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Examiners Reviewing Funds’ Startup Valuations

The Wall Street Journal reports that the SEC is focusing on funds’ procedures for valuing holdings in private technology companies. The article highlights funds’ increasing investments in “hot startups,” noting that “[f]ive of the biggest fund firms participated in funding rounds worth a combined $8.3 billion this year as of Sept. 30, up from $1 billion for the full year of 2011.” According to the article, “[e]xaminers, who are questioning fund managers as well as independent board members of fund companies, are asking about the procedures and tools funds are using to land at the prices they are placing on the startups.”
 
The focus by the SEC comes after another piece by the Wall Street Journal last month highlighted the variations in funds’ valuations of the holdings. For example, the article noted that, as of June 30, fund groups valued Uber Technologies, Inc. anywhere from $33.32 up to $40.02 per share. The article also cited one example of a fund valuation of a Brazilian retailer being dropped from $7.41 per share one quarter to $0.03 per share the next quarter after the fund determined that the retailer would be liquidated. After the company was instead acquired the following quarter, the valuation rose to $2.22 per share.  However, unlike securities trading on an exchange, these privately held companies do not have a market price and funds must assign a “fair value” to these securities every day. Funds use different procedures and have access to varying information about privately held companies, so the prices assigned to a particular company may vary.  The 1940 Act allows for a range of prices provided that the prices are determined in good faith.  As Scott McKee, who audits private company valuations for KPMG, points out in the article, “[u]ntil you get to a point where there’s an IPO, there is no one price.”