Topics include: Best Practices for Valuing Illiquid Portfolio Assets, Fair Value Measurement, Valuation Methods, Valuing Fund Interests, Mezzanine Loans, GIPS Valuation Hierarchy, International Private Equity and Venture Capital Valuation Guidelines (December 2012), CFA Institute Global Investment Performance Standards (2010)

1. 1
Fair Value
Measurement
Best Practices
for Firms Subject to the Investment Company Act of 1940

2. 2
Presentation
Outline
01.International Private Equity and
Venture Capital Valuation
Guidelines (December 2012)
02.CFA Institute Global Investment
Performance Standards (2010)
03.Key Takeaways

3. 3
01.
International Private Equity
and Venture Capital
Valuation Guidelines

4. 4
Determining the
Unit of Account
Multiple Tranches
• Unit of Account determined on same basis that
Market Participants would transact (single
instrument or bundle)
Debt Only
• Unit of Account likely individual debt instrument;
fair value based on yield analysis
Debt and Equity
• Depends on transaction structure of market
participants. In general, private equity investors
often invest in concert with one another and
realize value only when entire business is sold.
Unit of account should be assessed accordingly

5. 5
Fair Value
Measurement:
Conceptual
Considerations
To measure fair value of unquoted investments,
assume the underlying business is realized or
sold at the measurement date, appropriately
allocated to various interests, regardless of
readiness for sale or intent to sell
• If multiple investment tranches owned by fund
would be transacted simultaneously, they should
be valued in aggregate
• Assume that necessary marketing activities
have been completed to allow for hypothetical
exchange on measurement date

6. 6
Fair Value
Measurement:
Apportioning
Attributable
Enterprise Value
to Financial
Instruments
Incorporate effect of ratchets or other
contractual rights in fair value measurement
• Assume that in-the-money options and warrants
are exercised (adjusting for both share count
and exercise proceeds)
• Significant option and warrant positions may need
to be valued separately using an appropriate
option pricing model
• When debt must be repaid upon sale of the
underlying business, assume FV equal to
amount to be repaid
• If debt would not be repaid, fair value of debt,
amount deducted from enterprise value may differ
from par value

7. 7
Valuation
Methods:
Selection
Factors to consider:
• Nature of industry and current market conditions
• Quality and reliability of data used
• Comparability of enterprise or transaction data
• Development stage of enterprise
• Profitability and cash flow attributes of enterprise
• Unique facts and circumstances
• Results of calibration analysis
• Maximize use of techniques that draw heavily
on observable market-based measures of risk
and return
• DCF and industry benchmarks should rarely be
used in isolation from market-based measures

8. 8
Valuation
Methods:
Price of Recent
Investment
Generally most appropriate for early stage
companies subject to frequent funding rounds
• Quality of valuation indication will erode over
time
• Evaluate whether price represented fair value at
the time
• Difference in economic and governance rights
• Disproportionate dilution of existing investors
• Strategic motivations of new investor
• Forced sale or ‘rescue package’

9. 9
Valuation
Methods:
Multiples
Most applicable for investments in
established businesses with identifiable
stream of maintainable earnings
Steps in applying technique:
1. Apply appropriate and reasonable multiple to
maintainable earnings to derive Enterprise Value
2. Adjust Enterprise Value for surplus or non-operating
items, contingencies, and other relevant factors to
derive Adjusted Enterprise Value
3. Deduct value attributable to senior financial
instruments, taking into account potentially dilutive
features to derive Attributable Enterprise Value
4. Apportion Attributable Enterprise Value to relevant
instruments using market participant perspective

10. 10
Valuation
Methods:
Multiples
Multiples of total invested capital generally
most appropriate because of role of financial
structuring in private equity
• Multiples at acquisition should be calibrated to
relevant set of comparable companies
• Presumption is that multiples based on public
company stock prices are indicative of the
value of the company as a whole
• Multiples may be expressed in terms of
‘current’, ‘forecast’, or ‘historical’ earnings,
and should be matched to character of
maintainable earnings

11. 11
Valuation
Methods:
Net Assets
Likely appropriate for business whose value
derives mainly from underlying fair value of
assets rather than earnings
Potentially appropriate for unprofitable or
marginally profitable businesses
Steps in applying technique:
1. Derive Enterprise Value by measuring value of
assets and liabilities
2. Deduct value attributable to senior financial
instruments, taking into account potentially dilutive
features to derive Attributable Enterprise Value
3. Apportion Attributable Enterprise Value to relevant
instruments using market participant perspective

12. 12
Valuation
Methods:
Discounted
Cash Flows
(Enterprise)
Flexible, but risky, valuation technique
• Required inputs (detailed cash flow
forecasts, terminal value, discount rate)
require substantial subjective judgment
• Indicated value often sensitive to small
changes in inputs
• Generally perceived to be more useful as a
cross-check of values estimated under
market-based techniques

