Accounting and Valuation Guide: Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies

689 Pages·2019·4.582 MB·English

by  AICPA

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Accounting and
Valuation Guide

Valuation of Portfolio Company Investments of
Venture Capital and Private Equity Funds and
Other Investment Companies
June 1, 2019
1811-5988
© 2019 by
American Institute of Certified Public Accountants. All rights reserved.
For information about the procedure for requesting permission to make copies of
any part of this work, please email [email protected] with your
request. Otherwise, requests should be written and mailed to Permissions Department,
220 Leigh Farm Road, Durham, NC 27707-8110 USA.
1 2 3 4 5 6 7 8 9 0 AAP 1 9
ISBN 978-1-94830-662-1
iii
Preface
About This AICPA Accounting and Valuation Guide
ThisAICPAAccountingandValuationGuidehasbeendevelopedbytheAICPA
PE/VC Task Force (task force). This guide provides guidance and illustra-
tionsforpreparersoffinancialstatements,independentauditors,andvaluation
specialists1,2 regarding the accounting for and valuation of portfolio company
investmentsofventurecapitalfunds,privateequityfundsandotherinvestment
companies.Thevaluationguidanceinthisguideisfocusedonmeasuringfair
valueforfinancialreportingpurposes.
The financial accounting and reporting guidance contained in this guide has
been reviewed and approved by the affirmative vote of at least two-thirds of
themembersoftheFinancialReportingExecutiveCommittee(FinREC),which
is the designated senior committee of the AICPA authorized to speak for the
AICPAintheareasoffinancialaccountingandreporting.Conformingchanges
madetothefinancialaccountingandreportingguidancecontainedinthisguide
willbeapprovedbytheFinRECChair(orhisorherdesignee).Updatesmade
tothefinancialaccountingandreportingguidanceinthisguideexceedingthat
ofconformingchangeswillbeapprovedbytheaffirmativevoteofatleasttwo-
thirdsofthemembersofFinREC.
Thisguidedoesthefollowing:
•
IdentifiescertainrequirementssetforthintheFASBAccounting
StandardsCodification®(ASC).
•
Describes FinREC's understanding of prevalent or sole industry
practiceconcerningcertainissues.Inaddition,thisguidemayin-
dicate that FinREC expresses a preference for the prevalent or
soleindustrypractice,oritmayindicatethatFinRECexpresses
apreferenceforanotherpracticethatisnottheprevalentorsole
industrypractice;alternatively,FinRECmayexpressnoviewon
thematter.
•
Identifies certain other, but not necessarily all, industry prac-
ticesconcerningcertainaccountingissueswithoutexpressingFin-
REC'sviewsonthem.
1 Wordsortermsdefinedintheglossaryaresetinitalicizedtypethefirsttimetheyappearin
eachchapterofthisguide.
2 Althoughthisguideusesthetermvaluationspecialist,VSsection100,ValuationofaBusi-
ness,BusinessOwnershipInterest,Security,orIntangibleAsset,whichispartofAICPAProfessional
Standards,definesamemberwhoperformsvaluationservicesasavaluationanalyst.Furthermore,
theMandatoryPerformanceFramework(MPF)andApplicationoftheMPF(collectivelyreferredto
asMPFdocuments)thatwerejointlydevelopedbytheAICPA,theRoyalInstitutionofChartered
Surveyors(RICS),andtheAmericanSocietyofAppraisers(ASA),inconjunctionwiththeCertified
inEntityandIntangibleValuations(CEIV)credential,defineanindividualwhoconductsvaluation
servicesforfinancialreportingpurposesasavaluationprofessional.Thetermvaluationspecialist,
asusedinthisguide,issynonymouswiththetermvaluationanalyst,asusedinAICPAProfessional
Standards,andthetermvaluationprofessional,asusedinMPFdocuments.
Manyprivateequityfundsandventurecapitalfundsemployprofessionalstoperformvaluations
forthefund'sinvestmentsand,thus,thefundmayproducevaluationsinternally,ratherthanengag-
inganexternalparty.Otherfundsmayengageanexternalthirdpartytoperformvaluationsorto
corroboratethefund'svaluations.Whenreferringtothevaluationspecialistwithinthisguide,itis
generallypresumedthatthevaluationspecialistmaybeeitheranexternalpartyortheindividual(s)
withintheentitywhopossesstheabilities,skills,andexperiencetoperformvaluations.
©2019, AICPA AVG-PCI
iv
•
Provides guidance that has been supported by FinREC on the
accounting,reporting,or disclosure treatment of transactions or
eventsthatarenotsetforthinFASBASC.
AccountingguidancefornongovernmentalentitiesincludedinthisAICPAAc-
countingandValuationGuideisasourceofnonauthoritativeaccountingguid-
ance.FASB ASC is the authoritative source of U.S.accounting and reporting
standardsfornongovernmentalentities,inadditiontoguidanceissuedbythe
SEC.AICPAmembersshouldbepreparedtojustifydeparturesfromU.S.gener-
allyacceptedaccountingprinciples,asdiscussedinthe"AccountingPrinciples
Rule"(ETsec.1.320.001and2.320.001).3
ThisguideisconsideredtobetechnicalliteratureforpurposesoftheManda-
toryPerformanceFramework(MPF)andApplicationoftheMPF(collectively
referred to as MPF documents),that were developed in conjunction with the
CertifiedinEntityandIntangibleValuationsTM(CEIVTM)credential.4Inaddi-
