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Tuck School of Business at DartmouthTuck School of Business at Dartmouth

Foster Center for Private EquityFoster Center for Private Equity

Private Equity Valuation Private Equity Valuation Survey ResultsSurvey Results

May 2003May 2003

2Foster Center for Private EquityFoster Center for Private Equity

ContentsContents

SectionSection SlidesSlides

IntroductionIntroduction 3-43-4

Executive summaryExecutive summary 5-65-6

Survey population and respondentsSurvey population and respondents 7-87-8

Analysis and discussion of resultsAnalysis and discussion of results 9-399-39

AcknowledgementsAcknowledgements 3939

About the center for private equityAbout the center for private equity 4040


IntroductionIntroduction

This presentation is a detailed analysis of the results of a This presentation is a detailed analysis of the results of a survey on guidelines, policies, and practices for valuation in survey on guidelines, policies, and practices for valuation in the private equity industry (both venture capital and buyout). the private equity industry (both venture capital and buyout).

The survey was conducted by the Foster Center for Private The survey was conducted by the Foster Center for Private Equity at the Tuck School of Business at Dartmouth College. Equity at the Tuck School of Business at Dartmouth College. Over 700 firms of all sizes and geographical locations within Over 700 firms of all sizes and geographical locations within the US received the survey. the US received the survey.

Phase I of the study (survey of venture firms) was completed Phase I of the study (survey of venture firms) was completed from April to July of 2002. Phase II of the study (survey of from April to July of 2002. Phase II of the study (survey of buyout firms) was completed from January to March of 2003. buyout firms) was completed from January to March of 2003.


Introduction (continued)Introduction (continued)

Phase III of the project will identify all commonly used Phase III of the project will identify all commonly used valuation practices and, by means of a survey, will determine valuation practices and, by means of a survey, will determine the most useful and acceptable components of a valuation the most useful and acceptable components of a valuation guideline. This will be conducted in the Winter of 2003. guideline. This will be conducted in the Winter of 2003.


Executive summaryExecutive summary

• 368 out of 738 participants responded to the survey (48%). 368 out of 738 participants responded to the survey (48%). Of these, 230 are primarily venture focused (62%) and 138 Of these, 230 are primarily venture focused (62%) and 138 are primarily buyout focused (38%).are primarily buyout focused (38%).

• Both venture and buyout firms indicate that an industry-wide Both venture and buyout firms indicate that an industry-wide valuation standard is important and have a real interest in valuation standard is important and have a real interest in seeing one developed.seeing one developed.

• However, firms also see challenges to developing a However, firms also see challenges to developing a standard and have real differences of opinion about specific standard and have real differences of opinion about specific details of a standard.details of a standard.

• More than half of the respondents prefer that a private More than half of the respondents prefer that a private equity industry association take the lead in developing equity industry association take the lead in developing reporting standards.reporting standards.


Executive summary (continued)Executive summary (continued)

• Firms report that improved LP reporting and greater Firms report that improved LP reporting and greater transparency will be the benefits of a standard. transparency will be the benefits of a standard.

• 51% of firms report that they are aware of existing valuation 51% of firms report that they are aware of existing valuation proposals and standards (NVCA, BVCA or EVCA)proposals and standards (NVCA, BVCA or EVCA)

• However, only 30% of firms acknowledge that they use the However, only 30% of firms acknowledge that they use the existing proposals/standards as a basis for internal existing proposals/standards as a basis for internal guidelines.guidelines.

• In comparing venture and buyout, 63% of venture firms that In comparing venture and buyout, 63% of venture firms that were aware of existing proposals/standards use one as a were aware of existing proposals/standards use one as a basis for internal guidelines, compared to only 47% for basis for internal guidelines, compared to only 47% for buyout firms.buyout firms.

• 46% of firms would like to be part of the process of creating 46% of firms would like to be part of the process of creating an industry valuation standard. an industry valuation standard.


Characteristics of survey respondentsCharacteristics of survey respondents

Size of Last Fund Raised

Last fund< $250M

Last fund> $750M

Last fund$251 to $750M

Last fund< $250M

Last fund> $750M

Last fund$251 to $750M

Venture Firms Buyout Firms

Note: percentages do not add to 100% because some survey participants did not respond to the question


Characteristics of survey respondentsCharacteristics of survey respondents

Year of First Fund


1980 orbefore

1980 to1989

1990 to1999

2000 orafter

1980 orbefore

1980 to1989

1990 to1999

2000 orafter

Note: percentages do not add to 100% because some survey participants did not respond to the question


Almost 50% of firms would like to see an Almost 50% of firms would like to see an industry valuation standardindustry valuation standard

Yes NoNot Sure

Question: Would you like to see an industry standard for valuation Question: Would you like to see an industry standard for valuation practices? practices?


