For example, a reduction in the Investment’s Fair Value
maintainable.
may have occurred for a number of reasons, including
the following: This methodology may be applicable to companies with
negative earnings, if the losses are considered to be
• the performance and/or prospects of the Underlying
temporary and one can identify a level of “normalised”
Business are significantly below the expectations on which
maintainable earnings.
the Investment was based. Prima facie indicators of this
include a failure to meet significant milestones or to 15




This may involve the use of averaging of earnings figures Guidance on the interpretation of underlined terms is given
for a number of periods, using a forecast level of earnings below.
or applying a “sustainable” profit margin to current or
forecast revenues. Appropriate Multiple
In using the Earnings Multiple methodology to estimate A number of earnings multiples are commonly used,
the Fair Value of an Investment, the Valuer should: including price/earnings (P/E), Enterprise Value/earnings
before interest and tax (EV/EBIT) and depreciation and
i. apply a multiple that is appropriate and reasonable
amortisation (EV/EBITDA). The particular multiple used
(given the risk profile and earnings growth prospects
should be appropriate for the business being valued.
of the underlying company) to the maintainable
(N.B: The multiples of revenues and their use are presented
earnings of the company;
in 3.8. Industry Valuation Benchmarks)
ii. adjust the amount derived in (i) above for surplus
In general, because of the key role of financial structuring
assets or excess liabilities and other relevant factors
in private equity, multiples should be used to derive an
to derive an Enterprise Value for the company;
Enterprise Value for the Underlying Business. Therefore,
iii. deduct from the Enterprise Value all amounts relating where a P/E multiple is used, it should generally be applied
to financial instruments ranking ahead of the highest to a taxed EBIT figure (after deducting finance costs
ranking instrument of the Fund in a liquidation and relating to working capital or to assets acquired or leased
taking into account the effect of any instrument that using asset finance) rather than to actual after-tax profits,
may dilute the Fund’s Investment in order to derive since the latter figure will generally have been significantly
the Gross Attributable Enterprise Value; reduced by finance costs.
iv. apply an appropriate Marketability Discount to the By definition, earnings multiples have as their numerator
Gross Attributable Enterprise Value derived in (iii) a value and as their denominator an earnings figure.
above in order to derive the Net Attributable The denominator can be the earnings figure for any
Enterprise Value; and specified period of time and multiples are often defined as
“historical”, “current” or “forecast” to indicate the earnings
v. apportion the Net Attributable Enterprise Value
used. It is important that the multiple used correlates to the
appropriately between the relevant financial
period and concept of earnings of the company being valued.
instruments.


Reasonable Multiple costs associated with them which should be reflected in the
value attributed to the business in question.
The Valuer would usually derive a multiple by reference to
market-based multiples, reflected in the market valuations It is important that the earnings multiple of each comparator
of quoted companies or the price at which companies have is adjusted for points of difference between the comparator
changed ownership. This market-based approach presumes and the company being valued. These points of difference
that the comparator companies are correctly valued by should be considered and assessed by reference to the two
the market. Whilst there is an argument that the market key variables of risk and earnings growth prospects which
capitalisation of a quoted company reflects not the value of underpin the earnings multiple. In assessing the risk profile
the company but merely the price at which “small parcels” of the company being valued, the Valuer should recognise
of shares are exchanged, the presumption in these that risk arises from a range of aspects, including the nature
Guidelines is that market based multiples do correctly of the company’s operations, the markets in which it operates
reflect the value of the company as a whole. and its competitive position in those markets, the quality of its
management and employees and, importantly in the case of
Where market-based multiples are used, the aim is to
private equity, its capital structure and the ability of the Fund
identify companies that are similar, in terms of risk attributes
holding the Investment to effect change in the company.
and earnings growth prospects, to the company being valued.
For example, the value of the company may be reduced if it:
This is more likely to be the case where the companies are
similar in terms of business activities, markets served, size, • is smaller and less diverse than the comparator(s) and,
geography and applicable tax rate. therefore, less able generally to withstand adverse
economic conditions;
In using P/E multiples, the Valuer should note that the
P/E ratios of comparator companies will be affected by • is reliant on a small number of key employees;
the level of financial gearing and applicable tax rate of
• is dependent on one product or one customer;
those companies.
• has high gearing; or
In using EV/EBITDA multiples, the Valuer should note
that such multiples, by definition, remove the impact on • for any other reason has poor quality earnings.
value of depreciation of fixed assets and amortisation of
goodwill and other intangibles. If such multiples are used
without sufficient care, the Valuer may fail to recognise
that business decisions to spend heavily on fixed assets or
to grow by acquisition rather than organically do have real 17




