International Private

Equity and Venture Capital

Valuation Guidelines

November 2023
Preface
► On 21 June 2023, the Securities and
Exchange Board of India (SEBI) issued a
circular, “Standardized approach to
valuation of investment portfolio of
Alternate Investments Funds (AIFs)1”.
Thereafter, Indian Venture and
Alternate Capital Association (IVCA)
officially endorsed the International
Private Equity and Venture Capital
(IPEV) guidelines2.
► The IPEV Board had released its most
recent guidelines on 14 December 2022
(IPEV Guidelines)3. Some of the key
concepts under these guidelines have
been elaborated in the upcoming slides.

1 Link to circular issued by SEBI

2 Link to IVCA endorsing IPEV guidelines
3 Link to the IPEV Guidelines
Table of
Contents
1 2 3
Valuation guidance Additional guidance Leading practices: complex capital
structures / early-stage investments
► Objective ► Enterprise Value as a starting point
► Fair value ► Insider funding round / Bridge finance ► Differential rights
► Principles ► Indicative offers ► Scenario analysis / OPM
► Exercising judgements ► Contractual restrictions ► Indicative milestones
► Consistency ► ESG ► Examples
► Valuation methods ► Governance
► Calibration ► Fund of funds
► Back testing
Valuation
guidance
IPEVC Guidelines – objectives

Articulate best practices for valuing debt and

equity securities

► Consistency of valuation methodology

► Appropriateness of valuation judgements
► Calibrating valuation inputs
► Rigor and thoughtfulness in valuation
approach

Suggested governance practice regarding

valuations

► Document valuation policy, incorporating

IPEVC guidelines
► Document inputs, assumptions, rationales
► Independent internal valuation committee
and/or external advisors
► Incorporate back-testing as a component of
valuation process

Page 5 IPEV Guidelines – Key concepts for valuation of investment portfolio

Fair value

Fair value is the price that will be received to sell an asset in an

orderly transaction between market participants at the
measurement date
► Assumes hypothetical sale in the principal or most
advantageous market (irrespective of whether investee
Company or Investors intend to sell in the near future)
► Forced transaction or distress sale situation not to be
considered
► In case of multiple securities or tranches in the same Investee,
evaluate if Market Participant would consider exiting all
positions simultaneously. If yes, consider one single unit of
account.
► Should incorporate specific restrictions pertaining to the
asset, e.g., right of pre-emption, ROFO, Tag/Drag
► Assumes hypothetical transaction commenced at a point of
time in advance of measurement date
► Price of recent investment not automatically deemed to be fair
value — calibration is required

Page 6 IPEV Guidelines – Key concepts for valuation of investment portfolio

Valuation Principles

► Economic substance over strict legal form

► Value generally realized through sale/floatation of the entire company. Hence, the value of business provides insights into stake values
for equity instruments.
► However, there could be some situations where fair value derived from expected cashflows and risk of relevant financial instruments
(instead of overall business value)
► Minority stake where other owner’s interest not aligned
► Maximize techniques that draw heavily on observable market data
► Market data may require adjustments based on facts/circumstances
► Adjustments do not automatically reduce reliability
► Results of one technique may be used to cross-check or used in conjunction with other techniques
► Valuation is inherently subjective and depends on
► Judgement about the company, its markets and environment, including the state of M&A market
► Stock market conditions and other factors/expectations
► Valuations provide interim indications of progress in investee entities; actual results are determined on exits/realizations

Page 7 IPEV Guidelines – Key concepts for valuation of investment portfolio

Exercising judgements

► Consider information which is known or knowable

► Would reasonably be available based on routine enquiry or due diligence
► Information on performance of investment may be “in-arrears” e.g., September information for December valuation
► Valuer should be wary of applying excessive caution
► Often, the below mentioned situations make it difficult to estimate fair value:
► Investments made with a view to build, develop, effect change
► Rescue financing or turnaround
► Valuer needs to conclude the best estimate, even if:
► Range of fair values is significantly wide
► Probabilities of each possible estimate cannot be reasonably assessed
► Probability and impact of achievement of milestone is difficult to predict
► Estimation of an increase of decrease in value may involve references to broad indicators
► Expected transactions post-measurement date may provide indication of fair value
► Uncertainties about change in price, risk of failure/delay should be considered
► Proximity may help make judgements on what was knowable

Page 8 IPEV Guidelines – Key concepts for valuation of investment portfolio

Consistency

► Use consistent valuation techniques over the years unless

there are change in market conditions or investment-specific
factors
► Change appropriate if it results in measurement which is more
representative of fair value
► Basis for change to be documented
► Possible events leading to change could be:
► Change in stage of development (e.g., pre-revenue to post-
revenue)
► Development of new markets
► Availability of information
► Techniques improve
► Market conditions change
► Investments with similar characteristics, sectors, geographies
should have consistent techniques

