Asset Management Valuations and Ils

Asset
Management
updates
Private equity
and ILS valuations
—
September 2020
Agenda
Private equity valuations
ILS valuations
Audit considerations
Q&A
© 2020 KPMG, a group of Bermuda limited liability companies which are member firms of the KPMG network of independent member firms affiliated with KPMG International Cooperative (*KPMG International”), a Swiss entity. All
rights reserved.
2
.
Private equity
valuations
Principles
of valuation
Key underlying thoughts
01 Valuation is an art not a science
02 Substance over form
03 Refer to the valuation guidance
Documentation and reasoning for inputs

04 and assumptions is (always) key
05 Valuation is the most difficult area of the audit
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Valuation guidance
• International Private Equity and Venture Capital (“IPEV”) Valuation Guidelines (“IPEV
Guidelines”) – updated December 2018
• AICPA ‘Valuation of Portfolio Company Investments of Venture Capital and Private Equity
Funds and Other Investment Companies’ (“AICPA Guidance”) – released August 2019
Considerations Key points to note

• Previously IPEV guidelines were the • Neither IPEV nor AICPA support
main source of guidance for valuations the use of Price of a Recent Investment
of PE investments as a standalone valuation technique
• AICPA released guidelines in August • Both IPEV (Chapter 3.10) and AICPA
2019 which applies US GAAP principles (Chapter 10) discuss and promote
to valuation principles the concept of ‘Calibration’,
• There are no significant differences whereby the Price of Recent
between the two sets of guidelines Investment is used to calibrate inputs
for another formal valuation techniques
e.g. Market Multiples
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Valuation guidance
Focus on early stage investments
IPEV guidelines (Chapter 3.10) provide guidance for valuing seed, start-up and early-stage investments.
The Milestone Approach can be used whereby the valuer attempts to assess whether there is an
indication of change in Fair Value based on a consideration of milestones e.g. changes in results vs
budget, changes in the market, etc.
AICPA Guidance acknowledges the challenges associated in valuing early-stage investments and that traditional
approaches may not be appropriate. It sets out some more prescriptive guidance around the valuation of early-
stage portfolio company investments:
 Chapter 13 (13.39 – 13.42) notes that financing transactions, particularly arm's length transactions that
involve new investors, are generally viewed as better evidence for establishing fair value estimates
because transactions between shareholders are infrequent, and the motivations for these transactions may
not be known.
 Appendix B of the AICPA Guidance summarizes the typical stages of development for many portfolio
companies (Stage 1 to Stage 6) and which valuation approach(es) would typically be appropriate or
inappropriate for each stage.
 Although the AICPA Guidance gives some more prescriptive guidance around the valuation of early-stage
portfolio company investments, the underlying principles are consistent with those set out in the IPEV
guidelines.
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How do we estimate Fair Value?
Market Participants determine the price they will pay for individual equity instruments using Enterprise
Value estimated from a hypothetical sale of the Investee Company, as follows:
Adjust for relevant factors

such as surplus cash
and excess liabilities
Are you happy

Estimate value with the answer?
of the whole using Deduct financial instruments
valuation techniques ranking higher than Because of the uncertainties inherent
the Fund’s in estimating Fair Value for private equity
Investments, care should be applied
in exercising judgment and making
Calculate Fund’s holding the necessary estimates. However,
of each equity instrument the valuer should be wary of applying
of the Investee Company excessive caution.
(i.e. Fair value of the
equity holding)
Fair value is the price that would be

Allocate to the Attributable Enterprise received to sell an asset or paid to
Value across the Investee Companies transfer a liability in an orderly transaction
various equity instruments (i.e. dividing between market participants at the
the Attributable EV by the number of
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8
. measurement date – it is an exit price
shares issued)
Valuation techniques - arriving at Enterprise Value
Asset approach Income Approach Market approach
• Based on net asset value (NAV) • Converts future amounts (e.g. cash flows • Uses prices and other relevant
• Balance sheet-focused or income and expenses) to a single information generated by market
current (i.e. discounted) amount. transactions involving identical or
• Assets and liabilities of the company comparable (i.e. similar) assets, liabilities
are adjusted from book value to fair • Fair value measurement reflects current
market expectations about those future or a group of assets and liabilities, such
market values as a business.
amounts.
Example of valuation techniques: • E.g. Use market multiples derived from a
set of comparables.
• Present value techniques
• Option pricing models, such as the
Black-Scholes-Merton formula or a
binomial model (ie a lattice model), that
incorporate present value techniques
and reflect both the time value and the
intrinsic value of an option
 The Valuer should exercise their judgment to select the valuation technique or techniques most appropriate
for a particular Investment.
 Methodologies are not ranked, but those that are based on market inputs are likely to be more reliable
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Market
approach
Multiples
The ballpark estimation of value is typically derived from the peers’ trading multiples. A range may be established based
on the high, low, and interquartile multiples.
EQ Multiples EV Multiples Industry-Specific Multiples