13. 13
Valuation
Methods:
Discounted
Cash Flows
(Investment)
Most appropriate when:
• Exit is imminent
• Exit pricing has been substantially agreed
• Particularly suitable for valuation debt and
mezzanine investments for which value derives
mainly from instrument-specific cash flows and
risks rather than from the value of the enterprise
as a whole
• For non-equity instruments, pre-defined terminal
values enhance the reliability of the technique
• Implied discount rate at initial investment should
be adjusted over time for changes in market
conditions

14. 14
Valuation
Methods:
Industry
Valuation
Benchmarks
Industry-specific benchmarks often based on
assumption that investors are willing to pay for
revenue and that normal profitability within the
industry does not vary much
• Reliable technique only in limited situations
• Most likely to be useful as a sanity check against
other valuation indications

15. 15
Valuing Fund
Interests
May use attributable portion of NAV if:
• Reported NAV is appropriately derived using
proper fair value principles as part of a robust
process
• Fair value of underlying investments measured
as of the same date as the fund interest
valuation
• Interests in the Fund are not actively traded
• Management has not decided to sell the fund
interest for an amount other than applicable
portion of net asset value
Adjustments may be appropriate for:
• Timing differences
• Potential performance or other fees payable
• Other factors

16. 16
Valuing Fund
Interests:
Secondary
Transactions
Data from secondary transactions must be
considered if:
• Relevant terms of the transaction are known
• The transaction is considered orderly
• Prices in secondary transactions may be
influenced by factors beyond fair value and
based on assumptions and return expectations
unique to the counterparties
• If secondary transaction prices are available, but
secondary market not deemed active, prices
should be augmented with other inputs, such as
NAV

17. 17
Application:
Other
Considerations
Terms of internal funding rounds not
necessarily indicative of fair value
• When debt is trading at a discount to par,
deduct par value from Enterprise Value
unless the subject company has acquired
the debt in the market and intends to cancel
rather than repay
• Bridge financing should be included as part
of the overall investment being valued, if
consistent with market participant
perspective
• When valuing PIK instruments, assess
expected present value of amount to be
recovered

18. 18
Application:
Other
Considerations
Impact of ratchets and other liquidation
preferences should be assessed relative to the
likelihood that the investor would receive
benefit of full contractual right (in practice, full
benefits may not be realized)
• Mathematical option pricing models are
rarely used by market participants, and have
not seen wide usage in the private equity
marketplace
• Indicative offers may provide useful
additional support, but are generally
insufficiently robust to be used in isolation

19. 19
Application:
Mezzanine
Loans
Price at which mezzanine loan was issued
generally reliable indicator of fair value at
that date
• Should assess whether indications exist
that loan will not be fully recovered
• Should assess whether changed in
required yield are indicated
• Attached warrants should be evaluated
separately from the mezzanine loan

20. 20
02.
CFA Institute Global
Investment Performance
Standards

21. 21
Global Investment Performance Standards (2010): Private Equity Provisions
Recommended Provisions Required Provisions
Frequency of Valuation PE investments must be valued at least quarterly PE investments must be valued annually
Basis of Valuation The fair value basis is required The fair value basis is required
Valuation Methodologies
Material differences between valuation used in performance reporting and financial
reporting should be explained and disclosed
Disclose valuation methodologies used in most recent period
Selected Methodologies &
Assumptions
Key assumptions used to value portfolio investments should be disclosed
The selected valuation methodology must be the most appropriate for a
particular investment based on its nature, facts, and circumstances
Valuation Considerations
The following factors should be considered:
1. Quality and reliability of data used in each methodology
2. Comparability of enterprise or transaction data
3. Stage of development of the enterprise
4. Additional considerations unique to the enterprise
Changes in Valuation
Method
Disclose material changes to valuation policies and/or methodologies Disclose material changes to valuation policies and/or methodologies
Industry Valuation
Guidelines
Disclose which, if any, industry valuation guidelines adhered to, in addition
to GIPS
Disclose which, if any, industry valuation guidelines adhered to, in addition
to GIPS
Investment Performance
Multiples
Disclose multiples of committed and cumulative paid-in capital:
1. Investment Multiple: Total Value to Paid-In Capital
2. Realization Multiple: Distributions to Paid-In Capital
3. Paid-In Capital Multiple: Paid-In Capital to Committed Capital
4. Unrealized Capital Multiple: Residual Value to Paid-In Capital
Disclose multiples of committed and cumulative paid-in capital:
1. Investment Multiple: Total Value to Paid-In Capital
2. Realization Multiple: Distributions to Paid-In Capital
3. Paid-In Capital Multiple: Paid-In Capital to Committed Capital
4. Unrealized Capital Multiple: Residual Value to Paid-In Capital
Use of Valuation Hierarchy The valuation hierarchy (see next slide) should be used
Disclose if the valuation hierarchy differs materially from the recommended
hierarchy
Valuation Inputs Disclose the use of subjective unobservable inputs in valuing investments Disclose the use of subjective unobservable inputs in valuing investments
Independent Valuation
Review
Valuations should be obtained from a qualified independent third party Not required

