Investment sold at a discount within six months of valuation: Fund A valued its investment in Company A at the median LTM EBITDA multiple of 7.5x. Six months later, it sold the investment to Fund B at a multiple of 6.5x.
In considering the factors that might have contributed to the difference between the valuation and the sale price, Fund A’s management noted that there were significant changes in market conditions as a result of the Covid-19 pandemic.
Fund A’s management determined that changes to its valuation process were not needed because the impending Covid-19 pandemic was not known or knowable to Fund A when it valued Company A.
Investment sold at a premium within a month of valuation: The same circumstances mentioned above apply except that Fund A began negotiations for the sale of Company A to Fund B before its valuation process was finalized. The sale was completed within a month of valuation.
Fund A’s management identified Fund B’s perception of the value of combining Company A and Company B as the key factor in the difference between Fund A’s value and the sale price. Management also determined that the deal team knew that Fund B believed there were synergies in combining the companies but did not incorporate that information into the valuation.
Fund A’s management concluded that any known assumptions related to a market participant’s perception of value and any ongoing sale negotiations should be incorporated into the valuation process. Fund A’s management will be able to improve its valuation process by ensuring that any indications of value known by the deal team are incorporated into the valuation. Citing conservatism as a key consideration, fund managers are often hesitant to adjust valuations, even when there are indications of value known by the deal team, unless there is a letter of intent (LOI) in place. Fund managers should be aware that this practice could lead investors to question the effectiveness of their valuation policy.
Danielle Darley is a partner in assurance services with Weaver, a national accounting firm. She can be reached at [email protected]. Kaci Howell is a managing director of valuation services with Weaver. She can be reached at [email protected].