In August 2019, the American Institute of Certified Public Accountants (AICPA) issued an accounting and valuation guide for investment companies discussing how to fair value their portfolio company investments. This guide, Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies, is a non-authoritative document that specifies best practices to be performed during the fair value process.
The AICPA presents examples for valuation specialists, financial statement preparers, and independent auditors regarding the accounting for and valuation of portfolio investments held by investment companies that lie in the scope of FASB ASC 946, Financial Services—Investment Companies (including business development companies, private equity funds, hedge funds, and venture capital funds).
The length and complexity of this document can be daunting, so we have compiled a list of some of the key takeaways from the guide.
Harmonize Diverse Views
One of the most valuable aspects of the AICPA valuation guide is that it harmonizes the many diverse views of industry participants, valuation specialists, and auditors into one cohesive unit to ensure clarity and personalization. The guide was created by the AICPA Private Equity/Venture Capital (PE/VC) task force—including specialists from all corners of the investment industry—and brings together various points of view from those who prepare the valuation, those who audit the valuation, and those who actually make the investments.
No matter your role in the fair value process, this guide provides personalized suggestions on best practices to follow in your specific position.
Useful Information in the Appendices
The AICPA accounting guide contains three appendices—each detailing a different aspect of fair value in investments.
Appendix A: Considerations related to internal control over financial reporting and principles that are important to the establishment and maintenance of an effective valuation process.
Appendix B: Valuation reference guide exposing issues regularly faced during the process.
Appendix C: 16 User-friendly case studies that are experienced in practice and a chapter on frequently asked questions.
Investment funds may choose to update their valuation policies and procedures to align closely with the new guide to enhance valuation documentation.
The new guide also dedicates an entire chapter to the calibration requirement, defining the implementation of calibration with concrete examples, insights, and best practices—an addition that was previously not included in any other document.
Calibration is the process of using observed transactions in the portfolio company’s own instruments (i.e. the fund’s initial investment) to ensure that the valuation techniques that will be employed to value the portfolio company investment on subsequent measurement dates begin with assumptions that are consistent with the original observed transaction along with recent observed transactions.
Calibration to the transaction price is required when the initial transaction for an investment represents fair value, and is also used when subsequent funding rounds take place. Calibration ensures that the valuation technique reflects current market conditions, and it helps a reporting entity to determine whether an adjustment to the valuation technique is necessary.
Using the examples and best practices issued in the new guide, investors and auditors can become more equipped to handle this requirement.
The PE/VC task force believes it is best practice for investment companies to perform periodic backtesting. Backtesting refers to the process of using the observed value of the fund’s interests as implied by the ultimate sale, liquidity event, or other significant change to assess the fair value estimated for an investment at an earlier date. The primary purpose of backtesting is to assess and improve the valuation process going forward.
The guide further explains backtesting and provides examples for better comprehension. It suggests that this is something that should be done as part of the investment company’s valuation process and not just the auditors’ review.
The new AICPA valuation guide is simply that—a guide. The Institute is not issuing requirements meant to add stress to an investor’s life, it is giving expert advice on how to skillfully navigate valuation of portfolio company investments. The comprehensive guide contains more explanations of the nuances of this process, and its commitment to providing modern, real-life examples, applications, and best practices will ease the burden and confusion surrounding the fair value process