Page 9 IPEV Guidelines – Key concepts for valuation of investment portfolio

Methods

► Market approach
► Multiples
► Industry Valuation Benchmarks
► Available Market Prices
► Income Approach
► DCF
► Replacement Cost Approach
► NAV
► Price of Recent Investment (“PORI”) is a good starting point,
but one must consider current facts/circumstances to capture
changes until the measurement date. They can be:
► Market conditions
► Performance of Investee company
► Inputs to valuation methods calibrated to PORI

Page 10 IPEV Guidelines – Key concepts for valuation of investment portfolio

Calibrating to the price of recent investment

Calibration at future measurement date

► Calibration is a process applied when the price of initial investment is deemed fair. It says that valuation techniques to estimate fair value in the future
should be evaluated using market inputs as on the date of investment. Since contemporaneous market inputs would generate fair value at inception,
updated market inputs will generate fair value at future dates as well.

► Example:

Particulars Original investment date - 1 April 2022 Measurement date - 31 March 2023

Comparable
A 12.0x 15.0x
Companies Multiple

Investee Company B 10.0x (Implied at the time of entry) 13.0x (if difference expected to remain same)

Difference C=A-B 2.0x 2.0x*

Multiples of comparable companies have increased to 15.0x

An investment is purchased on 1 April 2022 at an
as of 31 March 2023. Valuer may conclude that 2.0x
implied EV/EBITDA multiple of 10.0x, while
Comment difference in the multiple at entry level should be maintained,
comparable companies
thereby implying use of 13.0x multiple on updated EBITDA of
were trading at 12.0x multiple.
investee company as on measurement date.
*Valuer has discretion whether an absolute movement or a relative (%) movement would be appropriate.

► Similar concept can be used with an income approach by using an implied discount rate and deconstructing it into components to provide a basis for
company specific risk premium.

Source: IPEV Guidelines & EY Analysis

Page 11 IPEV Guidelines – Key concepts for valuation of investment portfolio

Backtesting

► IPEV Guidance says that valuers should seek to understand

what causes differences between fair value measurements and
actual exits by funds.
► Valuers should identify what information was known/knowable
as of measurement date and whether it was properly
considered in the most recent valuation on measurement date
given the actual exit price results/liquidity event (e.g., IPO,
sale).
► This tests the rigor of the estimation process and can be used
for continuous improvement. It is not used to identify
theoretical mistakes, but to provide meaningful insights that
can be applied in the future. Over time, it can help assess
inherent biases and reliability of assumptions.

Source: IPEV Guidelines & EY Analysis

Page 12 IPEV Guidelines – Key concepts for valuation of investment portfolio

 Other
considerations
Adjustments to/Allocation from enterprise value to arrive at final value

► Steady-state working capital expected by a buyer

► Higher-ranking claims, such as debt:
► If debt expected to be repaid on change of control, pay-off
value, including pre-payment penalty
► If debt expected to continue on change of control, market
participants negotiated value, considering
favorable/unfavorable interest rate terms
► Excess-cash/surplus assets
► Unrecorded liabilities pertaining to incentive compensation,
bonus, tax, deferred consideration, pension
► ESG factors such as decommissioning provisions, mandatory
contributions, expected legislations
► Dilution due to options and warrants
► Ratchets, liquidation preferences

Page 14 IPEV Guidelines – Key concepts for valuation of investment portfolio

Insider funding rounds / Bridge financing

1 2 3 4
If existing investors put Valuer needs to assess if Financing from existing In the case of bridge
money broadly in the same transaction price was investors if priced lower financing to an existing
proportion as their “appropriately negotiated” than previous round may investee in anticipation of
investments, commercial indicate a decrease in follow-on investment,
need for fair valuation value. original investment and
diminishes bridge fund can be
considered as part of a
“package” and valued on a
combined basis

Page 15 IPEV Guidelines – Key concepts for valuation of investment portfolio

Indicative offers

Indicative offers are not Offers received recently Offers may be based on When offer moves to
observable market from a third party may insufficient information contracting stage, more
prices but represent provide a good indicator or subject to future weight can be placed.
buyer’s starting point for fair value. However, events/stringent Negotiated price for a
for negotiations - some valuer should consider conditions. Hence, these yet-to-be-closed
buyers know that price motivation of the party, are generally transaction would be
adjustments would be e.g., deliberate high insufficiently robust to adjusted for uncertainty
made in diligence. offers to open be used in isolation as associated with the
negotiations/gain standalone evidence of pending transaction.
access. fair value.

