Estimating Fair Value for Investment Companies

By Adrian M. Schrock and Sidney S. Sherwood, CPA
Estimating Fair Value for Investment Companies
The comment period for the working draft of the American Institute of CPA's (AICPA) Accounting and Valuation Guide, “Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies,” came to an end on Aug. 15, 2018. The guide was developed by the AICPA Private Equity/Venture Capital Task Force and AICPA staff to provide guidance and illustrations about accounting for and valuation of portfolio investments of venture capital and private equity funds and other investment companies. 

As noted in the guide, it is not meant to be “a detailed ‘how-to’ guide but, rather, to provide investment companies that invest in equity and debt instruments of portfolio companies with (a) an overview and understanding of the valuation process and the roles and responsibilities of the parties to the process and (b) best practice recommendations for complying with 'Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 946, Financial Services – Investment Companies,' and applying 'FASB ASC 820, Fair Value Measurement.'"1

The guide addresses determining value from two different perspectives: determining the value of debt and equity instruments of a portfolio company and determining the value of the entire portfolio company, which often is used in a top-down approach for determining the value of the underlying holdings. The guide includes best practices to approaching valuations and provides a detailed discussion of concepts and examples for the various key components for estimating the fair value of these hard-to-value, illiquid investments. 

The guide covers key areas, including:
  • Determining the assumptions of a market participant
  • Considering the expected time horizon of an investment when estimating the fair value at a specific measurement date
  • Understanding the recommended views on complex structures, such as when multiple types of securities may be held by the investment company, including those held across multiple related or affiliated investment companies
  • Adjusting for control and marketability
  • Calibrating the valuation model for an investment when the initial transaction is at fair value (as required by FASB ASC 820-10-35-24C)
  • Back-testing of realized investments by comparing the selling transaction price to previous fair value estimates in order to gain insight that might enhance an investments company’s valuation models going forward
  • Considering uncertainties and contingencies surrounding a transaction and what information that might provide about a market participant's viewpoint and estimating the fair value
  • Treating transaction costs when determining fair value estimates

The AICPA and other stakeholders have committed substantial amounts of time to develop this valuation guide. As it nears final issuance, it is important for investments companies to compare their current valuation practices to the new guidelines and make adjustments as necessary. 

 

1 AICPA Accounting and Valuation Guide, "Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies," American Institute of CPAs, May 15, 2018, working draft, p. 9, https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/working-draft-of-pe-vc-guide.html

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Adrian Shrock
Adrian Schrock
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Sidney S. Sherwood
Office Managing Partner, Elkhart