• Price / Earnings (PE) • Enterprise Value (EV) / EBIT • EV / # of Subscriptions (Cable)
• Price / Book Value of Equity (PB) • EV / EBITDA • EV / # of Beds (Hospitals)
• Price / Free Cash Flow to Equity • EV / Book Value of Assets • EV / R&D Expenditure (Pharma)
• Price / Earnings to Growth (PEG) • EV / Free Cash Flow to Firm • EV / EBITAR (Airlines)
• EV / Sales • PB (FIs)
Considerations
• Industry-specific multiples • Only use multiples that are generally accepted in the industry.
• Capital structure • EV multiples are more meaningful when the companies have different capital structure.
• Consistency • Debt-free earnings (e.g. EBIT) should be compared to EV multiples; residual earnings (e.g. EPS) to EQ multiples.
• Adjustments to financials • Adjustments should be made to exclude extraordinary items outside the normal course of business.
• Trailing / forward multiples • Multiples should best reflect normalised earnings (e.g. forward multiples are more meaningful for high growth
companies).
• Outliers
• Peers with radically different business environments should be excluded (e.g. distressed companies).
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Identifying comparable companies
Comparable companies are publicly traded companies with available market data that are used to determine a ballpark
estimate of value. Peers must be carefully selected in order to reach meaningful conclusions.
Selection Criteria
Geography Operational Financial
Seek peers in close geographic proximity Industry and sector, product mix, market Size, profitability, growth prospects,
with the same general economic value structure, customers, channels, business asset-base (manufacturing vs service),
drivers and risks cycle and stage ownership vs leasehold
Number of Peers
 Ideally 5-10 peers with sufficiently similar operations and financial characteristics
 If large (>15), it could be reasonable to eliminate the least comparable peers
Adjustments
 Non-recurring and / or non-operating items
 Differences in the amortization of tangible and intangible assets and the handling of goodwill
 Differences in the treatment of leases (operational leasing vs financial leasing)
 Adjusting for acquired, divested or terminated businesses
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Fair value waterfall – worked example
i. Estimate value of the whole using valuation techniques – Enterprise Value
EV/EBITDA Multiple
$m
EBITDA 20 A
Multiple 9x B
Enterprise Value 180.0 C=AxB
ii. Adjust for relevant factors such as surplus cash and excess liabilities – Adjusted Enterprise Value
Fair Value of pension deficit (25) E

Deferred tax asset on pension deficit 5 F
Cash and cash equivalents 15 G
Adjusted Enterprise Value 175 H=C+E+F+G
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Fair value waterfall – worked example (cont.)
iii) Deduct financial instruments ranking higher than the Fund’s – Attributable Enterprise Value:
$m
Bank (3rd party) debt (100) I
Attributable Enterprise Value 75 J=H+I
Loan Notes 50 K
Ordinary equity 25 L
iv) Allocate to the Attributable Enterprise Value across the Investee Company’s various equity instruments and
v) Calculate Fund’s holding of the instruments of the Investee Company
Loan Notes 50% M

Ordinary Equity 80% N
$m
Loan Notes 25 P=KxM
Ordinary Equity 20 Q=LxN
Net attributable value 45 R=P+Q
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Discounts/premiums
Application of discounts / premiums:
Control premium Minority discount Illiquidity discount

amount buyer is willing to pay amount deducted to reflect that amount deducted to reflect the
over the market price to acquire partial ownership may be worth relative absence of marketability
a controlling share less than its proportional share
of the total business
May be applicable if buying - May be applicable when using May be applicable when
a controlling share in an entity the CoTrans method comparing to prices quoted
i.e. >50% - Applicable when there is no in an active market
transfer of control i.e. <50%
- Consider tag / drag rights
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Discounts/premiums
‘Marketability' vs liquidity
• Marketability and liquidity adjustments are often confused