Venture firms are slightly more in favor of an Venture firms are slightly more in favor of an industry valuation standardindustry valuation standard


Yes Not SureNoYes NoNot Sure

48%48% 43%43%


Small venture firms are comparatively more Small venture firms are comparatively more interested in an industry standardinterested in an industry standard

Yes NoNot Sure

Smaller FundsLast fund < $250M

Mid Size FundsLast fund $251M - $750M

Larger FundsLast fund > $750M

51%51% 41%41% 41%41%

Yes NoNot Sure Yes NoNot Sure

Venture Firms


Small and midsize buyout firms are also more Small and midsize buyout firms are also more interested in an industry valuation standardinterested in an industry valuation standard

Yes NoNot Sure




44%44% 48%48% 34%34%

Yes NoNot Sure Yes NoNot Sure

Buyout Firms


Write-in comments provide added support for an Write-in comments provide added support for an industry valuation standardindustry valuation standard

• 123 of 368 firms (33%) provided write-in comments on the 123 of 368 firms (33%) provided write-in comments on the positive or negative aspects of a valuation standardpositive or negative aspects of a valuation standard

• 93 of the 123 (76%) indicate that an industry standard 93 of the 123 (76%) indicate that an industry standard would benefit the industry. Most comments state that a would benefit the industry. Most comments state that a standard would help improve the comparability between standard would help improve the comparability between funds, reporting, and transparency. funds, reporting, and transparency.

• However, 25 of 123 firms (20%) state that a standard would However, 25 of 123 firms (20%) state that a standard would not be a benefit. Most comments indicate that inefficiency not be a benefit. Most comments indicate that inefficiency and lack of transparency are good for the industry and a and lack of transparency are good for the industry and a standard would be either too restrictive or vague (i.e. a one-standard would be either too restrictive or vague (i.e. a one-size fits all standard is not appropriate).size fits all standard is not appropriate).


Typical positive comments includeTypical positive comments include

• ““An industry-wide valuation standard would develop a level An industry-wide valuation standard would develop a level playing field, LPs with interests in a number of funds could playing field, LPs with interests in a number of funds could properly evaluate performance of the fund and avoid having properly evaluate performance of the fund and avoid having one fund value an investment at 100% and another at 50%, one fund value an investment at 100% and another at 50%, for ex. It would be nice to have one standard.”for ex. It would be nice to have one standard.”

• ““The very survival of the PE industry is dependent on The very survival of the PE industry is dependent on waking up to the need for real and dependable uniformity in waking up to the need for real and dependable uniformity in valuation.”valuation.”

• ““An industry-wide valuation standard would put more An industry-wide valuation standard would put more pressure on private equity firms to honestly report on the pressure on private equity firms to honestly report on the financial condition and equity value of their portfolio financial condition and equity value of their portfolio companies.”companies.”


Typical negative comments includeTypical negative comments include

• ““I assume that you are referring to standard valuation I assume that you are referring to standard valuation practices. I do not see significant benefit. In fact, it could practices. I do not see significant benefit. In fact, it could serve to hurt returns, if sellers and their agents learn of serve to hurt returns, if sellers and their agents learn of such standardized valuation methodology.”such standardized valuation methodology.”

• ““MUCH prefer the way it is today ... industry thrives on the MUCH prefer the way it is today ... industry thrives on the 'gray' of valuation … interim returns would be estimates, 'gray' of valuation … interim returns would be estimates, and poor predictors of long term value in portfolio, thus very and poor predictors of long term value in portfolio, thus very harmful to GP”harmful to GP”

• ““Don't see a benefit of industry wide standards, each firm Don't see a benefit of industry wide standards, each firm would be well-advised to have their own process. If you would be well-advised to have their own process. If you don't know what it's worth, you shouldn't be in the don't know what it's worth, you shouldn't be in the business!”business!”


