Valuation of AIF portfolio at year-end

Definition of financial assets

According to this regulation “financial assets, including derivatives included in assets, are measured no later than at the end of the reporting period, at reliably determined fair value”. Here, however, we encounter a problem because, due to the nature of the private market, determining fair value in the case of Venture Capital investments is highly problematic.

Year-end closing and obligation to revaluate assets on a VC fund’s portfolio

The topic of portfolio revaluation is a key issue raised during the mandatory audit of an Alternative Investment Company’s annual accounts. The professional scepticism required of auditors may lead to conservative assumptions being made as to the value of the portfolio, and this in extreme cases may result in the abuse of write-downs, valuation at net asset value, or maintaining the value of investments at acquisition value, i.e. the valuation methods prevailing in the case of classic manufacturing or service entities. However, here we are talking about investment activity, so for some managers such approach is unacceptable due to the created message to the investor (lack of positive revaluation, with a significant cost base, clearly indicates permanently negative financial results, interspersed with profits from years in which profitable exits are made).

A certain market consensus on the Polish Venture Capital market is the methodology proposed by PFR for the valuation of assets not listed on an active market, which divides equity investments into three stages:

• Acquisition price – when there is no more up-to-date information about the object of valuation than is apparent from the transaction;
• Adjusted transaction price – when, due to internal or external factors, the value of the investment now deviates from the terms of the last authoritative investment round;
• Dedicated valuation model – when a company has an appropriate performance history and operating model.

Due to its plasticity and ease of implementation, the adjusted transaction price model enjoys great interest among Venture Capital funds. However, it should be pointed out that the timeframe for its application, although variable, was modelled as 24 months. This timeframe gains significance, as two years have just passed since the introduction of this methodology and it may turn out that some of the managers will be obliged to prepare dedicated valuation models for their portfolio of deposits.
This is a non-trivial task, as one has to reconcile often contradictory positions of managers and investors (who by definition care about the increase of the portfolio value) and auditors (who are more willing to see a write-down than an appreciation of value), therefore the turn of the year should be used for

• verification of the provisions of the accounting policy with regard to asset revaluation;
• selection of the valuation method for individual investments;
• verification of the completeness of transaction documentation;
• verification of recorded changes in the capital structure for investments made;
• reviewing and updating valuation models used in previous periods;
• obtaining input data for valuation models.

Such activities will allow us to be better prepared for the preparation and audit of the financial statements, on which work in the accounting departments starts already at the beginning of the first quarter of 2022.