The Securities and Exchange Commission has begun an informal inquiry into how private equity firms value their investment assets and how they are “marked to market”. A listing of the firms that received the inquiry letter has not been released but thus far, it appears the inquiry has focused on smaller firms as publicly traded firms already provide quite a bit of information in quarterly and annual filings.

One of the main areas of concern for the SEC is the valuation of the private equity firm’s investment portfolio. Often, these investments are marked to market using complex valuation methodologies and intricate financial models. Additionally, business valuation is as much an art as it is a science and that has led to different valuations being reported for the same portfolio company. The chief concern is whether private equity firms have been overstating the values of the portfolios in order to generate more attention and attract new potential investors.

In order to remove themselves from some level of scrutiny, some firms have turned to valuation specialists in order to help with the process. After receiving these third party valuations, some private equity firms discuss the valuations, methodologies employed and assumptions utilized with their auditors and other advisors. Additionally, many private equity firms also contend that interim valuations are less important to investors as private equity funds earn profits only when they sell a holding, not on an annual basis like many other investment vehicles.

Since the SEC is at the beginning of their inquiry, it’s hard to tell what may come of it, but it certainly looks like valuations are going to be getting more attention going forward. Our business valuation team is here to help should you have any questions or concerns on your own valuations or the valuations of companies you are looking to invest in. Please contact me (btaylor@kahnlitwin.com) or any other member of our team for further assistance.

KLR is one of the largest accounting firms in Boston that offers business valuation services including ESOP valuations, small business valuations, fair market value reports, estate and gift tax preparation and acquisition assistance. Litigation support services such as marital dissolution (divorce) and shareholder and partnership buyouts and disputes are also offered.