Introduction to Private Equity Valuation
Private equity funds predominantly invest in illiquid securities, often without readily available market prices. This creates valuation challenges, as managers must either rely on third-party inputs (such as brokers or valuation consultants) or determine values internally. Under accounting frameworks such as IFRS and US GAAP, most private equity investments fall under Level 3 of the fair value hierarchy—those requiring unobservable inputs and management judgment. Because GPs exercise broad discretion in these cases, a number of inherent potential conflicts of interest are present. In order to provide oversight of these conflicts, a number of compliance policies and procedures are commonly in place.
The starting point for understanding valuation approaches is the fund formation documents, namely the Private Placement Memorandum (PPM) and Limited Partnership Agreement (LPA). These documents typically set out high-level rules for valuing both liquid and illiquid assets. For example:
– Securities listed on a recognized exchange are valued at the average closing sales price on a trading day.
– Over-the-counter securities are valued at the average closing sales price on a trading day.
– Illiquid securities are valued based on relevant factors at the GP’s discretion, including comparable transactions, financial position, operating performance, liquidation terms, interest rates, economic conditions, recent significant events, and ownership levels.
While these rules provide structure, they still grant GPs considerable discretion, especially for Level 3 assets. This is broadly aligned with “mark-to-model” valuation. To reduce subjectivity, many firms establish a Valuation Committee, which, although not legally required, is considered best practice.
Valuation Committees typically consist of senior GP personnel, such as portfolio managers, finance, compliance, and operations staff. They usually meet quarterly, though ad-hoc meetings are held if material events affect valuations. Their role is to ensure policies are applied consistently across funds, review supporting analysis, and challenge conclusions. Subcommittees often focus on individual portfolio companies, with recommendations then escalated to the full committee or the GP’s Investment Committee.
Best practice is for GPs to prepare valuation memoranda for each holding, even when no change in value occurs. These documents summarize valuation conclusions, models used, supporting data, and any concerns requiring closer monitoring. This memorializes the process and demonstrates discipline to LPs and regulators.
Valuations at cost (upon acquisition) or realized value (upon sale) are straightforward. The more difficult challenge is determining interim fair values. Typically, GPs revalue quarterly, but they may also adjust valuations if material events occur, such as a financing round or market shock.
In some cases, GPs engage third-party valuation consultants. These firms provide independent opinions on asset values, either as a discretionary tool of the GP or as mandated by fund documents—for example, if a single investment exceeds 20% of committed capital. However, consultants are expensive and their conclusions are usually advisory rather than binding. For this reason, third-party valuations remain less common in PE than in hedge funds, though adoption is increasing under LP and regulatory pressure.
Because valuations directly affect Net Asset Value (NAV), unrealized gains, management fees, and carried interest, LPs pay close attention to the process. Disagreements between LPs and GPs are often escalated to the Limited Partner Advisory Committee (LPAC). Fund documents usually allow LPACs to object within a set time (e.g. 30 days). If objections persist, a multi-step appraisal procedure involving independent experts may be triggered. Given the time and cost, most disputes are resolved through compromise or by deferring to the GP’s expertise.
Third-Party Administrators (TPAs)
Fund administrators are third parties that provide accounting and investor services. Their main functions include:
Fund accounting services:
– Recording asset purchases and trades
– Calculating profit and loss, fees, accruals, and NAV
– Preparing financial statements
– Maintaining partnership and general ledgers
– Performance measurement and reporting for managers
Investor services:
– Overseeing capital commitments, contributions, and withdrawals
– Ensuring compliance with AML and KYC requirements
– Preparing tax reports for investors
Historically, many private equity firms self-administered, with the GP acting as its own administrator. By contrast, hedge funds quickly adopted third-party administration, with some even employing dual administrators for additional oversight. LPs have increasingly pressured private equity managers to follow suit, citing independence and transparency. Today, an estimated two-thirds of private equity funds outsource administration to third-party providers, and this figure is rising.
The scope of services has expanded to include asset verification, where administrators confirm fund holdings directly with custodians and counterparties. This provides LPs with greater comfort over asset existence. However, due to the illiquid and bespoke nature of private equity portfolios, administrators generally add little value to core valuation processes, which remain heavily reliant on GP expertise.
In summary, private equity valuations rely heavily on GP judgment, supported by governance mechanisms such as valuation committees, LPAC oversight, and, increasingly, third-party administrators. The growing use of TPAs reflects LP demand for independent oversight and regulatory trends toward transparency, though their role in valuing illiquid assets remains limited.