Page 16 IPEV Guidelines – Key concepts for valuation of investment portfolio

Contractual Restrictions

Restriction to not sell listed stock is characteristic of owner and not the
asset - hence application of discount will be inconsistent with the unit of
account.

Funds that cannot sell a listed investment because of contractual sale

restrictions still has to consider “price in the principal (or most
advantageous market)” - restriction does not change the market in
which it would be eventually sold.

Discount for lack of marketability (DLOM) was earlier applied for such
restrictions [underwriter’s lock up or lock-in period]. 2022 IPEV
guidance amendment now aligned with recent accounting guidance by
Financial Accounting Standards Board’s (“FASB”) that no discount to be
applied in such cases. FASB’s decision had dissenting members, so was
not unanimous.

Amendment consistent with guidance to not apply a discount for

blockage factors (size vs. trading volume), since they are characteristic
of fund’s holding

DLOM does apply for government/legal restrictions, which are

characteristics of the asset.

Page 17 IPEV Guidelines – Key concepts for valuation of investment portfolio

ESG

► ESG factors gaining the focus of investors, regulators and

governments, and may impact value from qualitative and
quantitative perspective.
► Quantitatively observable/measurable considerations include:
► impact on cashflows from actions (taken/anticipated) such
as an alternate source of energy
► judgement on risk profile/company specific risk premium
► comparability with peers.
► Qualitative factors with judgmental impact include:
► location,
► diversity
► governmental action
► Risks/opportunities from ESG initiatives/regulatory
environment should be included in valuation to the extent that
are deemed known or knowable

Page 18 IPEV Guidelines – Key concepts for valuation of investment portfolio

Governance

► IPEV defers to international valuation standards, but sets

expectations
► Investors expect strong control framework
► Documentation of significant judgements
► Process to challenge assumptions
► Right level of seniority
► Measure effectiveness of reviewer’s challenge through
back-testing
► Independence
► Individuals apart from the deal team should be part of the
governance process
► Non-executives and/or external specialists
► Well-thought out and detailed valuation policy should cover
► Consistency in approach
► Accuracy and completeness of information
► Management of conflicts
► Compliance and effective application

Page 19 IPEV Guidelines – Key concepts for valuation of investment portfolio

Valuing “fund of funds” – interests in another fund

► Last reported NAV of underlying interest/fund can be the

starting point (as long as that NAV considers the fair value of
investments)
► If measurement date different, assess if differences could be
significant. Adjust for known or knowable changes to get it
trued up to measurement date of fund of funds
► Orderly secondary transaction prices become relevant
► If a decision to sell is made, secondary transaction prices
provide better evidence
► Appropriate controls/processes need to be in place to assess
valuations received from fund manager
► If NAV is not available or cannot be used and secondary
market information is not available, use the income approach

Page 20 IPEV Guidelines – Key concepts for valuation of investment portfolio

Leading practices:
complex capital structures /
early-stage investments
Differential rights

Complex capital structures

► Funds invest in early-stage companies using a combination of different classes of shares, which could provide unique rights, preferences, etc. Portfolio
companies could have a different series of convertible preferred stock with differential rights. Hence, while estimating fair value, one should estimate how
each class of share will participate in a sale or liquidity event. Different share classes may be subject to different risk/return expectations and it may be
necessary to estimate post-money equity value using a valuation technique.

► Guideline further state that early stage entities may have limited outcomes and the “headline” value (i.e., fully diluted number of shares X price per share
of recent round) rarely takes into account inferior rights of junior class of shares. Hence, informed judgement is needed to conclude on fair values between
significant financing events.

► Example:
Date of investment Investors Amount invested Stake acquired Headline value (post-money) Preferred series
July 2022 Fund A US$10m 20% US$50m Convertible series A
Mar 2023 Fund B US$20m 20% US$100m Convertible series B

► Fund A’s stake gets diluted to 16% after investment by Fund B. Fund A valuer needs to apply judgement whether post-money headline value of US$100m is
usable or different valuation techniques (e.g., backsolve method) needs to be applied to arrive at value Series A shares.

