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Valuation of Private Equity Investments in Practice
Academic research has indicated that venture capitalists (‘VCs’) place little reliance on conventional valuation models in estimating the values of early-stage ventures (‘ESVs’) due to the unreliability of such enterprises’ expected future cash flows (e.g. (Miloud et al., 2012: 152-153)). That is not entirely accurate and reflects a research gap. There are other common valuation approaches which may be applicable (such as the market comparables approach), particularly based on large numbers of similar deals that many VC-firms have executed – especially if such deals are concentrated in a few industries where a VC-firm has developed domain expertise. Many VC-firms have developed knowledge, skills, and abilities for valuing private companies due to requirements to comply with the financial reporting requirements established by recognized professional accounting standard-setting bodies.

VC-firms are “reporting entities”1 in their own right and issue financial statements to their limited partners to communicate the financial position and financial performance of their funds. VC firms’ financial statements are prepared in accordance with professional standards for investment companies. Those standards (in both the US & UK) include presenting both “cost” and “fair values” for their private equity investments on their Statement of Assets, Liabilities & Partners’ Capital and on a Schedule of Investments.
Conceptually, the professional reporting standards specify fair value reporting for investments of this nature because: (i) the funds’ key stakeholders (particularly its limited partners that have typically provided most of the capital for a VC-firm’s fund(s)) are fundamentally interested in value changes as they impact the value of their personal investments in the fund; and, (ii) reporting the carrying values of investments at their best estimate of fair value as changes occur over long holding periods (even before these are realized through an exit transaction) provides the limited partners with relevant, “useful information”1 for their own investment decisions (i.e. in the particular VC-fund) and to do otherwise (i.e. only reporting realized gains) would result in less meaningful, less robust, and more erratic reporting of any economic benefits or losses accruing to them.
Accordingly, VC-firms must prepare annual valuation estimates for all their private equity investments, including ESVs. VC-firms have developed ways and means of doing so. These involve different approaches and different informational inputs – which are typically described in their Notes to Financial Statements.
For insights on relevant valuation approaches, methods, and principles relevant to VVs' own financial reporting, please download & read the full article.
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