• Under IPEV (since 2008) and IFRS 13 a ‘marketability’ discount is no longer appropriate
• However, the impact of liquidity or illiquidity should be taken into account when determining Fair Value
Marketability Liquidity
A discount to reflect the An adjustment to reflect the
time required to effect a relative liquidity of an
transaction investment
The perceived inability to realise

• An liquid asset is more valuable
an investment on a timely basis
to a market participant than an
due to:
illiquid asset
• The type of investment • Market Participant purchaser
• Barriers to exit would assess that there is a
• Market in which to expect to higher risk associated with
transact holding a minority position than
for a control position.
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Income
approach
Income approach: Discounted Cash Flow
Applicability of Approach
Discounted Cash Flow
• Historical results are not

Present Value* of Cash Flow for indicative of future expected
Explicit Forecast Period *Calculated using
results
+ the estimated market
discount rate
• Typically, significant near-
Present Value* of Terminal Value term growth expected
(based on another investment • DCF is perceived to be the
or market approach) most theoretically sound of
the valuation methodologies,
+ when meaningful detailed
Redundant (Non-Operating) Net Assets forecasts are available.
(not required for business operations) • Due to the high level
= subjectivity in selecting
inputs in DCF, private equity
Fair Market Value
funds tend to prefer the
(adjusted enterprise value) market approach.
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Discounted cash flows
There is no hierarchy of Valuation Techniques
required by accounting standards. However, the use
of multiple Valuation Techniques is encouraged.
Therefore, while many industry participants believe
that DCF-based valuations are open to a high level
of subjectivity in selecting inputs for this technique
when valuing equity Investments for the Private Capital
industry, income-based techniques may be helpful
in corroborating Fair Value estimates determined
using market-based techniques.
Per 2019 IPEV Guidelines
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or earnings of the underlying business
Deriving the value of a business by calculating the present value of expected Use with extreme caution!
future cash flows, made up of
Ensure that it is used in
- Cash flows from the underlying business corroborating Fair Value
- Terminal value of the enterprise at a hypothetical exit estimates determined using
market based techniques.
Offers a high level of flexibility as can be applied to any stream of cash
flows, hence often used when no other basis is relevant. However…..  Commonly used:
• High growth companies,
 Lots of highly subjective inputs and assumptions start-ups, predictable
- Cash flow forecasts forecasts and earnings.
- Terminal value
- Appropriate risk-adjusted discount rate
 Limited ‘hard’ or market based inputs

 Valuation very sensitive to the assumptions
 Bulk of the value often arises from terminal value assumptions
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of the investment
Particularly suitable for valuing non-equity investments in instruments such as debt or mezzanine debt,
since the value of such instruments derives mainly from instrument-specific cash flows and risks
rather than from the value of the Underlying Business as a whole
Project cash flows forward and Commonly used

discount back at the cost of capital
• Nearing realization event:
• Same caveats as previous slide once sale price is agreed and heads
of agreement signed
• Mezzanine debt instruments
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Price
of recent
investment
and calibration
Price of recent investment
Is the initial cost (transaction price) of an investment in a private
operating company an acceptable proxy for fair value at
subsequent measurement dates?
WITH A
99.9% Price of Recent Investment
removed as a valuation
CHANCE THE technique to reinforce the
ANSWER premise that fair value must be
IS… estimated as each measurement
date. Use PRI observations to
calibrate your model.
NO
…which brings us to Calibration.
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Calibration
The process of using observed transactions to ensure valuation techniques begin with assumptions
consistent with original observed transaction
Required when initial transaction is at fair value