Source: IPEV Guidelines & EY Analysis

Page 22 IPEV Guidelines – Key concepts for valuation of investment portfolio

Scenario analysis / option pricing

Seed, start up, early stage, high growth, new age companies, differential rights
► Some of the useful techniques are:
► Scenario-based methods which include:
► Simplified scenario analysis
► Relative value scenario analysis
► Full scenario analysis or Probability-Weighted Expected Return Method (“PWERM”)
► Option Pricing Method (“OPM”) is a forward-looking method that considers current equity value and allocates it to various classes of equity, considering
continuous distribution of outcomes rather than future distinct scenarios
► Current Value Method (“CVM”) allocates equity value as though business was to be sold on measurement date
► Hybrid method which is a combination of scenario-based method and OPM.
Simplified scenario analysis Relative value scenario analysis

Particulars Probability Common equity Series A Series B

High Value exit – IPO / strategic sale 80% Particulars Probability Discount to latest round

High Value exit – IPO/ strategic sale 60% 0% 0% 0%

Low exit - Liquidation Preference to
20%
impact value Low exit - Liquidation Preference to impact value 40% 20% 10% 0%

► These techniques require initial calibration to transaction value on investment date and recalibration for additional rounds.
► Assessing progress towards milestones allows valuer to ascertain changes in the probability of various scenarios and the potential outcome of various
scenarios.

Source: IPEV Guidelines & EY Analysis

Page 23 IPEV Guidelines – Key concepts for valuation of investment portfolio

Scenario analysis / option pricing

Seed, start up, early stage, high growth, new age companies, differential rights
► Practices have evolved in certain jurisdiction to place more weight on hybrid or OPM method in early stages of investment when likely exit will be
dependent upon another round of financing. As one nears an exit possibility through IPO or M&A, more weight is given to a fully diluted approach.

► American Institute of Certified Public Accountants (“AICPA”)’s PE/VC taskforce has also issued an accounting and valuation guide for valuation of portfolio
company investments of venture capital/private equity funds, which is broadly in line with IPEV guidelines.

Source: IPEV Guidelines, AICPA’s Accounting and Valuation Guide & EY Analysis

Page 24 IPEV Guidelines – Key concepts for valuation of investment portfolio

Indicative milestones

Financial measures Technical measures Marketing and sales measures

► Revenue growth ► Phase of development ► Testing phase

► Profitability expectations ► Testing cycles ► Market introduction
► Cash burn rate ► Patent/regulatory approvals ► Market share
► Covenant compliance

Page 25 IPEV Guidelines – Key concepts for valuation of investment portfolio

Example 1 – Simple capital structure

► Fair value of the fund’s interest = pro rata share of total equity
value
► All investors have the same class of securities and:
► Do not require more complex models, such as OPM or
scenario analysis
► They typically enter together and exit together investor
interests are aligned
► When the company is ultimately sold or goes public, all
investors will receive a pro rata share of the value that is
realized

Page 26 IPEV Guidelines – Key concepts for valuation of investment portfolio

Example 2 – VC investment, bimodal outcomes or high probability of conversion

► Initial investment = preferred stock with a 1x LP, generally

convertible to common shares at a 1:1 ratio
► As time passes, new rounds of financing are raised:
► “Upround” typically 1x LP at higher price, pari passu with
earlier rounds
► “Downround” may have additional features to minimize
dilution
► Historical approach – use the fully diluted equity value and
allocate that value to the investor interests on an as-converted
basis
► Rationale: investors will realize value only through a sale of
the company or an IPO and as a result, their focus is on the
company’s upside, where shares will convert
► When is this approach reasonable?
► If market participants would assume that the preferred is
sure to convert at the liquidity event, or if the company is
at such an early stage, the outcome is likely to be bimodal,
then using a fully diluted approach would be a reasonable
approximation

Page 27 IPEV Guidelines – Key concepts for valuation of investment portfolio

Example 3 – Participating preferred

► Participating preferred securities share in the upside on an as-

converted basis without having to forego their liquidation
preference
► First repay the LP for each participating preferred class
► Allocate the remaining equity value to all classes on an as-
converted basis
► If the investors in aggregate have control and hold the senior
securities, allocate controlling equity value using Current
Value Method (CVM)
► Value of investor securities cannot be any less than what
the investors could realize by selling the company on the
measurement date
► If the investors do not have control, the junior securities will
benefit from allowing more time for the business value to
appreciate
► CVM and fully diluted value are generally not appropriate
in this situation

Page 28 IPEV Guidelines – Key concepts for valuation of investment portfolio

Example 4 – Downside scenario has value

► Liquidation preferences matter when there is value on the

downside, for example:
► PE-backed companies (e.g., LBO, turn-arounds, corporate
carve-outs)
► Later stage VC-backed companies
► Frequently, more established companies have only one class of
investor securities, since a large investment is required in the
initial acquisition:
► In these cases, considering a CVM is usually reasonable,
since investors could sell the company if it were to their
advantage to do so
► If there are multiple classes of securities, it is important to
capture the differences in value, i.e.,:
► Use a forward-looking method such as scenario analysis,
OPM or a hybrid method, or treat each class as a debt-like
preferred plus common
► Capture the effect of the LPs considering the downside
protection

Page 29 IPEV Guidelines – Key concepts for valuation of investment portfolio

Does it really matter?

