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Portfolio valuation methodology
A description of the methodology used to value the Group’s
portfolio is set out below in order to provide more detailed
information than is included each year in the accounting policies
for the valuation of the portfolio. The methodology complies in all
material aspects with the guidelines of the British Venture Capital
Association.
Basis of valuation Investments are reported at the Directors’
estimate of Fair Value at the reporting date. Fair Value represents
the amount for which an asset could be exchanged between
knowledgeable, willing parties in an arm’s length transaction.
General In estimating Fair Value, we seek to use a
methodology that is appropriate in light of the nature, facts and
circumstances of the investment and its materiality in the context
of the total portfolio. Methodologies are applied consistently from
period to period, except where a change would result in a better
estimation of Fair Value. Given the uncertainties inherent in
estimating Fair Value, a degree of caution is applied in exercising
judgments and making the necessary estimates.
Quoted investments Quoted investments are valued at the closing
mid-market price at the reporting date. This value is reduced by a
Marketability Discount of between 0% and 25% dependent on the size
of the Group’s holding relative to normal trading volumes in that
stock. Where there are formal restrictions on dealing in a
particular security, a discount is applied, reducing over the term
of the restriction. In the case of a six-month restriction, a
discount of 20% would normally be used.
Unquoted investments Most unquoted investments are valued using
one of the following methodologies:
- cost, less any required provision;
- price of recent investment;
New investments are valued at cost for the first 12 months and then
until another methodology becomes more appropriate. This generally
occurs when the first full set of accounts covering a period of at
least six months since the date of investment becomes
available.
Any investment in a company that has failed or is expected to fail
within the next 12 months has the equity shares valued at nil and
the fixed income shares and loan instruments valued at the lower of
cost and net recoverable amount.
Generally, the process of estimating the Fair Value of an
investment involves selecting one of the above methodologies and
using that to derive an Enterprise Value for the investee company.
The process is then to:
- deduct from the Enterprise Value all financial instruments
ranking ahead of the Group;
- apply an appropriate Marketability Discount;
- apportion the remaining value over the other financial
instruments including the Group’s loans, fixed income shares and
equity shares.
Where that apportionment indicates a shortfall against the loans or
fixed income shares, then the Group considers whether, in
estimating Fair Value, the shortfall should be applied, and if so,
to what extent.
The Marketability Discount will generally be between 10%-30% with
the level set to reflect the Group’s influence over the exit
prospects and timing for the investee company.
When using the earnings multiple methodology, earnings before
interest and tax (“EBIT”) are used, adjusted to a maintainable
level and taxed at the standard corporation tax rate. Generally,
the latest full year historical accounts are used unless there is
an indication of a forecast downturn in earnings in the current or
forecast year, in which case those earnings may be used. An
appropriate multiple is applied to these earnings to derive an
Enterprise Value. Normally the multiple will be the average taxed
EBIT multiple for the relevant sector of the FTSE Global SmallCap
Europe index, adjusted downwards by the Group to exclude
loss-making companies.
Where a company reports an operating loss or the industry standard
valuation methodology is by reference to the asset base, then the
value may be estimated using the net assets methodology.
The price of recent investment methodology is used mainly for
investments in venture capital companies and includes cost of the
investment or valuation by reference to a subsequent financing
round. Valuation increases above cost are only recognised if that
round involved a new external investor and the company is meeting
milestones set by the investors. The relevance of this methodology
can be eroded over time due to changes in the technology, business
or market which may indicate an impairment has occurred. In this
case, carrying values will be reduced to reflect Fair Value.
Other factors that may be taken into account include:
- the expected effect of ratchets, options and liquidation
preferences;
- any industry standard valuation methodology;
- offers received as part of a sale process which may either
support the value derived from another methodology or be used as
the valuation less a Marketability Discount of typically 10%.
For the Group’s smaller investments, the valuation is determined by
a more mechanistic approach using information from the latest
audited accounts. Equity shares are valued at the higher of an
earnings or net assets methodology. Fixed income shares and loan
investments are valued at the lower of cost and net recoverable
amount. Approximately 15% by value of the Group’s unquoted
investments are valued using this methodology.
An analysis of the portfolio by valuation method is given in the portfolio analysis.
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