• Also required for subsequent transactions at fair value
Carry forward calibrated inputs and adjust to reflect comparable market date and any change to company itself
• Ensures valuation technique reflects current market conditions and helps to determine whether adjustment to valuation
technique is necessary
Calibration is most relevant when the measurement date is close to the transaction date
• However, even if substantial time has passed, calibration may be useful
• If there have been additional orderly transactions in portfolio company’s instruments subsequent to initial transaction:
• Calibrating to the more recent transactions will typically be more relevant than calibrating to the original transaction
Calibration can also be used to ensure that the movement in the valuation between measurement dates is reasonable, even
in the absence of a recent transaction
Calibration stops being relevant when there has been a significant change in circumstances as to warrant a change in
valuation methodology
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Calibration example
Scenario Calibration at acquisition date
• Buyout Fund Tabart Capital Partners (TCP) • A basket of comparable companies trades
purchases 100% of Portfolio Company A (PCA) at an EBITDA multiple of 11.0x.
for consideration of $1,000, financed by:
• Calibration therefore indicates:
• $500 equity and $500 debt
(variable market interest rate; • PCA’s fair value using a market methodology
repayable upon a change in control) is based on an EBITDA multiple that is 9.1%
less than the comparable company multiples
• The transaction is considered to have taken (10.0x / 11.0x -1)
place at fair value
• The fair value of the enterprise is therefore
$1,000 (the purchase price)
• PCA’s LTM EBITDA at the date
of acquisition is $100
• Indicating an implied EBITDA multiple
of 10.0x at acquisition ($1,000 / $100)
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Calibration example (cont.)
Subsequent valuation PCA’s enterprise value would be
• PCA’s LTM EBITDA is now $110
estimated as:
• Comparable company multiples have
increased to 12.0x LTM EBITDA: $110
• Judgement is required to understand what,
if anything, has changed that would indicate
that PCA’s discount to the comparable Multiplied by (12.0x * 95%): 11.4x
companies would be more, less, or the same
as the calibrated 9.1% discount at entry.
EV: $1,254
• Assuming that PCA is 50% along the way to
achieving expected operational improvements,
the difference to comparable companies’
multiple is now deemed to be 5%.
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Early stage
investments
Challenges in estimating equity value
Conventional valuation techniques are often challenging to apply to startup companies
Asset Approach Income Approach Market Approach
• Net asset value (NAV) is • Cash flows are very difficult to • Financial data only available
generally not a good reliably forecast for listed companies, which
indicator of business value, • Business model unproven, generally are not comparable
especially for FinTech, and ability to pivot is not to startups
which are cash flow-based considered • Many startups have negative
businesses that are not • Complete management earnings, so earnings
asset heavy team may not be in place multiples are not applicable
• NAV generally does not • Minimal short term • Other types of multiples (e.g.,
consider intangible assets prospects of being self- revenue, GMV, views, etc.)
or economic goodwill sustaining are indirectly linked to final
• Limited historical / comparable cash flows which makes
data to assess projections comparability difficult (e.g.,
• Appropriate discount rate is different margins, growth
difficult to estimate; traditional rates)
CAPM models are not applicable • Implied multiples from
• With losses in initial years, publicly reported valuations
terminal value is a larger are not comparable without
component of equity value, knowing the deal terms
making valuation less reliable
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• Probability of failure is generally
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considered
Early stage
investments
Considerations for early-stage portfolio companies

 With no revenues or profits, typical valuation models are difficult to apply
 Portfolio companies typically receive several rounds of financing based on overall
outlook and:
 Achievement of past milestones
 Probabilities of meeting future milestones
 Cash needs
 Few, if any, publicly traded comparable companies can be used as benchmarks for
valuation
 Models used require significant judgement and often are not continually updated
Must consider numerous subjective inputs and assumptions to gain perspective

about the reasonableness of any valuation!
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Earl stage
investments
Relationship between FV
and stages of enterprise development
• Fair value is not static; its changes over time
• Stages of development is one of the principal elements contributing to changes
in fair value
• Consider achievement of milestones in conjunction with other relevant factors
• Different approaches may be more appropriate for some stages of enterprise
development than for other stages
Valuers should consider all three approaches!
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Valuation
pitfalls
Pitfalls
Pitfalls to be wary of
• A degree of caution or prudence is good
• Excessive or outrageous prudence is not!
• Use reasonable assumption and estimates
• Sector multiples
• Focus on the Fund’s package of investments
• Historic or prospective data?
• Some judgments may be too big to call
• Consideration of premiums/discounts to multiples
• Consideration of rights attaching to the investment
e.g. pure equity, preference shares, etc.
• Valuing convertible instruments? (can refer to Appendix B of AICPA Val Guide)
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Valuations in turbulent times (CV-19)
Use your policy as an anchor to enable consistency over a period and robustness.
Price of recent investments was encouraged to be supplemented with alternative valuation

