Survey on Private Equity Valuation Methods (Part 2)

Vivian Fu (MBA II), Johnson Graduate School of Management, Cornell University

9 minutes to read

(10) In which industries your firm would MOSTLY prefer to invest? (Your answer for the following questions will be based on answer to this question.)

(Definitions from PWC Money Tree)

Industry Responses Percentage
Software 26 20.80%
Business Products and Services 17 13.60%
Industrial / Energy 10 8.00%
Biotechnology 8 6.40%
Medical Devices and Equipment 6 4.80%
Consumer Products and Services 6 4.80%
Telecommunications 5 4.00%
IT Services 5 4.00%
Healthcare Services 5 4.00%
Electronics / Instrumentation 4 3.20%
Semiconductors 3 2.40%
Media and Entertainment 3 2.40%
Financial Services 3 2.40%
Networking and Equipment 2 1.60%
Retailing / Distribution 2 1.60%
Computers and Peripherals 0 0.00%
Other 20 16.00%



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Software and Business Products & Services are the two most popular industries that VC and PE firms would like to invest in. Due to the survey was designed to find out if industry preference will also affect the choice of valuation method, 20 respondents have selected "Other" for this question. Among those stated "Other", 6 of 20 stated that they are generalists or investing in a diversified group. 5 out of 20 are investing not only in healthcare, but also medical devices, business or financial services. 5 out of 20 are specialized in a specific type of technology like wireless & supporting technology or clean technology. In addition, we have firms interested in manufacturing, building materials or security & safety industries.

Please answer the following questions based on the industry you selected for Question 10

Pre-investment Valuation:

(11) What valuation method(s) does your firm use when evaluating initial investment (frequency distribution):

Seed Early Expansion Later Bridge Mezzanine - debt Buyout PIPES Turnaround Distressed
Comparable Transactions 36 59 45 29 3 8 24 6 3 1
Comparable Multiples (P/E, EV/EBITDA) 10 26 39 34 4 7 34 5 5 1
Discounted Cash Flows 5 17 18 23 1 3 23 4 3 0
Net Assets of Investment Company 6 8 5 5 1 2 8 1 2 2
Industry Valuation Benchmarks (e.g. price per subscriber) 16 30 24 22 3 4 12 5 2 1
Adjusted Present Value 6 7 11 10 1 3 6 0 0 0
Option Valuation Approach 2 1 5 7 1 2 0 0 0 0
Other 13 14 3 4 1 0 1 1 3 0



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The result shows that "Comparable transactions" appeared to be the most popular valuation methods used by both VC and PE firms in doing their valuation. If we analyze across different stages of investment, "Comparable transactions" method is used mainly at Seed, Early and Expansion stage, as the investors are looking into a more mature stage: Later, Bridge, Buyout and Turnaround, "Comparable multiples" becomes the dominant method.

(Continue on Question 11)

(11) What valuation method(s) does your firm use when evaluating initial investment (frequency distribution):

Industry Comparable Transac-tions Compa-rable Multiples Dis-counted Cash Flows Net Assets of Invest-ment Company Industry Valuation Bench-marks Adju-sted Present Value Option Valuation Approach Other
Software 45 36 32 9 1 10 3 0
Other 33 32 27 14 5 13 9 1
Business Products and Services 23 29 13 21 6 4 5 3
Industrial / Energy 10 11 3 9 2 1 3 0
Semiconductors 9 3 8 2 9 4 0 4
Telecommunications 11 7 3 8 3 2 1 1
Biotechnology 15 3 8 4 1 2 0 2
Healthcare Services 8 8 6 4 1 0 3 0
Consumer Products and Services 5 7 5 4 2 0 3 2
Medical Devices and Equipment 9 2 1 4 6 0 3 1
Financial Services 6 5 3 4 3 0 1 2
IT Services 9 9 1 3 1 0 1 0
Electronics / Instrumentation 5 5 0 5 3 1 2 0
Networking and Equipment 6 4 2 2 2 0 2 2
(blank) 4 2 2 2 0 2 2 0
Media and Entertainment 6 2 3 0 0 2 0 0
Retailing / Distribution 2 0 2 2 0 0 2 0

If we analyze the result in terms of industry, it is found that "Comparable Transactions" is also the most popular choice among different industries. "Comparable Multiples" comes as the second most popular method.

