IPEV calibration means explaining the movement in value of an investment over time, with reference to both changes in the market and changes in the performance and status of the portfolio investment under review. Best practice valuation documentation and analysis will already have included calibration analysis. However, the revised IPEV guidelines have made it explicit for valuations under the guidelines.
| "When the price of the initial investment in an Investee Company or instrument is deemed Fair Value…then the valuation techniques that are expected to be used to estimate Fair Value in the future should be evaluated using market inputs as of the date the investment was made. This process is known as Calibration." |
Some of our clients have found it challenging to interpret what this requirement means in practice and we see diversity in how it has been implemented.
Our recommendations
In our Top Tips for PE valuations we recommend that clients calibrate the valuation inputs to the original deal model. Put simply, if the entry price was at a 20% discount to comparable companies, then this should be a starting point when considering future valuations.
This does not mean that the discount always needs to be 20%, but it does mean that the valuer needs to understand why it has moved (by reference to the relative performance/prospects of the comparable companies versus the portfolio company). It is also important to track how the business performs against budget and to understand how assumptions on Key Performance Indicators (KPIs) used in the valuation have changed over time.
For PE investments, our general expectation is that value is more likely to move than not. PE firms typically invest in businesses with a view to selling them within a five year window, during which they are likely to have changed the asset through operational and financial enhancement.
The business is also likely to have grown in size. These are some of the factors which will impact the level of premia or discount applied to comparable companies and this, in turn, will change the value. Calibration is useful as it requires the valuer to pause and assess the reasonableness of any proposed changes to the original entry price.
What this means in practice
Although IPEV does not restrict calibration to just new or old investments, in reality there will be differences as to how relevant direct calibration will be.
- For recent investments (often held at cost) this is unlikely to have an impact. However, it is helpful to begin calibration at the time of investment rather than waiting until subsequent valuations. This simply entails contemporaneously noting the premium/discount to traded comparable companies and noting the valuation assumptions inherent in the deal model.
- For early stage investments, calibration is likely to take the form of milestone analysis against the original deal model.
- Calibration is often most useful for investments held for one to three years where the original deal rationale still holds and the evolution of the company and the wider market is well known.
- For older investments for example three years, calibration may be less useful as the business and the market may have evolved significantly, making calibration more challenging. However, year-on-year valuations should provide evidence of a gradual evolution from original pricing so calibration can remain relevant.
Attul Karir, Director, Valuations, PwC
David Franklin, Senior Manager, Valuations, PwC
Katrina Hallpike, Senior Manager, Valuations , PwC
Valuation Group June 2014