tion,AICPAmemberswhoperformengagementstoestimatevaluethatculmi-
nateintheexpressionofaconclusionofvalueoracalculatedvaluearesubject
totherequirementsofVSsection100,ValuationofaBusiness,BusinessOwner-
shipInterest,Security,orIntangibleAsset,whichispartofAICPAProfessional
Standards.
Thisguidedoesnotincludeauditingguidance;5however,auditorsmayuseitto
obtainanunderstandingoftheaccountingrequirementsandthevaluationpro-
cessapplicabletoportfoliocompanyinvestmentsofventurecapitalandprivate
equityfundsandotherinvestmentcompanies.
Recognition
PE/VCTaskForce
SeanMcKee,Co-Chair
AmandaMiller,Co-Chair
ScottBurger
TravisChamberlain
TimothyCurt
DavidDufendach
JohnFerro
QuintinKevin
DavidLarsen
AdrianMills
RaymondRath
BelanneUngarelli
3 AllETsectionscanbefoundinAICPAProfessionalStandards.
4 Additional information about the CEIV credential and MPF documents is available at
www.aicpa.org/membership/join/credentials.html?tab-1=5.
5 AU-Csection540,AuditingAccountingEstimates,IncludingFairValueAccountingEstimates,
andRelatedDisclosures,inAICPAProfessionalStandardsaddressestheauditor'sresponsibilities
relatingtoaccountingestimates,includingfairvalueaccountingestimatesandrelateddisclosures,
inanauditoffinancialstatements.
AuditorsmayalsofindithelpfultorefertotheAICPAAuditGuideSpecialConsiderationsin
AuditingFinancialInstruments,which,amongotherthings,addressestheauditor'sresponsibilities
relatingtoauditingaccountingestimates,includingfairvalueaccountingestimates,andrelateddis-
closures.
AVG-PCI ©2019, AICPA
v
AICPASeniorCommittee
FinancialReportingExecutiveCommittee
(memberswhenthiseditionwascompleted)
JamesDolinar,Chair
J.KellyArdreyJr.
MichelleAvery
CathyClarke
MarkCrowley
RichardDietrich
WilliamFellows
JoshuaForgione
AngelaNewell
MarkNorthan
WilliamSchneider
JaySeliber
JeffSisk
LynneTriplett
JeremyWhitaker
MichaelWinterscheidt
AleksZabrevko
(pastmemberswhocontributedtothisedition)
AaronAnderson
LindaBergen
MuneeraCarr
RickDay
GautamGoswami
RandolphGreen
WalterIelusic
MattKelpy
JackMarkey
SteveMoehrle
BJOrzechowski
DanitaOstling
RobertOwens
RichardPaul
BernardPump
PhillipSantarelli
MarkScoles
DustyStallings
BrianStevens
AngelaStorm
MichaelTamulis
The AICPA and the PE/VC Task Force gratefully acknowledge the follow-
ing individuals and groups for their assistance in development of this guide:
Chad Arcinue, Shaan Elbaum, Sally Ann Flood, Tracy Green, Michael Hall,
Stephen Holmes, Jonathan Howard, Daniel Iamiceli, Deborah Jones, Travis
Krueger,KevinLowry,MichaelMaher,MassimoMessina,RichardPeteka,Eric
Rechtschaffen,AnneRockhold,AjayShah,RachelSimons,AdamSmith,Moez
Virani,RichardWallaceandtheNCREIFPREAReportingStandards.
©2019, AICPA AVG-PCI
vi
AICPAStaff
YelenaMishkevich
SeniorManager
AccountingStandardsServices
MarkSmith
SeniorManager
ForensicandValuation
DanielNoll
SeniorDirector
AccountingStandardsServices
EvaSimpson
Director
ForensicandValuation
Guidance Considered in This Edition
RelevantguidanceissuedthroughMay1,2019,hasbeenconsideredinthede-
velopmentofthiseditionoftheguide.However,thisguidedoesnotincludeall
accounting,valuation,andotherrequirementsapplicabletoanentityorapar-
ticularengagement.Thisguideisintendedtobeusedinconjunctionwithall
applicablesourcesofrelevantguidance.
In developing this guide, all guidance issued up to and including the follow-
ingwasconsidered,butnotnecessarilyincorporated,asdeterminedbasedon
applicability:
•
FASB Accounting Standards Update (ASU) No.2019-04,Codifi-
cationImprovementstoTopic326,FinancialInstruments—Credit
Losses,Topic815,DerivativesandHedging,andTopic825,Finan-
cialInstruments
•
AICPA's Statement on Standards for Valuation Services No. 1,
ValuationofaBusiness,BusinessOwnershipInterest,Security,or
IntangibleAsset(VSsec.100)
Usersofthisguideshouldconsiderguidanceissuedsubsequenttothoseitems
listedpreviouslytodeterminetheireffect,ifany,onentitiesandengagements
coveredbythisguide.Indeterminingtheapplicabilityofrecentlyissuedguid-
ance,itseffectivedateshouldalsobeconsidered.
FASB standards quoted are from the FASB Accounting Standards Codifica-
tion ©2019, Financial Accounting Foundation. All rights reserved. Used by
permission.
AICPA.org Website
TheAICPAencouragesyoutovisitthewebsiteataicpa.org,andtheFinancial
Reporting Center at www.aicpa.org/frc. The Financial Reporting Center sup-
ports members in the execution of high-quality financial reporting. Whether
you are a financial statement preparer or a member in public practice, this
center provides exclusive member-only resources for the entire financial re-
porting process,and provides timely and relevant news,guidance and exam-
plessupportingthefinancialreportingprocess.Anotherimportantfocusofthe
AVG-PCI ©2019, AICPA
vii
Financial Reporting Center is keeping those in public practice up to date on
issuespertainingtopreparation,compilation,review,audit,attestation,assur-
anceandadvisoryengagements.CertaincontentontheAICPA'swebsitesref-
erencedinthisguidemayberestrictedtoAICPAmembersonly.
©2019, AICPA AVG-PCI