Recent transactions involving the sale of similar companies Maintainable Earnings
are sometimes used as a frame of reference in seeking to
In applying a multiple to maintainable earnings, it is
derive a reasonable multiple. It is sometimes argued, since
important that the Valuer is satisfied that the earnings figure
such transactions involve the transfer of whole companies
can be relied upon. Whilst this might tend to favour the use
whereas quoted multiples relate to the price for “small
of audited historical figures rather than unaudited or
parcels” of shares, that they provide a more relevant source
forecast figures, it should be recognised that value is by
of multiples. However, their appropriateness in this respect
definition a forward-looking concept, and quoted markets
is often undermined by the following:
more often think of value in terms of “current” and “forecast”
• the lack of forward-looking financial data and other multiples, rather than “historical” ones. In addition, there is
information to allow points of difference to be identified the argument that the valuation should, in a dynamic
and adjusted for; environment, reflect the most recent available information.
There is therefore a trade-off between the reliability and
• the generally lower reliability and transparency of
relevance of the earnings figures available to the Valuer.
reported earnings figures of private companies; and
On balance, whilst it remains a matter of judgment for the
• the lack of reliable pricing information for the transaction Valuer, he should be predisposed towards using historical
itself. (though not necessarily audited) earnings figures or, if he
believes them to be reliable, forecast earnings figures for
It is a matter of judgment for the Valuer as to whether,
the current year.
in deriving a reasonable multiple, he refers to a single
comparator company or a number of companies or Whichever period’s earnings are used, the Valuer should
the earnings multiple of a quoted stock market sector or satisfy himself that they represent a reasonable estimate of
sub-sector. It may be acceptable, in particular circumstances, maintainable earnings, which implies the need to adjust for
for the Valuer to conclude that the use of quoted sector or exceptional or non-recurring items, the impact of
sub-sector multiples or an average of multiples from a discontinued activities and acquisitions and forecast
“basket” of comparator companies may be used without downturns in profits.
adjusting for points of difference between the comparator(s)
and the company being valued.


Appropriate Marketability Discount In assessing the influence of the Fund over the timing of
Realisation, nature of Realisation and Realisation process,
The notion of a Marketability Discount relates to an
some of the factors the Valuer should consider are as follows:
Investment rather than to the Underlying Business.
Paragraph (iv) above therefore requires the discount to • are there other like-minded shareholders with regard to
be considered and applied at the level at which the Fund Realisation and what is the combined degree of influence?
begins to participate in the Enterprise Value.
• is there an agreed exit strategy or exit plan?
Marketability will vary from situation to situation and is a
• do legal rights exist which allow the Fund together with
question of judgment. It should be noted that the Fair Value
like-minded shareholders to require the other shareholders
concept requires that the Marketability Discount is to be
to agree to and enable a proposed Realisation to proceed?
determined not from the perspective of the current holder of
the Investment, but from the perspective of Market Participants. • does the management team of the Underlying Business
have the ability in practice to reduce the prospects of a
Some of the factors the Valuer should consider in this
successful Realisation? This may be the case where the
respect are as follows:
team is perceived by possible buyers to be critical to the
• the closer and more certain is a Realisation event for ongoing success of the business. If this is the case, what is
the Investment in question, the lower would be the the attitude of the management team to Realisation?
Marketability Discount;
The Valuer might consider that under specific circumstances
• the greater the influence of the Fund over the timing of the Marketability Discount is not appropriate and should
Realisation, nature of Realisation and Realisation process, not be applied. When a discount is applied, the Valuer
the lower would be the Marketability Discount; should consider all the relevant factors in determining
the appropriate Marketability Discount in each particular
• if the underlying company were not considered saleable
situation. A discount in the range of 10% to 30% (in steps
or floatable at the reporting date, the questions arise of
of 5%) is generally used in practice, depending upon the
what has to be done to make it saleable or floatable, how
particular circumstances.
difficult and risky that course of action is to implement
and how long it is expected to take; and
• the impact of stock market conditions and mergers and
acquisitions activity levels on the ability to achieve a
flotation or sale of the Underlying Business.
19




