Valuation complexities often evolve as funds mature, presenting new challenges for fund managers, auditors, and fund administrators alike. While early-stage investments often rely on recent rounds of financing or comparable transaction valuations, later-stage portfolios require more nuanced methodologies, incorporating market conditions, performance metrics, and exit probabilities. Without a clear strategy for managing these complexities, funds may face challenges during the audit process, potentially leading to valuation discrepancies, delays in financial reporting, or even investor concerns.
To shed light on this topic, we’ve collaborated with Angie Ty, an audit partner at CohnReznickLLP with expertise in the alternative investments industry, to outline key valuation considerations for mature portfolios, best practices for reasonable fair valuations, common red flags identified by auditors, and ways fund administrators can enhance transparency in the valuation process.
Early in a fund’s life cycle, valuation methodologies generally tend to be straightforward, often relying on inputs including the last round of financing or other observable transactions. The last round of financing would generally become less relevant as a portfolio matures. This is particularly true when an investment approaches a planned liquidity event, such as an IPO or change of control: Valuation methodologies become more complex or necessarily shift as circumstances become more sophisticated. These methodologies may include discounted cash flow analyses, precedent transactions, and market comparables.
Key challenges that emerge as portfolios mature include:
Without a robust valuation strategy, these complexities can lead to inconsistent financial reporting, investor skepticism, and audit challenges.
A well-documented and transparent valuation process is critical to the facilitation of audit readiness and maintaining investor confidence. Best practices include:
Funds should establish a comprehensive valuation policy aligned with industry standards(e.g., interpretive guidance from the AICPA, IPEV Guidelines) and apply it consistently across investments. A documented policy reduces subjectivity and confirms consistent application across the portfolio’s lifecycle.
As a portfolio matures, it’s likely that no single valuation method is sufficient in isolation. A triangulation approach—combining DCF analysis, public market comparables, and precedent transactions—can provide a more holistic view and strengthen valuation conclusions.
Mature funds should periodically, as appropriate, reassess key valuation inputs, such as revenue projections, discount rates, and industry comparables. Regular calibration to actual performance improves accuracy and audit readiness.
As the portfolio matures and the valuation inputs become less observable, funds will want to keep detailed records explaining valuation inputs, sources, and methodologies to improve transparency and facilitate the audit process. Although a consistent and comparable approach to valuation is fundamental, there are situations that may arise that would require funds to change methodologies or their approach to a portfolio company’s valuation. If the circumstance arises, funds should document the factors (predictable cash flows, time to exit, etc.) considered to make changes to their valuation approach and/or inputs from one period to another. Funds may also be required to disclose these changes in valuation methodologies in the notes to their financial statements.
For complex assets, engaging a valuation firm can add credibility and reduce conflicts of interest. Many auditors prefer valuations backed by third-party expertise.
Auditors focus on consistency, methodology, and the reasonableness of assumptions when reviewing valuations. The most common red flags for an auditor include:
Significant changes in valuation without clear justification raise concerns. Funds should document key drivers behind any material shifts, and these could be qualitative and/or quantitative in nature.
Auditors scrutinize subjective inputs, such as revenue growth projections or discount rates. Funds should substantiate these assumptions with market data and third-party sources.
Maintaining consistency is critical. If comparable assets within the same fund have significantly different valuation methodologies or inputs, auditors may challenge the reasoning.
Funds must provide clear audit trails showing how valuations were derived. Missing or incomplete documentation can result in audit delays or restatements. The most reliable data for auditors is data provided by third-party sources, including the underlying portfolio company. Any data provided by the underlying portfolio company may be confirmed directly by the auditor to verify the information.
If fund valuations deviate materially from public comparables or market transactions, auditors will expect a well-supported rationale.
Management should consider performing retrospective reviews as part of their valuation process to confirm their valuation process is effective. A retrospective review is completed by comparing any exits in the current year to the prior period’s valuation. Any exits that are significantly different from the prior period should be understood and documented.
By addressing these concerns proactively, funds can support the audit process and maintain investor trust.
A strong partnership with an experienced fund administrator can significantly enhance valuation transparency and audit readiness. Here’s how:
As funds mature, increasing valuation complexities require a proactive approach to methodology, documentation, and audit preparation. By implementing best practices, addressing common red flags identified by auditors, and leveraging fund administration expertise, funds can maintain transparent and defensible valuations—ultimately building confidence with investors and auditors alike.
At Vector AIS, we specialize in supporting fund managers with accurate, audit-ready numbers and seamless reporting. If you're navigating valuation challenges in a mature portfolio, let’s talk.
CohnReznick helps organizations optimize performance, manage risk, and maximize value through associated firms operating under the CohnReznick brand: CohnReznick LLP, a licensed CPA firm providing assurance services; and CohnReznick Advisory LLC (not a licensed firm) providing advisory and tax services. For alternative investments, we have deep experience in fund valuations.
Contact Vector AIS to learn how we can support your fund administration needs and connect with CohnReznick for audit and valuation.
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