Private Equity Fund Managers Do Not Over-Value Their Company Investments

Abstract

We study the valuation behaviour of private equity fund managers using a European private equity fund investor's database. We had not only complete cash flow information from all 2,500 indirect company investments of their funds, but most importantly all its 15,000 valuations by the fund managers. Our overall conclusion is that private equity fund managers do not over-value, in fact they value conservatively in line with valuation guidelines. The average observed valuation of the company investments is close to at cost value over the first two years of investment life. Over the next years, the valuation reflects a fairer value and is strongly influenced by the valuation year. Interestingly, the average valuation declines. We believe this effect is due to the early write-off of bad investments combined with the inability to recognise or write-up top performing investments. We also look at the difference between the last valuation and the exit price to see whether the fund manager under- or over-values. Unlike previous research, we find no evidence that the last valuation before the exit over-values the investment. In fact, the fund managers value very conservatively. The largest underestimation comes from exceptionally well performing company investments. Moreover, again in contradiction to previous research, we found little evidence that factors like experience of the fund manager, market segment or fund size strongly influence the valuation behaviour.

Keywords: venture capital, private equity, valuation

JEL Classification: G12, G14, G24