Private Equity Valuation Considerations

While market conditions continue to present periods of volatility, with major indices experiencing fluctuations and economic factors like inflation and monetary policy adjustments always at play, the focus for private equity valuations remains on adapting to the current environment and anticipating future trends.

Key Takeaways  

• Consider Calibration: Continuously reconcile current valuations with original investment theses and prior analyses. 
• Qualitative Factors Matter: Beyond quantitative analysis, consider qualitative insights to support investment value in the current market. 
• Reconcile Multiple Approaches: Compare values from various methodologies and address any outliers for a robust conclusion. 
• Transparency & Consistency: Maintain clear valuation policies, apply them consistently, and document any deviations. 
• Tailored Approach: Recognize that there is no "one-size-fits-all" solution; each valuation requires unique considerations. 

What is Private Equity Valuation and Why Do You Need One?  

A private equity valuation refers to the process of determining the value of a company or asset that is privately held (i.e., not publicly traded on stock exchanges). Unlike public companies whose values can be inferred from market prices, private companies require more complex, subjective valuation methods.  

These valuations are critical for several reasons:  

• Making informed investment decisions – Determining whether to enter or when to exit opportunities, negotiating deal terms, pricing transactions fairly, as well as comparing opportunities across different investments 
• Assessing fund performance – Calculating the net asset value and internal rate of return to gauge the success of strategic initiatives, risk management and exit strategy planning 
• Compliance with reporting – Adhering to reporting requirements from a tax and legal standpoint, including providing investors with audited financial statements  
• Capital raising – Raising funds from investors by demonstrating the ability to generate returns and manage investments effectively 

Fair Value Pricing in Private Equity  

At the core of private equity valuations for financial reporting is the concept of fair value, defined by ASC 820-10-20. Fair value is defined as “the price that would be received to sell an asset…in an orderly transaction between market participants at the measurement date.”  It’s important to remember this is an exit price concept, not an entry or transaction price.  

The assumptions made when an investment is initially purchased, which are often entity-specific, may not align with the perspective of a willing market participant in an orderly market. Despite ongoing economic shifts, markets are generally considered active and orderly, providing a framework for robust valuations. 

How is Private Equity Valued?

The most common methodologies employed in valuing private equity investments are the market approach and the income approach.  

Market Approach Valuation Considerations 

The market approach uses the guideline company or comparable company method. This involves analyzing earnings multiples (such as EBITDA - earnings before interest, taxes, depreciation, and amortization) and non-earnings multiples public comparables (comps).  

The most meaningful form of EBITDA depends on the subject company’s specifics (life cycle, seasonality, acquisitions, debt agreements). A forward-looking, next 12-months of EBITDA is often more insightful in dynamic markets.   

Revenue multiples, unlike EBITDA, ignore differences in profitability and are less frequently used in evaluating deals. It’s difficult to compare revenue multiples across different industries and stages of the subject company’s life cycle.  Where EBITDA is adjusted or revenue is further dissected (e.g., between recurring and non-recurring, subscription and non-subscription based), it’s important the public comps reflect the same assumptions for a meaningful analysis. 

How to Choose the Right Comps for Private Equity Valuations  

Private equity investors must identify companies similarly impacted by market conditions, as multiples vary across industries. This requires carefully reviewing criteria for selecting or eliminating comps used in past analyses.  

Income Approach Valuation Considerations 

The income approach, particularly the discounted cash flow (DCF) analysis, is another common valuation methodology for private equity. The DCF analysis is especially valuable in environments where current variables impacting a company and future recovery expectations can be explicitly reflected. This method can also serve as a corroborating tool for values derived from the market approach or other valuation methods.  

Consistency of assumptions across all methodologies is vital, and it is highly recommended that comps from the market approach be used as a sanity check for growth projections and the terminal (or horizon) value in a DCF analysis. 

Precedent Transactions (M&A Approach) for Private Equity Valuations  

This approach uses historical M&A data to derive multiples. In volatile markets, investment activity leans more on future performance expectations. When using this, consider: 

• Buyer type: Strategic vs. financial buyers have different perspectives on synergies. 
• Deal structure: Account for platform vs. add-on acquisitions and earn-outs. 
• Market shifts: Differentiate recent deals from prior activity, especially with changes in market capitalization.  

Given market fluctuations, it's best practice to weigh market approach methodologies less than in stable periods. Consider the relevant comps' stage of development, size, growth, and profitability, clearly defining their weight. Finally, calibration, linking the original investment thesis to current and prior valuations, enhances accuracy.  

Private Equity Valuation Process  

Ultimately, there is no "one-size-fits-all" approach to private equity valuations. Each company, industry, and market circumstance presents unique considerations that demand a tailored and well-supported valuation process:  

1. Preparing for a valuation starts with understanding its purpose, which guides the appropriate methodology.  
2. Once selected, gather key data such as financials, forecasts, capital structure, and operational KPIs.  
3. Engage stakeholders like management and legal to maintain accuracy or consult valuation experts if needed.  
4. Finally, review assumptions carefully and document the analysis clearly to support and defend the conclusions. 

Need guidance on your private equity valuations? Reach out to our team today for assistance in accurately valuing your investments.