TableofContents ix
TABLE OF CONTENTS
Chapter Paragraph
Introduction .01-.11
Background ................................................ .02-.05
Scope ...................................................... .06-.09
InformationIncludedinThisGuide .......................... .10
GuidetotheGuide ......................................... .11
1 OverviewofthePrivateEquityandVentureCapitalIndustry
andItsInvestmentStrategies .01-.81
Introduction ................................................. .01-.13
InvestmentStrategiesandPortfolioCompanyLifeCycle ...... .14-.21
TypicalFundStructuresandRoleofFundManager .......... .22-.27
FundEntity(LimitedPartnership)—TheInvestment
Company ............................................. .22-.24
Compensation,FundManagementFees,and
CarriedInterest ........................................ .25-.27
InvestorBase ............................................... .28-.38
DefinedBenefitPensionPlans ............................ .30-.31
SovereignWealthFunds .................................. .32
DevelopmentFinanceInstitutions .......................... .33
EndowmentFunds ........................................ .34
High-Net-WorthIndividualsandFamilyOffices ............ .35-.37
FundsofFunds ........................................... .38
InvestmentHorizonandReturnConsiderations ............... .39-.45
Long-TermOrientation .................................... .39-.41
RiskTolerance ............................................ .42-.45
ImpactonPortfolioCompanyValuations ..................... .46-.57
Planningfor"Exits" ....................................... .46-.48
StrategicBuyers .......................................... .49-.51
PublicEquityMarketsandIPO ............................ .52-.57
ConsiderationsforEarly-StagePortfolioCompanies .......... .58-.73
ThePortfolioCompany’sStrategyandPositioning ......... .66
MarketOpportunity ...................................... .67
ProductAdoptionandCustomerBehavior ................. .68
CompetitiveLandscapeandPresenceofaFirst-to-Market
Advantage ............................................ .69
RegulatoryApprovalandOtherGatingFactorstoMarket
Access ................................................ .70
UseofSubjectMatterExpertsandAdvisers ............... .71
ExecutiveManagementandTheirTrackRecords ........... .72
MacroInvestmentEnvironmentfortheParticular
Early-StagePortfolioCompany ......................... .73
RegulatoryEnvironment .................................... .74-.77
U.S.SecuritiesandOtherRegulation ...................... .75-.77
©2019, AICPA Contents