Founder education

Valuations in a time of uncertainty

March 27, 2020
Chad Willbur

Valuation of private equity investments is inherently difficult. There is no active market to provide up-to-date pricing, length of holding period is uncertain, and the companies are often in their early and high-growth stages, making indications sparse. This is especially true during periods of extreme volatility, like what’s happening now due to COVID-19.

The anticipated impact of COVID-19 has forced teams to rewrite sales forecasts, manage their cash, and trim parts of the business—all while access to capital is diminished. It means we are entering a period of impaired assets, where current value for an asset is less than what’s on a balance sheet.

Here are some key examples of the types of companies that may be impaired in the short-term:

  1. Companies that raised in the last six months (or in significantly different market conditions) 
    • Multiples have fallen since the start of the public market contraction. Companies that raised recently in a bull market may need to be reassessed. Anecdotally, in 2008 private markets lagged behind the public markets by 15 to 45 days.
  2. Companies that expected to raise capital in 2020 
    • Companies that planned to raise capital in 2020—particularly the first half—may face a dwindling cash balance at a time when capital is either expensive or, potentially, unavailable. Companies with less available cash may need to be reassessed for the risk associated with limited funding.
  3. Companies that planned to exit (IPO or acquisition) in 2020
    • Near-term exits are up in the air for the foreseeable future. Assumptions about the current value of an investment that are directly related to this anticipated exit will likely need to be revisited.
  4. Companies that have made significant changes to their forecasts 
    • Most companies will be significantly impacted by a prolonged downturn. Those with more sophisticated finance teams may be preparing revised forecasts to account for the changing market conditions. As companies reforecast, it is most appropriate to reassess fair value to account for these changes. 
  5. Companies disproportionately impacted by COVID-19 or the market contraction
    • The effects of the COVID-19 pandemic and ensuing market contraction won’t impact all companies equally. Some industries will be impacted more significantly than others. Companies offering services related to travel have experienced significant decreases in valuations. Others, like those in the biopharma industry may be positively affected.

Venture portfolios have the potential to be very reactive to all of the above scenarios. Concerns of impairment will undoubtedly bring valuations under increased scrutiny from each portfolio’s GPs and the LPs that fund them. 

Why asset impairment valuations are important

In periods of economic growth when forecasts are stable and capital is easily accessible, a more relaxed valuation standard is acceptable. In times of shake up and uncertainty, LPs will need to demonstrate a proof of assets, which will translate into a more regular assessment of the companies underlying their portfolios. 

This is what many experienced in 2008. We foresee that—most likely on a quarterly basis—LPs will demand a discussion with their GPs to review any potential markdowns (or markups). 

What asset impairment valuations will look like

Extreme volatility means the underlying inputs that feed into your valuation models are constantly changing. As the general business environment continues to change and your companies respond, you will want your valuations to consider all new and relevant indications.

Here are the important components that affect asset valuation:

  • Methodologies: Because prior pricing is no longer reliable, what models should you be using?
  • Inputs: Under new valuation methodologies, inputs previously not considered will now determine the valuation. Relevant inputs may also change dramatically (such as revenue growth, cash burn, etc).
  • Multiple scenarios: Extreme volatility creates an environment where multiple scenarios with materially different outcomes have near equal probability.

We expect that careful calibration will be necessary over the next 12 to 24 months—and your auditor will most likely expect it—which is why you need a smart, flexible way to forecast future valuations.

The best way to approach impaired valuation

Start preparing early. Your portfolio companies will need your help during these turbulent times, and your GPs and LPs will be asking a lot of you. Building a valuation solution to capture and adapt to changes as they occur will provide you with the support you’ll need for potentially difficult portfolio review calls. 

The good news is that the strong companies in your portfolio will continue to grow in the long-term, as will the strong fund managers that invest in them. To weather the storm until then, the best foot forward is to implement a solution to better track the potential risk in your portfolio. 

For current Carta investor services customers, expect product enhancements to help you deal with impaired valuations very soon. Whether you’re a customer or not and would like help in evaluating your portfolio, just reach out to us—we’re here to help. 

This blog was written with Aaron Jacobs.

DISCLOSURE: This publication contains general information only and Carta Investor Services, LLC (“Carta”), an affiliate of eShares, Inc. dba Carta, Inc., is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services.  This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor.  This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.