By way of illustration for unquoted securities: Apportion the Net Attributable Enterprise Value
appropriately
• Where the Fund (together with like-minded shareholders
with regard to Realisation) has legal rights and the ability The apportionment should reflect the respective amounts
in practice to initiate a Realisation process and require accruing to each financial instrument holder in the event
other shareholders to co-operate, or there is in place an of a sale at that level at the reporting date. Where there
agreed Realisation strategy, a discount rate of 10% may are ratchets or share options or other mechanisms (such as
be appropriate. “liquidation preferences”, in the case of Investments in early-
stage businesses) in place which would be triggered in the
event of a sale of the company at the given Enterprise Value
with regard to Realisation) does not have such a degree of
at that date, these should be reflected in the apportionment.
influence over Realisation, possibly by virtue of holding a
minority of the equity, but the other shareholders are not Where, in respect of financial instruments other than equity
strongly opposed to a Realisation, a discount rate of 30% instruments, the apportionment results in a shortfall when
may be appropriate (NB. where a Realisation event is not compared with the amounts accruing up to the reporting
foreseeable at all, perhaps because the Fund holds a date under their contractual terms, the Valuer should
minority equity stake and the majority shareholders are consider whether, in estimating Fair Value, the shortfall should
totally opposed to a Realisation, methodologies which be applied and, if so, to what extent. If the circumstances
involve an assessment of the value of the business as a are such that it is reasonably certain, taking account of
whole may not be appropriate). the risks attaching, that the Fund will be able to collect all
amounts due according to the relevant contractual terms,
then the shortfall should not be applied.
with regard to Realisation) does not have the ability to
require other shareholders to co-operate regarding
Realisation, but there is regular discussion about 3.5 Net Assets
Realisation prospects and timing by the board and/or
This methodology involves deriving the value of a business
shareholders, a discount rate of 20% may be appropriate.
by reference to the value of its net assets.
This methodology is likely to be appropriate for a business
whose value derives mainly from the underlying value of its
assets rather than its earnings, such as property holding
companies and investment businesses.


This methodology may also be appropriate for a business that 3.6 Discounted Cash Flows or Earnings
is not making an adequate return on assets and for which a (of Underlying Business)
greater value can be realised by liquidating the business and
This methodology involves deriving the value of a business
selling its assets. In the context of private equity, it may
by calculating the present value of expected future cash
therefore be appropriate, in certain circumstances, for
flows (or the present value of expected future earnings, as a
valuing Investments in loss-making companies and
surrogate for expected future cash flows). The cash flows
companies making only marginal levels of profits.
and “terminal value” are those of the Underlying Business,
In using the Net Assets methodology to estimate the Fair not those from the Investment itself.
Value of an Investment, the Valuer should:
The Discounted Cash Flows (DCF) technique is flexible in
i. derive an Enterprise Value for the company using the sense that it can be applied to any stream of cash flows
appropriate measures to value its assets and liabilities (or earnings). In the context of private equity valuation, this
(including, if appropriate, contingent assets and flexibility enables the methodology to be applied in situations
liabilities); that other methodologies may be incapable of addressing.
While this methodology may be applied to businesses
ii. deduct from the Enterprise Value all amounts relating
going through a period of great change, such as a rescue
to financial instruments ranking ahead of the highest
refinancing, turnaround, strategic repositioning, loss making
ranking instrument of the Fund in a liquidation in order
or is in its start-up phase, there is a significant risk is
to derive the Gross Attributable Enterprise Value;
utilising this methodology.
iii. apply an appropriate Marketability Discount to
The disadvantages of the DCF methodology centre around
the Gross Attributable Enterprise Value to derive
its requirement for detailed cash flow forecasts and the need to
the Net Attributable Enterprise Value; and
estimate the “terminal value” and an appropriate risk-adjusted
iv. apportion the Net Attributable Enterprise Value discount rate. All of these inputs require substantial subjective
appropriately between the relevant financial judgments to be made, and the derived present value
instruments. amount is often sensitive to small changes in these inputs.
Guidance on the interpretation of underlined terms is given Due to the high level of subjectivity in selecting inputs for this
in the “Earnings multiple” section above. technique, DCF based valuations are useful as a cross-check
of values estimated under market-based methodologies and
should only be used in isolation of other methodologies
under extreme caution. 21




In assessing the appropriateness of this methodology, 3.7 Discounted Cash Flows (from the Investment)
the Valuer should consider whether its disadvantages
This methodology applies the DCF concept and technique
and sensitivities are such, in the particular circumstances,
to the expected cash flows from the Investment itself.
as to render the resulting Fair Value insufficiently reliable.
Where Realisation of an Investment or a flotation of the
In using the Discounted Cash Flows or Earnings
Underlying Business is imminent and the pricing of the
(of Underlying Business) methodology to estimate
relevant transaction has been substantially agreed, the
the Fair Value of an Investment, the Valuer should:
Discounted Cash Flows (from the Investment) methodology
i. derive the Enterprise Value of the company, using (or, as a surrogate, the use of a simple discount to the expected
reasonable assumptions and estimations of expected Realisation proceeds or flotation value) is likely to be the
future cash flows (or expected future earnings) and most appropriate methodology.
the terminal value, and discounting to the present
This methodology, because of its flexibility, is capable of
by applying the appropriate risk-adjusted rate that
being applied to all private equity Investment situations.
quantifies the risk inherent in the company;
It is particularly suitable for valuing non-equity Investments
ii. deduct from the Enterprise Value all amounts relating in instruments such as debt or mezzanine debt, since the
to financial instruments ranking ahead of the highest value of such instruments derives mainly from instrument-
ranking instrument of the Fund in a liquidation in order specific cash flows and risks rather than from the value of
to derive the Gross Attributable Enterprise Value; the Underlying Business as a whole.
iii. apply an appropriate Marketability Discount to Because of its inherent reliance on substantial subjective
the Gross Attributable Enterprise Value derived judgments, the Valuer should be extremely cautious of using
in ii above in order to derive the Net Attributable this methodology as the main basis of estimating Fair Value
Enterprise Value; and for Investments which include an equity element.
The methodology will often be useful as a sense-check
iv. apportion the Net Attributable Enterprise Value
of values produced using other methodologies.
appropriately between the relevant financial
instruments. Private equity risk and the rates of return necessary to
compensate for different risk levels are central commercial
Guidance on the interpretation of underlined terms is given
variables in the making of all private equity Investments.
in the “Earnings multiple” section above.
Accordingly there exists a frame of reference against which
to make discount rate assumptions.