techniques in the 2018 update to the Guidelines – this is even more relevant now since
those recent transaction prices are no longer reliable indicators of fair value.
Consider triangulation where market is multiples are particularly volatile and / or

unreliable.
Be careful not to double dip – be cautious not to be exposed to the ‘dominator effect’,
where comps earnings have not reduced, yet their multiples have come down significantly.
When valuations have been compiled – take a step back in the current environment –
what would you pay for this asset in todays market – if not, ask why? Does it make sense
Does the original investment thesis still hold?
May need to be innovative – consider a range, consider increased disclosure.
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Governance
and documentation
Governance
Governance considerations
A valuation is never ‘right’ unless sold on that day, but the reported valuation reflects the judgement of
the valuer/ house / board, hence a suitable control environment and level of documentation will drive the
suitability of the output
• Preparation should involve both:

• Deal team: who know the individual asset best; and
• Finance teams: to ensure compliance with IPEV and consistency in applications of methods;
• i.e. not just one or the other.
• Internal approval challenge process –deal partners scrutinising each others valuations prior to submission to
valuation committee / board
• Valuation committee –should have an element of independence and authority
• Backtesting – now a requirement per IPEV 2015 and should be documented more fully than previously. Also consider
history of asset value growth, not just period between recent valuation and final exit.
• SEC has increased focus on use of independent valuers, though market practice in Europe is still some way off,
despite initial sentiment within AIFMD
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Backtesting
Backtesting is now a requirement per IPEV (since 2015) Limitations of backtesting – may not be able to anticipate
and should be documented more fully than previously. the exact price an actual transaction would close until
Also consider history of asset value growth, not just a liquidity event occurs.
period between recent valuation and final exit. Best practice for investment companies to perform
Primary objective of backtesting is to assess and improve periodic backtesting on investments which have had
the fund’s valuation processes using the benefit of subsequent realizations, liquidity or other significant
hindsight. events
Not intended to highlight mistakes of correct previous
valuation conclusions.
Elements of backtesting are to:
 Determine what information and factors were known
or knowable as of the measurement date;
 Assess how well those factors were considered
in developing the fair value measurement; and
 Identify whether there were factors that were
relevant to the valuation as of the event date
that were not considered or given weight as of
the measurement date
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Governance
Documentation
Considerations we would expect to be covered in a valuation memo
• Investment background
• Rights attaching to the investment shares e.g. pure equity or preference shares
• Valuation methodology
• Changes during the year which may include:
– Increase/decrease in shareholding
– Acquisitions or disposals of underlying investments
– Changes in valuation methodology
– Exit strategy
• Valuation calculations
• Support for key assumptions
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Principles
of ILS valuation
Kyle Vrieze, FCAS
—
September 28, 2020
Agenda
• Structure and nature
of an ILS Investment
• Components of value
• Fair value considerations
• Trapped collateral
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Example
ILS structure Cedant Investors
Reinsurance Risk Capital Shares

or Financial Contract Premium
Return of principal
Collateral and coupon
Trust Transformer Debt / Preferred shares Fund(s)

Investment Return Capital
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Components
of value
• Original Funds Invested
• Earned Risk Premium
• Accrued Investment Income
• Accrued Expenses
• Profit Commissions (sometimes)
• Covered Losses
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Seasonal accrual
of risk premium
and expenses
• Some major ILS perils are seasonal
• Atlantic hurricanes and Japan typhoons peak in late Summer/early Fall
• Europe windstorm peaks in Winter
• It’s always earthquake season
• Risk Premium and Expenses are accrued according to pattern of seasonality.
• Aggregate structures can impact the pattern.
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Fair value
considerations
• Present Value Adjustment
• Risk Margin
• At what price would the
security freely exchange
between a knowledgeable
buyer and seller?
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Trapped collateral
• Reinsurance ILS depends on
commutation to release
collateral.
• ILWs must wait until the index

provider issues a final notice.
• Hurricane Irma—index provider

notice is still not final.
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Auditing level 3
investments
Audit team scope
Review and test the process usedAudit
by procedures
Test accuracy of the calculation
management to determine the fair value
Confirm the ownership of the investment Review subsequent events