Many firms report that an industry valuation Many firms report that an industry valuation standard is “important” or “very important”standard is “important” or “very important”

VeryImportant

ImportantSomewhatImportant

NotImportant

Insignificant

36%


Comparatively, more venture firms report that a Comparatively, more venture firms report that a standard is “important” or “very important”standard is “important” or “very important”

1 2 3 4 5 1 2 3 4 5


38%33%

Scale: 1 = Insignificant to 5 = Very Important


Small venture firms place a higher importance on Small venture firms place a higher importance on an industry valuation standardan industry valuation standard




1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

41%41%28%28% 28%28%

Venture Firms



About one-third of buyout firms report that a About one-third of buyout firms report that a standard is “important” or “very important”standard is “important” or “very important”




1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

31%31% 32%32% 34%34%

Buyout Firms



Firms indicate that there will be real benefits if a Firms indicate that there will be real benefits if a standard is developedstandard is developed

Improved LP reporting

Provide greater industry

transparency

Improved calculationof interim returns

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

55%55%36%36%

46%46%



Both venture and buyout firms acknowledge that Both venture and buyout firms acknowledge that improved LP reporting will be a benefitimproved LP reporting will be a benefit

1 2 3 4 5 1 2 3 4 5


54%54% 57%57%



Venture and buyout firms also indicate that Venture and buyout firms also indicate that improved transparency will be a benefitimproved transparency will be a benefit

1 2 3 4 5 1 2 3 4 5


49%49% 42%42%



Firms indicate that there will be significant Firms indicate that there will be significant challenges to developing a standardchallenges to developing a standard

Low likelihood of agreement among

industry players

Difficulty in designing the components of a single standard

Concerns about theconfidentiality of individual

company valuations

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

75%75%52%52%

73%73%



Venture and buyout firms are both concerned with Venture and buyout firms are both concerned with the low likelihood of agreement in the industrythe low likelihood of agreement in the industry

1 2 3 4 5 1 2 3 4 5


76%76% 72%72%



However, large venture firms are particularly However, large venture firms are particularly concerned with low likelihood of agreementconcerned with low likelihood of agreement

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

76%76%91%91%

70%70%




Venture Firms



Firms are equally concerned with the difficulty of Firms are equally concerned with the difficulty of designing components of a single standarddesigning components of a single standard

1 2 3 4 5 1 2 3 4 5


74%74% 71%71%



However, larger venture firms are more concerned with However, larger venture firms are more concerned with difficulty in designing components of a single standarddifficulty in designing components of a single standard

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

73%73%

83%83%79%79%




Venture Firms



Firms are concerned with the confidentiality of Firms are concerned with the confidentiality of individual company valuationsindividual company valuations

1 2 3 4 5 1 2 3 4 5


50%50%54%54%



Midsize buyout firms are especially concerned about Midsize buyout firms are especially concerned about the confidentiality of company valuationsthe confidentiality of company valuations

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

48%48% 47%47%

65%65%




Buyout Firms



Venture firms are more likely to carry pre-IPO investments Venture firms are more likely to carry pre-IPO investments at cost with adjustments for subsequent financing eventsat cost with adjustments for subsequent financing events

How firms report carrying pre-IPO investments Venture Buyout

At cost with adjustments for subsequent At cost with adjustments for subsequent financing events for significant deterioration financing events for significant deterioration

84%84% 50%50%

At cost w/ no interim adjustments prior to At cost w/ no interim adjustments prior to exitexit

5%5% 13%13%

Marked to market using public company Marked to market using public company comparables and illiquidity discountscomparables and illiquidity discounts

1%1% 9%9%

Note: percentages do not add to 100% because some survey participants provided alternative answersor did not respond to the question


Venture firms are more likely to revalue a Venture firms are more likely to revalue a company when new outside financing occurscompany when new outside financing occurs

What events cause firms to revalue a portfolio company investment Venture Buyout

New outside financingNew outside financing 89%89% 66%66%

Missed milestones Missed milestones 55%55% 41%41%

Major changes in relevant industry sectorMajor changes in relevant industry sector 46%46% 43%43%

New strategic investorNew strategic investor 45%45% 41%41%

New inside financingNew inside financing 23%23% 23%23%

Other, please specifyOther, please specify 17%17% 17%17%

Don't use cost methodDon't use cost method 3%3% 6%6%


Venture firms are more likely to revalue portfolio Venture firms are more likely to revalue portfolio companies quarterlycompanies quarterly


Quarterly AnnuallySemi-Annually

MonthlyQuarterly AnnuallySemi-Annually

Monthly

Note: percentages do not add to 100% because some survey participants provided alternative answersor did not respond to the question


Venture firms are more aware of existing Venture firms are more aware of existing valuation standardsvaluation standards


NVCA BVCAEVCAANY NVCA BVCAEVCAANY

The proposed 1990 NVCA guideline is most the most widely known The proposed 1990 NVCA guideline is most the most widely known standard for US firmsstandard for US firms

57%

41%

Any indicates either the NVCA, EVCA, BVCA or Other


Large venture firms are more aware of current Large venture firms are more aware of current standards compared to small venture firmsstandards compared to small venture firms