► “Is anyone really using scenario analysis or OPM?”

► Yes – when it is important to consider the rights and preferences of the
various securities in the valuation.
► The impact on the fund’s aggregate investment in the portfolio
company depends on how different the rights are between the rounds,
and the mix of shares held.
► “We tried using OPM, but the answers did not make any sense”
► Many firms negotiate the price for the round using a fully diluted value,
which assumes all the classes of equity have the same value (even
common).
► OPM gives full credit to the value of liquidation preferences on the
downside, assuming that the various classes of equity are different. So
OPM uses a lower total equity value. This lower equity value reflects
the illiquidity of the investments and the negotiation dynamics that
give new rounds preferences relative to previous rounds.
► Investors demand and may achieve high rates of return in part due to
the illiquidity of private company investments, so the equity value used
in OPM, or scenario analysis, will reflect these high rates of return.
► The answers make more sense in situations where the equity value is
likely to evolve smoothly rather than jumping, as long as you start with
an equity value that is consistent with the allocation methodology
(consistent with the latest round)

Page 30 IPEV Guidelines – Key concepts for valuation of investment portfolio

Red flags on using post-money value

► “Fake” flat round

► New round has the same price as the previous round, but
has superior features
► Seniority, greater than 1x liquidation preference
► If the new investors care about seniority or negotiate for
greater than 1x LP,
chances are the downside protection matters to them
► Warrant coverage, greater than 1x conversion
► If the new investors have greater than 1x conversion or
warrant coverage, then the effective price per share is
lower than it would appear
► Investor interests not aligned
► In an upround, if the new round has control, those
investors might favor a sale
► If the rounds with lower liquidation preferences have
control, they might favor waiting for an IPO or holding out
for a high value exit
► Even in a simple capital structure, tensions may exist if the
investors include funds with different time horizons

Page 31 IPEV Guidelines – Key concepts for valuation of investment portfolio

Other common pitfalls

► Using a fully diluted approach even when the company is at a

point where a low value exit would provide a partial return to
the senior securities
► Using a fully diluted approach even when preferred is
participating or converts at other than 1x
► Failing to calibrate under the following circumstances:
► Using a median or average
multiple without considering differences between company
and comparables
► Using a control premium or marketability discount without
assessing the negotiation dynamics
► Using an immediate waterfall in an early-stage company,
assuming the investors get back a significant percentage of
their investment
► Using a waterfall method, even when there is a significant
time to exit, and junior securities control the timing of exit
► Using a median volatility without considering differences in
leverage or size/diversification.

Page 32 IPEV Guidelines – Key concepts for valuation of investment portfolio

Issues with using the OPM backsolve method when the latest round is senior

► Example: Series C financing closed near the valuation date.

► The price per share will be an observed result from the
allocation method
► Can solve for the implied company value that reconciles to the
Series C price
► When a recent transaction exists, it should be considered.
► To the extent that the transaction value isn’t representative of
fair market value, consider adjustments to the transaction price
and/or other methods.
► Angel rounds (first round of investment) or new rounds that are
senior may result in an unrealistically low implied company value.
► OPM may overstate the value of senior liquidation preferences
and understate the value of junior liquidation preferences, since
it assumes that the distribution of outcomes is log normal and
the waterfall will be strictly followed. In practice, the investors
who in aggregate have control of the business will choose the
timing of exit when it is advantageous for them, rather than
exiting to preserve value for the senior preferred if the senior
preferred do not have control.
► If you solve for the value assuming all preferred securities are
pari passu and the implied equity value changes significantly,
consider whether the pricing included a negotiation discount or
estimate the equity value using a different methodology.

Page 33 IPEV Guidelines – Key concepts for valuation of investment portfolio

 Contributors

Navin Vohra Parag Mehta Amish Mehta Hardik Shah Atul Gupta
Partner and National Leader Partner Partner Director Director
Valuations, Modelling and Economics, Valuations, Modelling and Economics, Valuations, Modelling and Economics, Valuations, Modelling and Economics, Valuations, Modelling and Economics,
EYMBS LLP EYMBS LLP EYMBS LLP EYMBS LLP EYMBS LLP
[email protected] [email protected] [email protected] [email protected] [email protected]
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