Knowing the value of assets is the bread and butter of private equity firms. However, this market has a growing demand for transparency, let alone fairness. Investors aren’t the only ones pressing those issues, as the US Securities and Exchange Commission has extended its oversight and resources to investigate predatory practices in private equity. That’s when third-party valuation comes into play.
It’s too soon to say it’s a common practice among private equity firms, as less than 25% currently outsource valuation services. Yet, it’s a rising trend in this market that can ultimately change investment decisions for big and small companies. Here’s why third-party valuation is so important in this niche and why Acquinox.capital is the best company for the task.
Not a Third Wheel
Independent private equity valuations have become a sign of trustworthiness for stakeholders. Such valuations are typically more robust and reliable as they come from a party not involved in the deal. It hasn’t always been like that, though. The wave of skepticism rose with the 2008 crisis, which was responded to by a new law, the Private Investment Advisers Registration Act, in 2010.
The central aspect of this law concerns “Fair Market Value,” which means that private equity companies must mark their positions based on the selling price. Thus, it doesn’t matter what investors want to do with the asset later, whether they keep or resell it; prices should always be market-based.
Indeed, most private equity firms have enough expertise and experience to do the job. However, this niche has grown skeptical after the crisis. In this context, third-party valuations assess those already done by private equity firms, checking whether they are accurate or realistic.
Valuations can take 45 to 60 days to conclude. This timeframe isn’t an issue under normal market conditions but can be very much so in volatile periods. Far too often, companies are reluctant to reduce the value of certain assets during downturns but can get pretty excited about marking them up in bullish periods. In this context, investors trust more on third-party valuators, especially when considering risk assessment.
What Do Third-Party Evaluators Do?
According to the SEC Quarterly Statement Rule, limited partners must have access to quarterly statements. Such statements should bring meaningful and accurate information regarding the company’s performance, guiding investors’ decisions regarding project selection.
Truthfully, the SEC doesn’t specify whether these statements must be made by third-party valuators, private equity firms, or even internally. Nevertheless, outsourcing such services may give more credibility to the figures presented to potential investors, chiefly risk-averse ones. Some big companies spare resources to create an internal valuation committee.
Third-party valuation services can give more legitimacy to their numbers, or maybe not, and that’s why they are so important. Investors and limited partners like to see valuation services independent of the project manager, thus avoiding the trap of biased numbers. So, one of the main functions concerning third-party valuators is to provide additional valuation reports that corroborate internal pricing.
Otherwise, red flags may rise, signaling it’s a bad deal. These evaluators help companies comply with local regulations and provide monthly reports. Investors have recently been asking for independent due diligence before making investment decisions.
Private Equity Firms Under Scrutiny
The private equity business has been thriving impressively in the past decade, with growth figures surpassing 100%. This sharp rise contrasts with the 50% reduction in companies listed in the US stock market in the last 20 years. As the industry grows, it also increases investors’ and lawmakers’ interest in what PE firms do.
While PE firms are unlikely to lose importance, investors and limited partners want more information regarding their methods. This includes detailing how fund managers run these calculations in the first place. The keyword here is “transparency,” as new investors want to know how PE firms develop and profit from their portfolios. So, such firms can expect to face ever-deeper scrutiny in the next few years.
The Office of Compliance Inspections and Examinations (OCIE) has found through academic evidence that prices are usually inflated in the fundraising stage. Worse still, some PE firms have been caught red-handed disclosing specific valuation methods to investors while, in fact, they were using different ones.
It has put fund managers under a magnifying glass, who now are pressed to maintain consistent methodologies throughout the process, clearly outlining any exceptions that may arise. Additionally, the SEC has amended the Private Fund Adviser Rules in 2023, further regulating the PE market.
PE firms challenged these rules in court in 2024, but most of them still stand. According to the new rules, PE advisors must avoid activities that may create a conflict of interest and are no longer allowed to offer compensation schemes to investment advisors.
FAQ
What is third-party valuation, and why is it important?
Third-party evaluators are independent professionals or companies who assess private equity valuations to ensure their accuracy and fairness. Since these evaluators are involved in the deal, investors often regard their opinions as more trustworthy.
What do third-party valuation services include?
Services include valuation reports, which will be compared to the internal pricing provided by a company. Monthly and quarterly reports and, sometimes, due diligence are also part of the deal.
Is third-party valuation mandatory by SEC rules?
Not at all. Private equity firms are still allowed and capable of handling quarterly statements and other reports. However, using such services may give companies a competitive edge over more risk-averse investors.
