Portfolio valuation for private markets

This article explains the principles of portfolio valuation for private funds, including standard methodologies, fiduciary responsibilities, and how to establish a defensible process for limited partner (LP) reporting and audits.

What is portfolio valuation for private funds?

Portfolio valuation for private funds is the process of determining the fair value of their illiquid investments, such as those in venture capital (VC) or private equity (PE). Unlike public stocks with readily available market data, private and alternative investments require a structured analysis to estimate their worth, making valuation a cornerstone of portfolio management, fund accounting, and reporting.

To understand portfolio valuation, you first need to be familiar with the types of assets that require this analysis in private markets. These are different from the typical stocks and bonds you might find in a public portfolio. Their value isn't listed on an exchange, so it must be estimated through a formal process.

• Private company equity: This includes both preferred and common stock in portfolio companies that are not publicly traded. Because there is no active market for these shares, their value must be derived using specific valuation methodologies rather than a simple market price.

• Profits interest units: These are a form of equity-like compensation often used in PE and LLCs. They give the holder a share in the future profits or equity appreciation of the company without the same tax implications as traditional stock.

• Private credit financing: This refers to loans made to private companies, and their value is closely tied to the overall company valuations of the borrowers. Their value depends on the creditworthiness of the borrower and the specific terms of the loan, not on a traded market price.

• Convertible instruments, warrants, and options: These are rights or securities that can convert into equity at a later date. Their valuation is complex because it depends on the terms of that future conversion and the underlying company’s estimated value.

Why portfolio valuation is a fiduciary duty

For a professional in fund management, accurate portfolio valuation is not just an accounting task but a fundamental fiduciary responsibility to your limited partners (LPs). This duty means you must act in the best interests of your investors. Providing a fair and accurate assessment of their investment's value is a key part of that trust.

These valuations are the bedrock for critical fund operations and reporting. Without a reliable valuation, you can't accurately report performance or manage the fund's economics.

Valuations directly influence the most important metrics, like the multiple on invested capital (MOIC), and financial calculations for your fund.

• Calculating net asset value (NAV): NAV is the fund's total assets minus its liabilities, representing the fund's total worth.

• Reporting fund performance: Key metrics like total value to paid-in capital (TVPI) rely on the residual value of the portfolio, which you determine through valuation. This reporting is a cornerstone of building and maintaining trust with your LPs.

• Determining carried interest: While valuations are essential for tracking a fund’s overall worth, carried interest is typically based on a fund’s realized returns (i.e., when assets are sold and profits are distributed to LPs). Valuations help track the progress toward the hurdle rate, but the final payout to the general partner (GP) depends on the actual cash returns.

Because of its importance, a formal portfolio valuation is required at several key moments in a fund's life. These trigger events give all stakeholders a current and accurate view of the fund's assets.

• Periodic financial reporting for LPs, typically on a quarterly and annual basis.

• The annual fund audit, where an independent auditor will scrutinize the valuation process and conclusions.

• Transactions involving a portfolio company, such as new priced rounds, an acquisition requiring a purchase price allocation (PPA), or an initial public offering (IPO).

How private market portfolios are valued

To produce a defensible asset value, fund managers and valuation specialists use a standard toolkit of methodologies. Accounting standards like Accounting Standards Codification Topic 820 (ASC 820) accept these approaches. They provide a framework for estimating the value of illiquid assets.

The three primary valuation methodologies each look at value from a different angle. A robust valuation process often considers more than one approach to arrive at a well-supported conclusion.

The market approach

The market approach estimates an investment's value by comparing it to similar companies or transactions. This method uses "pricing multiples," such as an enterprise value to revenue ratio, derived from the guideline public company method (GPCM) or recent merger and acquisition deals. You then apply the multiple to the private company's own financial metrics to imply a value.

The main challenge with this approach is finding truly comparable companies. It can be difficult to find public companies that are similar to niche, early-stage, or disruptive private companies. This can make the analysis highly subjective.

While finding truly comparable public companies can be subjective, the GPCM remains a cornerstone of the market approach. To help you apply this methodology, we've created a free calculator that simplifies the process. Input the latest financial information for your chosen public comps, and the tool auto-populates an estimated valuation for your private portfolio company.

Free GPCM valuation calculator

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The income approach

The income approach, most commonly applied through the discounted cash flow (DCF) method, values an investment based on the present value of its projected "future cash flows." This involves forecasting a company's financial performance and then discounting those future cash flows back to today's value. This discount uses a rate that reflects the investment's risk.

