What Happened?
The Cayman Islands government recently amended its 2020 Private Funds Law to classify Alternative Investment Vehicles within the scope and under the regulation of the Cayman Islands Monetary Authority (CIMA). The law came into effect after the EU blacklisted the Cayman Islands on tax matters, and was also driven by the OECD and Caribbean Financial Action Task Force. The amendment is one of many examples of increasing demand for transparency in Venture Capital & Private Equity portfolio reporting.
In April 2020, the SEC proposed a new rule on Fund Valuation Practices (Rule 2a-5) under the Investment Company Act that will essentially require private funds to follow comprehensive fair value determination methodologies. The issuance and codification of fair value guidance ASC 820 in GAAP also supports this push.
Industry players are also pursuing fair valuation best practices. The International Private Equity and Venture Capital Valuation (IPEV) Guidelines have been endorsed by around 40 National Venture Capital Associations around the globe. From the LP side, ILPA has consistently advocated for more transparency around valuation methodology in recent years.
The Regulations
SEC Rule 2a-5
Appropriate Fair Value Methodologies must be consistently applied, and periodically reviewed through testing
Valuation Risks (defined in proposal) must be periodically assessed
Pricing Services used by a Fund must be monitored and evaluated, and 3rd party Fair Valuation Procedures must have board oversight and meticulous record keeping
Cayman Islands
Private funds must have consistent asset valuation procedures carried out at a frequency that is appropriate for the assets held and meets fund reporting obligation to investors
Required to have an annual audit by a Cayman Islands-based auditor and filing of such audited financial statements with CIMA
All AIVs, including VC and PE firms, co-investment vehicles and master funds must register by August 7, 2020. Sovereign wealth funds and single family offices are not affected.
Practical Implications for VCs
In addition to requirements around registrations and filings which fall outside our area of expertise, technical implications for fund managers include:
Auditors are less likely to accept fair value valuation based on last round pricing.
More scrutiny will be placed on accurate application of all cap table implications when calculating fair value - i.e. correct consideration of complex issues such as warrants on proportional ownership. This is especially important for VCs with later stage investments and/or large portfolios.
Transparency around valuation methodology is essential and will be scrutinized by LPs and regulators
Proactive planning is essential to ensure that any extra costs and time requirements are understood.
Options to Ensure Compliance
Outsourcing services
Fund Administrators
Accounting Services
Valuation Service Providers
Hybrid options
Portfolio monitoring solutions
Cap table management solutions
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Professional services
Raw data output and analysed in Excel
Technology solutions
Valuation technology solutions incorporating portfolio monitoring, cap table management and robust valuation engines
Valuation Technology Considerations - The Expert View: Q&A with Kevin Pearl, VCM Software
We conducted a Q&A with VCM Software’s founder, Kevin Pearl, on how the global trend towards fair valuation regulations will impact the Private Equity & Venture Capital industries as a whole, and why firms need to act now.
VCM Portfolio Fair Value
VCM Portfolio Fair Value is a proven, portfolio-level software package, designed specifically to enable VC fund managers to tackle the intricate complexities of the new Fair Value requirements. Want to learn more? Leave your details below, we’ll be in touch!
Q: Do VCs need to use an external valuation house to calculate their Enterprise Value?
A: No, fund managers can independently determine the Enterprise Values of their portfolio companies. The Cayman Island Fund Law (Section 16.4.b) clearly states that “with the appropriate and consistent procedures…valuations of the assets of a private fund shall be performed by… (b) the manager or operator of the private fund…provided that –
(a) the valuation function is independent from the portfolio management function; or
(b) potential conflicts of interest are properly identified and disclosed to the investors of the private fund
Q: What are the advantages of utilizing technology solutions over outsourced services?
A: Technology solutions allow VCs to own all their cap table and valuation data – constantly available to use on an ongoing basis for yearly and quarterly valuations, investment analyses (IRR, multiples, etc.), plus cap table modeling of future rounds etc.
Q: What are the advantages of utilizing technology solutions over hybrid options?
A: The hybrid solutions execute the Fair Value calculation outside of their cap table platform, which necessitates the VCs to use a ‘third party’ provider each time they need to do a valuation (quarterly & yearly) – adding an extra layer of both expense and time relative to the technology solution, in addition to adding tension to an already tightly scheduled reporting period.
Q: What data needs to be captured to accurately perform valuation analysis?
A: Accurate and up-to-date cap table information – including all the specifics of the various rights related to each security; OPM parameters; Enterprise value
Q: Do technology providers also offer ongoing help to ensure that their clients remain compliant?
A: Yes, typically they offer a range of optional services, from working with fund accountants to ensure the processes are approved before the audit starts and inputting the cap tables and their preferences, to helping prepare transparent reports, enabling successful audit reviews.
Q: Is it possible to run the whole process, solely on technology solutions, without the input of the Vendor?
A: Yes, all the tools required to perform an accurate valuation analysis are included in the platform. Though in practical terms, the Vendor has expertise that usually adds value to the process, both saving time and increasing accuracy.
We can help!
PE Stack helps fund managers identify, qualify and assess software solutions. We work on your behalf to execute a comprehensive and efficient procurement process saving you time and money.
Please leave your details below and we will help you understand your options, or visit our Vendor Profiles platform for immediate access to detailed software intelligence.