at year end (can be multiple layers and or transactions occurring prior
require many share registers for holcos) to completion of the fieldwork
Review and test the reliability

and appropriateness of inputs
to the valuations and ensuring
relevant inputs are maintainable
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Initial questions
• Changes in business, changes in assumptions or methodologies
• Purchases / sales transactions (retrospective review - during year and
post year end)
• Has there been a change in methodology?
• Why is initial transaction price still appropriate?
• Provide support for:
• The choice of multiples
• Any internally generated figures
• Cash flow
• Discount rates
• Have external valuers been engaged / are reports available?
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Common issues
• Models – version control, final values not agreeing to financials
• Holdcos
• Consolidation analysis
• TBs and share registers are required
• SOI disclosure – is the correct entity / investment being disclosed?
• Valuing at NAV as practical expedient – most recent audited financial
statements are best evidence
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Useful
resources
Useful resources
IPEV Valuation Guidelines
(latest guidelines Dec 2018, plus Coronavirus Special Valuations Guidance March 2020)
http://www.privateequityvaluation.com/valuation-guidelines/4588034291
AICPA ‘Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other
Investment Companies’ (“AICPA Guidance”) – released August 2019
BVCA Guide to Private Equity

http://www.bvca.co.uk/Portals/0/library/Files/Website%20files/2012_0001_guide_to_private_equity.pdf
KPMG Q&A: Fair value measurement (Dec 2019)

https://frv.kpmg.us/reference-library/2017/qa-fv-measure.html
Covid
KPMG Article March 2020: Are fair values appropriately determined?
https://home.kpmg/xx/en/home/insights/2020/03/covid-19-assets-1b.html
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Questions?
Thank you
Contacts
Richard Hobday Kyle Vrieze Colin Campbell

Director, Corporate Finance Director, Actuarial Senior Manager, Audit
and Financial Risk Management
[email protected] [email protected]
+1 441 294 2600 [email protected] +1 441 294 2597
+1 441 294 2719
kpmg.bm
The information contained herein is of a general nature and is not intended to address the circumstances of any particular
individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such
information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on
such information without appropriate professional advice after a thorough examination of the particular situation.
© 2020 KPMG, a group of Bermuda limited liability companies and member firms of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.
The KPMG name and logo are registered trademarks or trademarks of KPMG International.
Document Classification: KPMG Confidential

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What are the main principles of valuation discussed in the document?

What are the main principles of valuation discussed in the document?

What guidance is provided for valuing early stage investments?

What guidance is provided for valuing early stage investments?

Asset

02 Substance over form

03 Refer to the valuation guidance

Documentation and reasoning for inputs

05 Valuation is the most difficult area of the audit

Considerations Key points to note

Adjust for relevant factors

Are you happy

Fair value is the price that would be

EQ Multiples EV Multiples Industry-Specific Multiples

Fair Value of pension deficit (25) E

v) Calculate Fund’s holding of the instruments of the Investee Company

Loan Notes 50% M

Control premium Minority discount Illiquidity discount

• Marketability and liquidity adjustments are often confused

The perceived inability to realise

• Historical results are not

Per 2019 IPEV Guidelines

 Limited ‘hard’ or market based inputs

Project cash flows forward and Commonly used

• Mezzanine debt instruments

Required when initial transaction is at fair value

Asset Approach Income Approach Market Approach

Considerations for early-stage portfolio companies

Must consider numerous subjective inputs and assumptions to gain perspective

Valuers should consider all three approaches!

Price of recent investments was encouraged to be supplemented with alternative valuation

Consider triangulation where market is multiples are particularly volatile and / or

Does the original investment thesis still hold?

May need to be innovative – consider a range, consider increased disclosure.

• Preparation should involve both:

• Fair value considerations

Reinsurance Risk Capital Shares

Trust Transformer Debt / Preferred shares Fund(s)

• ILWs must wait until the index

• Hurricane Irma—index provider

Confirm the ownership of the investment Review subsequent events

Review and test the reliability

BVCA Guide to Private Equity

KPMG Q&A: Fair value measurement (Dec 2019)

Richard Hobday Kyle Vrieze Colin Campbell

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