However the need to make detailed cash flow forecasts over 3.8 Industry Valuation Benchmarks
the Investment life may reduce the reliability and crucially
A number of industries have industry-specific valuation
for equity Investments, there remains a need to estimate the
benchmarks, such as “price per bed” (for nursing-home
“terminal value”.
operators) and “price per subscriber” (for cable television
Where the Investment comprises equity or a combination companies). Other industries, including certain financial
of equity and other financial instruments, the terminal value services and information technology sectors and some
would usually be derived from the anticipated value of services sectors where long-term contracts are a key feature,
the Underlying Business at Realisation. This will usually use multiples of revenues as a valuation benchmark.
necessitate making assumptions about future business These industry norms are often based on the assumption
performance and developments and stock market and other that investors are willing to pay for turnover or market
valuation ratios at the assumed Realisation date. In the case share, and that the normal profitability of businesses in
of equity Investments, small changes in these assumptions can the industry does not vary much.
materially impact the valuation. In the case of non-equity
The use of such industry benchmarks is only likely to
instruments, the terminal value will usually be a pre-defined
be reliable and therefore appropriate as the main basis
amount, which greatly enhances the reliability of the valuation.
of estimating Fair Value in limited situations, and is more
In circumstances where a Realisation is not foreseeable, likely to be useful as a sense-check of values produced
the terminal value may be based upon assumptions of the using other methodologies.
perpetuity cash flows accruing to the holder of the Investment.
These circumstances (which are expected to be rare in
3.9 Available Market Prices
private equity) may arise where the Fund has little ability to
influence the timing of a Realisation and/or those shareholders Private Equity Funds may be holding Quoted Instruments,
that can influence the timing do not seek a Realisation. for which there is an available market price.
In using the Discounted Cash Flows (from the Investment) Instruments quoted on an active stock market should be
methodology to estimate the Fair Value of an Investment, valued at their bid prices on the Reporting Date.
the Valuer should derive the present value of the
For certain Quoted Instruments there is only one market
Investment, using reasonable assumptions and estimations
price quoted, representing, for example, the value at which
of expected future cash flows and the terminal value
the most recent trade in the instrument was transacted.
and date, and the appropriate risk-adjusted rate that
quantifies the risk inherent to the Investment.
23




For other Quoted Instruments there are two market prices In the case of a six-month lock-up period, in practice a
at any one time: the lower “bid” price quoted by a market discount of 20% to the market price is often used at the
maker, which he will pay an investor for a holding (i.e. the beginning of the period, reducing to zero at the end of the
investor’s disposal price), and the higher “offer” price, which period.
an investor can expect to pay to acquire a holding. A third
If a different level of discount is appropriate in light of the
price basis for valuation purposes, as an alternative to either
particular circumstances of an Investment, the Valuer should
bid or offer, is the mid-market price (i.e. the average of the
use that rate and should disclose the fact that he has done so
bid and offer prices). Where a bid and offer price exists, the
together with the rationale for so doing.
bid price should be used, although the use of the mid-market
price will not usually result in a material overstatement
of value.
This methodology should apply when the bid prices are set
on an active market. An instrument is regarded as quoted
on an active market if quoted prices are readily and
regularly available from an exchange, broker, dealer,
industry group, pricing services or regulatory agency, and
those prices represent actual and regularly occurring market
transaction on arm’s length basis.
Marketability Discounts should generally not be applied to
prices quoted on an active market, unless there is some
contractual, Governmental or other legally enforceable
restriction preventing realisation at the reporting date.
In determining the level of Marketability Discount to apply
the Valuer should consider the extent of compensation
a holder would require when comparing the Investment
in question with an identical but unrestricted holding.

EVCA international company valuation guidelines

EVCA international company valuation guidelines

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EVCA international company valuation guidelines