New governance and best practices are being applied across all sectors, in all geographies. They are even gaining momentum in the “private equity” industry. The Validity of net asset values (NAVs) -i.e. evaluation of private equity assets- is under scrutiny.
The certification of the valuation process tends to become common best practice among investors and auditors. In Europe, a new regulation ( AIFM Directive projects) creates a third party evaluator to review fund managers’ NAVs. A rule-based automated “second opinion” on the NAVs is the new best practice. This automated process could be viewed as an equivalent of “value at risk” or sensitivity test for the NAVs produced by fund managers.
What is the fair price of a private company? Two methods are basically applied so far:
The DCF is criticized for being too sensitive to growth and discount rates, as well as to the calculation of a terminal value. Discount rates are implicitly given by comparables.
The comparable method remains central, notably in venture capital where cash flow projections are far from reliable. The assumption is that listed companies are evaluated on a permanent basis by buyers and sellers. By gathering a set of companies close enough to a given private company, it is possible to derive the value of the latter (discounting here and there to refine the result), assuming that: