IPEV Guidelines

A listed share has a price. An unlisted portfolio company has whatever number the manager writes down — and the manager is paid partly on that number.

The IPEV Guidelines exist to take the discretion out of it. Issued by the International Private Equity and Venture Capital Valuation Guidelines Board, they set out best practice for valuing every debt and equity investment an AIF holds in its investee companies, with one governing principle: report at fair value.

Fair value is the arm's length price — what a willing buyer and a willing seller, unconnected to each other, would agree. In Indian accounting terms, IND-AS 113 defines it as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

The point of insisting on fair value rather than cost is transparency. An investor deciding whether to commit to the manager's next fund needs the current one marked at what it is worth, not at what it was bought for.

The guidelines aim at high-quality, uniform, globally acceptable, principles-based valuation for the private equity and venture capital industry — Category I and II AIFs — so that practice is consistent irrespective of the size and composition of a portfolio. The IPEV Board has an understanding with the International Valuation Standards Council to keep the guidelines consistent with the IVSs.

Seven "most widely used" methods for valuing a portfolio company:

1. Price of previous transaction — a follow-on investment prices the company, and that implied value applies to the whole holding. For a first investment the holding is carried at cost, and revised on the pricing of later rounds.
2. Early-stage companies — milestone approach or scenario analysis, where probability and financial impact of research or development outcomes cannot be gauged and cash flow forecasts are unreliable. The option pricing method is also used: a forward-looking method that takes current equity value and allocates it across classes of equity over a continuous distribution of outcomes rather than a few discrete scenarios.
3. Multiples approach — for profit-making companies, using historical, sustainable or projected data, with ratios from quoted markets or recent transactions. A discount to the quoted multiple is normally applied for the illiquidity of unlisted stock, and may be reduced where the manager believes an exit is imminent.
4. Net asset valuation — for a company performing unsatisfactorily and loss-making, or one in the business of finance and investments, valued by reference to net tangible assets.
5. Discounted cash flow — recommended for having the strongest theoretical underpinning, but very sensitive to discount rate and cash flow assumptions, so to be used only where there is enough data for realistic ones.
6. Valuation of debt investments — DCF of future cash flows, including for subordinate debt, mezzanine capital and preference shares with predictable cash flows. Non-performing collateralised debt is valued on the collateral, the risk of converting it to cash and the time to do so; uncollateralised non-performing or restructuring debt on the most likely cash flows discounted at the rate a market purchaser of that distressed debt would use.
7. Industry metrics — non-financial measures such as sales multiples for loss-making companies or value per subscriber. The guidelines' own warning: the further the metric moves from future cash generation, the greater the likelihood it proves inaccurate.

At the fund level the same principle produces sum-of-parts, or the "bottom-up approach": NAV is the sum of the fair values of the underlying portfolio investments at the valuation date, and an investor's interest is their proportionate distributable NAV after tax, statutory payments, outstanding fees, expenses, carried interest and other contractual deductions.

In India, IPEV sits alongside a SEBI mandate rather than replacing it. The industry association has endorsed the guidelines and issued an explanatory guidance note for the Indian market, and the PPM must disclose — in Section VII — the valuer to be appointed, the frequency of valuation and whether the fund follows the IPEV Guidelines. Under SEBI's circular on a standardised approach to valuation in AIFs, prescribed valuation approaches must be followed and deviations or changes in valuation policy reported as prescribed. Fund due diligence asks a manager to describe any deviation between its valuation policy and IPEV.

Helios India Fund II holds Alta Mobility, bought 30 months ago for Rs 30 crore at a Rs 200 crore post-money valuation — a 15% stake. Alta has since raised Rs 100 crore of Series C at a Rs 500 crore post-money, diluting Helios to 12%. Alta now makes Rs 25 crore of EBITDA and carries Rs 37.5 crore of net debt. Listed comparables trade at 18x EBITDA.

Method 1 — price of previous transaction

Post-money at Series C                       Rs 500.00 cr
Helios stake after dilution                       12.0%
Fair value of holding                        Rs  60.00 cr

Method 3 — multiples, with an illiquidity discount

EBITDA                                       Rs  25.00 cr
Quoted comparable multiple                        18.0x
Less: 25% illiquidity discount on unlisted stock  13.5x
Enterprise value      25 x 13.5              Rs 337.50 cr
Less: net debt                               Rs  37.50 cr
Equity value                                 Rs 300.00 cr
Helios stake                                      12.0%
Fair value of holding                        Rs  36.00 cr

Two defensible methods, Rs 60 crore and Rs 36 crore — a spread of Rs 24 crore on a single position.

What that spread does to the fund. Helios has committed capital of Rs 400 crore, a hurdle of 10% and carried interest of 20%. Carrying Alta at Rs 60 crore rather than Rs 36 crore adds Rs 24 crore to NAV, roughly 6% of committed capital — and if that Rs 24 crore sits above the hurdle when the fund distributes, Rs 4.8 crore of it is carried interest to the manager who chose the method.

Which is why the choice is not the manager's alone to make quietly. The valuer is independent and disclosed in Section VII of the PPM; the frequency is disclosed; whether the fund follows IPEV is disclosed; and any deviation from the policy, or change to it, has to be reported under SEBI's standardised valuation circular and answered in investor due diligence. Where a Series C priced 18 months ago no longer reflects Alta's trading, a manager still holding it at Rs 60 crore is making a judgement its investors are entitled to see argued.

Chapter 14 (Valuation), section 14.8.3 sets out the IPEV Guidelines and the seven methods, and section 14.9 carries the sum-of-parts approach to fund valuation. Chapter 12 (Fund Due Diligence) asks about deviations between the fund's valuation policy and IPEV; Chapter 13 places the IPEV disclosure in Section VII of the PPM. Expect a "which of these is not an IPEV method" question, a question on why fair value rather than cost is the reporting basis, and application questions that hand you an EBITDA, a comparable multiple and an illiquidity discount.

• IPEV is guidance, not Indian law. SEBI's circular on a standardised approach to valuation in AIFs is the binding instrument; IPEV is endorsed by the industry association and disclosed in the PPM. Deviations have to be reported either way.
• The first investment is carried at cost. The price-of-previous-transaction method needs a previous transaction; it starts working from the follow-on round.
• The illiquidity discount is applied to the quoted multiple, and it may be reduced where an exit is imminent — it is not a fixed haircut.
• Net asset valuation is for under-performing or loss-making companies, and for finance and investment businesses. Using it on a profitable operating company is the wrong method, not a conservative one.
• DCF has the strongest theory and the weakest inputs. The guidelines recommend it and immediately warn that it is very sensitive to discount rate and cash flow assumptions.
• Fund NAV is bottom-up, and an investor's interest is not simply their share of it. It is the proportionate distributable NAV, after tax, outstanding fees, expenses and carried interest.
• IPEV addresses Category I and II AIFs — the private equity and venture capital industry. Category III NAV determination is dealt with separately, in Section VIII of the PPM.