Have you Planned and Coordinated Valuation of New Illiquid Investments with your Auditors?

Timing is Important – Don’t Wait Until Year End

Determining an accurate fair value (FV) is of vital importance for financial reporting and tax preparation. Most investment managers understand the necessity of determining an accurate FV to report their private investments to their investors and regulatory agencies. The timing of the valuation date is of utmost importance when preparing financial statements. If the reporting period is as of December 31, valuations performed some time prior to the year-end may not be considered an accurate FV by the auditors.

While many types of non-publicly traded investments require FV for financial reporting, including ownership interests in companies and investments made by private equity funds, the auditing firm is not allowed to perform the valuation. Investment managers must perform the valuations themselves or engage an independent valuation professional. Management should evaluate who should prepare the valuation.

It is essential for investment managers to communicate with their auditors throughout the year as they acquire new investments to discuss valuation issues as well as the timing and viability of their valuator’s conclusions. Communication at the time of the investment – not at the end of the year – is key to ensuring that proper planning is performed. Since the auditor will need the FV analysis shortly after the end of the year, the window of opportunity for getting the valuation completed in a timely manner is short.

For private equity firms, valuation methodologies typically include market approaches such as the comparable public companies’ multiples method or comparable M&A transactions method as well as income approaches such as the discounted cash flow method and capitalization of income method. In addition, under certain circumstances, an investment may be valued based on the latest round of equity financing. If the latest round of equity financing is completed close to the end of the year it may suffice. However, if it was completed several months prior to the valuation date, and there was volatility in the marketplace or significant changes in the company’s performance, that round of equity financing may not be relevant and not represent FV at the valuation date.  This is critical to the final value presented in the financial statements. Under current reporting standards, the investment manager will provide the auditor with their valuation analysis or their external independent valuation firm’s report. The auditor’s valuation specialist will review the analysis for reasonableness, considering the facts of the investment and relevant market data.

The most important takeaways that investment and private equity companies should consider are:

• When you make an investment, discuss it with your auditors. Don’t let the auditors be surprised at year-end. Your auditors need time to digest and understand the complexities of the investment.
• Designate an external valuation provider. Find the right match. If you have invested in various types of non-traditional securities, find a valuation expert who understands that industry and type of investment. It’s important to identify the proper valuation specialist and provide your auditors with time to review their skills and their ability to meet your needs.
• Make sure your documents allow for the transaction. There are times when partnership agreements limit you to a certain percentage of a private equity investment.

How Anchin Can Help

As we approach the fourth quarter, now is a good time to have a discussion with your auditors (if you haven’t already) about any investments you have made this year that may require a determination of FV. If we can be of any assistance, please reach out to Mitchell Rosenthal, Partner in Anchin’s Financial Services Practice, or your Anchin Relationship Partner.