This method has its limitations in the venture capital context. Pre-revenue portfolio companies often have highly speculative and unreliable financial forecasts. This can make a DCF analysis less meaningful and difficult to defend.

The asset approach

The asset approach values a company based on the fair market value of its tangible and intangible assets minus its liabilities. This is essentially a calculation of what it would cost to recreate the company's asset base.

The asset approach is rarely used for VC and PE fund valuations, especially for the high-growth, asset-light technology and software companies that define a typical venture portfolio. Instead, it is more commonly applied for holding companies, real estate funds, or companies undergoing liquidation. Their value lies in their intellectual property, growth potential, and market position, not their physical assets.

The challenge of traditional valuations

The traditional valuation process can be a manual, time-consuming ordeal for a fund's finance team. It often relies on disconnected spreadsheets and endless email chains to request data from portfolio companies, a process simplified by effective portfolio monitoring.

This manual process is not just inefficient; it's also risky, a fact compounded by record long investment holding periods that complicate valuation assumptions and increase audit scrutiny over time.

Defending your valuation conclusions to auditors and LPs is also a challenge, largely because there's no widely accepted industry standard for marking the value of portfolio companies. This lack of a universal methodology means your process and conclusions are always open to interpretation and scrutiny.

Establishing a defensible valuation policy

To handle these challenges, you should create a formal valuation policy. This document is a critical piece of fund governance (a topic covered in Carta’s VC regulatory playbook) that outlines your fund's approach to valuation for LPs and auditors. It demonstrates a commitment to a consistent, transparent, and repeatable process.

A robust valuation policy serves as your rulebook. It makes sure that everyone involved understands the process and their responsibilities. It should clearly detail the key components of your valuation methodology, such as:

• The specific valuation methods you'll use for different types of assets

• The frequency of valuations, such as on a quarterly basis

• The data sources for your inputs and assumptions

• The roles and responsibilities of the internal team, any third-party firms providing valuations, and the board or valuation committee

Meeting ASC 820 and audit requirements

Accounting standards like ASC 820 provide the framework for fair value measurement. This standard requires that you base valuations on the perspective of "market participants." This means what a willing buyer would pay in an orderly transaction, not just the fund's own optimistic view.

Preparing for a valuation audit requires clear documentation of all inputs, assumptions, and calculations. A platform-based approach simplifies this process significantly.

Carta's audit readiness features give your firm direct, view-only access to everything they need in a dedicated portal. This centralizes the general ledger, financial statements, and underlying valuation reports in one place. By streamlining access, you eliminate endless email chains and demonstrate a compliant, transparent process from day one.

How a single source of truth strengthens portfolio valuation

Carta’s portfolio valuations tool offers a modern approach that directly solves the challenges of the traditional process. By integrating directly with portfolio company cap tables and financials, Carta automates the tedious and error-prone manual data collection process. This changes valuation from a subjective exercise into a data-backed analysis, giving you and your stakeholders greater confidence in the results. This data also integrates directly with Carta’s event-based fund accounting software for fund administration customers.

This streamlined process connects directly to Carta’s fund administration software, automating the GL update and delivering accurate, auditable financial statements.

How a single source of truth strengthens portfolio valuation

Discover how Carta’s platform automates data collection, streamlines reporting, and provides audit-ready documentation, all in one place.

Request a demo to see how.

Frequently asked questions about portfolio valuation

How does a new financing round affect a portfolio company's valuation?

A new financing round, especially one led by a new institutional investor, provides a new market-based data point for a company's value. You can often use this post-money valuation as the primary indicator of fair value for that reporting period. While this is a straightforward approach for early-stage venture investments, it may not be applicable for private equity firms due to the complex nature of the companies they acquire. In those cases, the financing round is just one input for a more comprehensive valuation analysis.

What is the difference between portfolio valuation and measuring fund performance metrics?

Portfolio valuation determines the current worth of your assets at a single point in time. Performance measurement uses metrics like internal rate of return (IRR) and TVPI to analyze the returns generated on your invested capital over the life of the fund.

How often should a private equity fund value its portfolio?

The industry standard for private equity funds is to conduct a full portfolio valuation on a quarterly basis. This frequency is essential for providing timely updates to your LPs and for accurately tracking key performance metrics like TVPI. Since the “value” component of these metrics must be current, a new valuation is required each quarter. This cadence aligns with standard LP reporting cycles and ensures compliance with accounting principles.