I had a surreal experience at the end of 2008 trying to make sense of investee valuations. While I sat, staring at the snow in anticipation of some profound thought, I realised that all of the noise and clamour of the “financial crisis” had disappeared. It was as if some deity had used a constant and unrelenting snowfall to hypnotise the globe into a cryogenic slumber to give it time to reconsider itself and its actions.

Anyway, after rejoining reality, I wondered what the softening economy and 30-40% falls in public equity markets meant for my firm’s investees. Since times had significantly changed, I had to revisit the EVCA valuation guidelines to understand how I would be valuing these businesses. In doing this, I thought it would make a worthwhile post to give a very brief overview of the recommendations.

The EVCA uses the same guidelines that many other national private equity associations use, and as such, they recommend the following valuation methods (http://www.privateequityvaluation.com):

• Price of a recent investment method – used within 12 months of an investment if there haven’t been any material changes (I think we’d all agree that expectations have materially changed).
• Earnings multiple method – using the latest earnings forecast and an appropriate and reasonable multiple for the applicable industry and size of business, with a marketability discount applied. 
• Net Assets method - only used in cases where the underlying asset is traditionally valued according to specialised methods; such as property or a portfolio of listed investments.
• Discounted cash flows method – used in many other circles, but apparently based on too many subjective assumptions to be useful to the time horizon of private equity.

Upon reading the guidelines, you quickly notice support for the concept that something is worth only what someone is willing to pay. I say this because there is a heavy bias towards the earnings multiple method. This is okay with me, but I feel I should make a post in the next few days on the implications of using this valuation method. So stay tuned… and don’t spend too much time staring out into the snow.