The AICPA recently issued a working draft of an Accounting and Valuation Guide that provides guidance for financial reporting purposes regarding the accounting for and valuation of portfolio company investments of venture capital and private-equity funds and other investment companies within the scope of FASB ASC Topic 946, Financial Services — Investment Companies.
This guide may also be useful for noninvestment companies that make similar investments. The AICPA PE/VC Task Force and AICPA staff developed the working draft, which was reviewed and approved by the AICPA Financial Reporting Executive Committee.
Comments on the working draft can be emailed to Yelena Mishkevich (Yelena.Mishkevich@aicpa-cima.com) by Aug. 15.
Portfolio company investments are defined in the working draft as investments in both equity and debt instruments of privately held enterprises and certain enterprises with traded instruments.
Preparers encounter challenges when estimating fair value of these investments in accordance with FASB ASC Topic 820, Fair Value Measurement, because of the illiquid nature of the market for such investments and the significant subjectivity involved. The AICPA guide is being developed to assist management and boards of directors of investment companies as well as valuation specialists, auditors, and other interested parties with estimating fair value of such investments.
The working draft provides the PE/VC Task Force's perceived best practices for the valuation of investments in equity and debt instruments, and certain aspects of the accounting for those investments.
Specifically, the working draft recommends the following approaches for certain key areas:
- Consider the time horizon of the investment when estimating the fair value of an equity investment, considering the value of debt for the purpose of valuing equity and the value of any net operating losses, even when valuing a controlling position.
- For debt investments with warrant coverage, allocate value between the debt and warrants to report the fair value as separate line items on the schedule of investments.
- Estimate the value of the enterprise for the purpose of valuing equity interests in the enterprise without consideration of premiums or discounts.
- Estimate the fair value of debt and the value of debt for the purpose of valuing equity consistent with the cash flows, the market yield, and the remaining expected term.
- For equity investments in portfolio companies with complex capital structures, consider alternative methodologies or apply appropriate adjustments when using the option pricing method (OPM) to allocate value between senior and junior preferred classes of equity.
- Estimate value by calibrating the selected valuation model to any recent transactions and then update these assumptions for changes between the transaction date and the measurement date.
- Perform back-testing to improve the fund's valuation processes.
- Exclude transaction costs from the fair value of investments on day 2; that is, the fair value immediately after the transaction close may be less than the capitalized cost.