NVCA BVCAEVCA




Venture Firms

ANY NVCA BVCAEVCAANY NVCA BVCAEVCAANY


50%

68%74%


Venture firms are more likely to use existing Venture firms are more likely to use existing standards as the basis for internal guidelinesstandards as the basis for internal guidelines



The proposed 1990 NVCA guideline is most the most widely used The proposed 1990 NVCA guideline is most the most widely used standard for US firmsstandard for US firms

36%

20%



Midsize and large venture firms are more likely to use Midsize and large venture firms are more likely to use existing standards as the basis for internal guidelinesexisting standards as the basis for internal guidelines




NVCA BVCAEVCAANY NVCA BVCAEVCAANY NVCA BVCAEVCAANY

Venture Firms

33%41%41%



When aware of existing standards, venture firms When aware of existing standards, venture firms are more likely to use them for internal guidelinesare more likely to use them for internal guidelines


63%

47%


The proposed 1990 NVCA guideline is most the most widely used The proposed 1990 NVCA guideline is most the most widely used standard for US firmsstandard for US firms



Firms indicate that a PE industry association Firms indicate that a PE industry association should lead the effort if a standard is developedshould lead the effort if a standard is developed

PE In

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Ass

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LP In

dust

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Ass

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New

PE

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Ass

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SEC

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No

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Note: percentages do not add to 100% because some survey participants provided alternative answers


Both venture and buyout firms report that a PE Both venture and buyout firms report that a PE industry association should lead the effortindustry association should lead the effort

PE

In

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46% of firms surveyed would like to be part of the 46% of firms surveyed would like to be part of the process of creating industry standardsprocess of creating industry standards

NoYes NoAnswer


Venture firms are more interested in being part of Venture firms are more interested in being part of the process of creating an industry standardthe process of creating an industry standard


Yes No AnswerNo Yes No AnswerNo


AcknowledgementsAcknowledgements

• The survey questionnaire was developed by Professor The survey questionnaire was developed by Professor Colin Blaydon with the assistance of Foster Center staff Colin Blaydon with the assistance of Foster Center staff and Tuck Business School Students. and Tuck Business School Students.

• The analysis and presentation of the survey results were The analysis and presentation of the survey results were conducted by: conducted by:

Professor Colin BlaydonProfessor Colin Blaydon

Professor Fred WainwrightProfessor Fred Wainwright

Professor Michael HorvathProfessor Michael Horvath

Sean Ruhmann (Tuck Class of 2003)Sean Ruhmann (Tuck Class of 2003)


The Foster Center for Private Equity focuses on macro and micro issues relating to private The Foster Center for Private Equity focuses on macro and micro issues relating to private equity: capital markets, financing structures, governance and entrepreneurship. It is actively equity: capital markets, financing structures, governance and entrepreneurship. It is actively involved in the practitioner communities of private equity, both to gain information about current involved in the practitioner communities of private equity, both to gain information about current trends and challenges and to share insights and solutions. The center interacts with institutional trends and challenges and to share insights and solutions. The center interacts with institutional investors, venture capitalists, buy-out investors, corporate venturers, angel investors, investors, venture capitalists, buy-out investors, corporate venturers, angel investors, entrepreneurs, portfolio companies, industry lawyers and accountants, industry associations, entrepreneurs, portfolio companies, industry lawyers and accountants, industry associations, and the media. Through these outreach efforts, the center also promotes networking that and the media. Through these outreach efforts, the center also promotes networking that facilitates the pursuit of venture-backed activities.facilitates the pursuit of venture-backed activities.

A thought leader in the field of private equity, the Foster Center's work is represented in A thought leader in the field of private equity, the Foster Center's work is represented in prestigious publications and industry conferences. The center is a regular contributor to the prestigious publications and industry conferences. The center is a regular contributor to the Venture Capital JournalVenture Capital Journal, the leading industry magazine, and its directors are often sought out as , the leading industry magazine, and its directors are often sought out as authorities by top business publications, such as authorities by top business publications, such as The Wall Street JournalThe Wall Street Journal. The center seeks to . The center seeks to educate Tuck students in entrepreneurship and private equity investing through such courses as educate Tuck students in entrepreneurship and private equity investing through such courses as Private Equity Finance, Advanced Entrepreneurship, Field Studies in Private Equity and through Private Equity Finance, Advanced Entrepreneurship, Field Studies in Private Equity and through supporting internships, fellowships and independent studies.supporting internships, fellowships and independent studies.

For additional information on the Foster Center: For additional information on the Foster Center: http://mba.tuck.dartmouth.edu/pecenter/http://mba.tuck.dartmouth.edu/pecenter/

About the Foster Center for Private EquityAbout the Foster Center for Private Equity

Economy & Finance

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