(12) Please rank the valuation methods according to your preference in terms of importance for your valuation analysis:

Industy Comparable Transactions Comparable Multiples (e.g. P/E, EV/EBITDA) Discounted Cash Flows Adjusted Present Value Industry Valuation Benchmarks (e.g. price per subscriber) Grand Total
Software 14 9 1 24
Other 5 4 6 1 2 18
Business Products and Services 3 7 7 17
Industrial / Energy 1 5 4 10
Biotechnology 5 1 1 7
Consumer Products and Services 1 3 2 6
Medical Devices and Equipment 4 1 1 6
IT Services 1 3 1 5
Electronics / Instrumentation 2 1 1 4
Healthcare Services 1 3 4
Telecommunications 1 1 1 1 4
Financial Services 2 1 3
Semiconductors 3 3
Media and Entertainment 1 1 2
Retailing / Distribution 2 2
Networking and Equipment 1 1
(blank) 2 2
Grand Total 45 40 24 5 4 118



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This question asked respondents to rank their preference on valuation methods. The result here displayed the first choice that respondents made according to the industry that they mostly invest in. The result is in line with what we find in terms of stages (see Question 11), "comparable transactions" and "comparable multiples" are the most popular among the listed 7 valuation methods.

(13) Please select the term clause(s) that you would take into consideration for your valuation analysis:

Responses Percentage
Stock options & warrants 106 83.5%
Anti-dilution clauses 99 78%
Ratchet clauses 90 70.9%
Convertible Debt Instruments 81 63.8%
Liquidation preferences 75 59.1%
Commitments to take up follow-on capital investment 60 47.2%
Other 10 7.9%



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Please answer the following questions based on the industry you selected for Question 10

Post-financing Valuation for Portfolio Companies:

(14) Concerning determining interim portfolio company valuation between financing rounds, which factors do you consider?

Seed Early Expansion Later Bridge Mezzanine - debt Buyout PIPES Turnaround Distressed
Rarely Change (if no material events occur) 38 57 42 29 6 5 21 3 4 1
Comparable Transactions 6 13 13 5 1 5 9 2 3 1
Comparable Multiples (P/E, EV/EBITDA) 5 10 10 7 0 7 17 3 2 0
Discounted Cash Flows 1 2 7 4 1 3 7 3 2 0
Net Assets of Investment Company 2 6 2 1 0 1 2 0 1 0
Industry Valuation Benchmarks (e.g. price per subscriber) 4 6 0 3 0 2 3 1 0 0
Adjusted Present Value 3 2 0 1 1 0 1 0 0 0
Option Valuation Approach 0 0 1 1 0 1 0 0 0 0
Other 1 4 3 0 0 1 1 1 0 0



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It is interesting to find that VC and PE firms rarely change their interim portfolio company valuation unless there is material event occurred. Hence, there is some opinion among industry that it needs fair value pricing to protect limited partners' interest.

(15) Do you think the Private Equity industry has done an adequate job at developing guidelines & standard for fair value pricing?

Responses Percentage
Yes 46 36.8%
No 50 40.0%
Not Sure 29 23.2%



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However, from this result, it shows that general partners at PE firms aware the issue of fair value pricing and hope to get more guidelines or set up standard for fair value pricing.

(16) Do you prefer cash in/cash out performance metrics or IRR?

Responses Percentage
Cash in / Cash out 31 24.4%
IRR 32 25.2%
Neither 2 1.6%
Both 62 48.8%



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Almost half of the respondents prefer to use both cash in/cash out and IRR for performance evaluation. While IRR is a measure that is easy to compare for performance across different funds, it is important to know how the VC and PE firms manage the cash flow in and out of the investment to assess the realized return as IRR only reflects the unrealized in most cases.

(17) Is performance attribution a factor in deciding which valuation method to use?

Responses Percentage
Yes 22 17.5%
No 70 55.6%
Not Sure 34 27%



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(18) Is valuation method dictated in your subscription agreements?

Responses Percentage
Yes 25 19.8%
No 101 80.2%



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Majority of the VC and PE firms surveyed does not disclose their valuation methods in the subscription agreements. Further analysis could be conducted to see if VC and PE firms would change the way that they evaluate investment if the valuation methods are required to be disclosed.

Summary

Overall, the VC firms are mostly invested in early stage of the company with $1 - 5 million of investment. They normally invest in Series A and B of rounds. For PE firms, majority of the respondents are doing buyout deals and focus on cash-for-equity investment of $10 - 20 Million. Majority of the firm on average invests in about 0 - 9 companies per year and with an investment horizon of 3 - 5 years. It is common for VC & PE firms to have only about 1 - 5 analysts in the firm to carry out valuation analysis.

The result indicates that VC & PE firms are more interested in companies in Software or Business Products and Services industry. Despite lack of public information, VC and PE firms would use comparable transactions and comparable multiples for valuation. In addition, most of the firms would consider stock options & warrants, anti-dilution and ratchet clauses when valuing the company. As VC & PE firms rarely change their interim portfolio company valuation, it may be important for the industry to come up with fair value pricing guidelines and standard going forward.

The above publication was produced with the help of WebSurveyor.