22. 22
GIPS
Valuation
Hierarchy
(Inputs)
1. Objective, observable, unadjusted quoted market
prices for identical investments in active markets
on the measurement date
2. Objective, observable quoted market prices for
similar investments in active markets
3. Quoted prices for identical or similar investments
in markets that are not active
4. Market-based inputs, other than quoted prices,
that are observable for the investment
5. Subjective unobservable inputs for the investment
where markets are not active at the measurement
date. Use these inputs only to the extent
observable inputs and prices are not available or
appropriate. Unobservable inputs reflect
assumptions about the assumptions market
participants would use in valuing an investment

23. 23
03.
Key Takeaways

24. 24
Best Practices for
Valuing Illiquid
Portfolio Assets
Recognize that valuation matters, and it
will really matter when something has
gone awry
• Document valuation procedures to follow
(and follow them)
• Designate a member of senior
management to be responsible for
oversight of the valuation process
• Create contemporaneous and consistent
documentation of valuation conclusions
and rationale

25. 25
Best Practices for
Valuing Illiquid
Portfolio Assets
Stay abreast of evolving best practices
(or know people who do)
• Solicit relevant input from the
professionals responsible for the
investment, auditors, and third-party
experts
• Check your math
• Disclose the process and conclusions -
potential investors take comfort in
transparency

26. 26
Contact
Information
Travis W. Harms, CFA, CPA/ABV
901-322-9760
harmst@mercercapital.com
Jeff K. Davis, CFA
615-345-0350
jeffdavis@mercercapital.com
MERCER CAPITAL
Clark Tower
5100 Poplar Avenue, Suite 2600
Memphis, Tennessee 38137
www.mercercapital.com

27. 27
Portfolio Valuation
Services
Mercer Capital’s

28. 28
About
Mercer Capital
• Business valuation and financial advisory firm
founded in 1982
• Core competency is the valuation of private equity
and debt securities
• Valuation and positive assurance opinions
• Fairness and solvency opinions
• Transaction advisory
• Litigation support
• 400 assignments annually, primarily for domestic
entities
• 40 employees (employee-owned)
• Valuation and industry thought leaders

29. 29
Overview
of Services
Valuation
• Tax compliance
• Corporate valuation services
• Employee Stock Ownership Plan valuation
Transaction Advisory Services
• Fairness and solvency opinions
• M&A and investment banking services
• Buy-sell agreements and private company transactions
Financial Reporting
• Private equity, mutual fund, BDC, and other investment
company portfolio valuation services
• Purchase price allocation
• Impairment testing services
Litigation Support
• Expert testimony
• Business damages
• Shareholder disputes / divorce

30. 30
Financial
Reporting
Valuation
Services
Mercer Capital provides a comprehensive suite of valuation services to
assist boards of directors, portfolio managers, financial managers and
others with financial reporting requirements.
In an environment of increasingly complex fair value reporting standards
and burgeoning regulatory scrutiny, Mercer Capital helps clients resolve
fair value reporting issues successfully.
Mercer Capital fair value opinions are consistently accepted by the Big
Four audit firms and other reviewing entities.
Our professionals hold the Accredited in Business Valuation (ABV)
designation from the AICPA, the Accredited Senior Appraiser (ASA)
designation from the American Society of Appraisers and the Charter
Financial Analyst (CFA) designation from the CFA Institute.
Valuation Services for Investment Funds
• Portfolio Investment Valuation
• Fairness and Solvency Opinions
• Litigation Support
Valuation Services for Portfolio Companies
• Purchase Price Allocation
• Goodwill Impairment Testing
• 409A / Equity Compensation Valuation

31. 31
Key Industry
Verticals
Financials
• Depositories
• Asset managers
• BDCs
• Insurance
• Brokers and investment banks
Manufacturing
• Durable and non-durable goods
• Consumer and industrial
Healthcare
• Facilities companies
• Medical devices
• Staffing companies
Distribution and Transportation
• Wholesale distribution
• Asset-based transportation companies (all modes)
• Third-party logistics providers

32. 32
Senior
Professionals
Jeff K. Davis, CFA
• Managing Director
• 10 years with Mercer Capital
• Spent 13 years as a sell-side analyst covering small-
and mid-cap banks and specialty finance
• Weekly editorial contributor to SNL Financial
Travis Harms, CFA, CPA/ABV
• Senior Vice President
• 15 years with Mercer Capital
• Extensive financial valuation reporting experience,
including on behalf of private equity, BDCs and broker-
dealers

33. 33
Senior
Professionals
Z. Christopher Mercer, ASA, CFA, ABAR
• CEO / Founder (1982)
• Prolific author and thought leader on private security
valuation
• Has prepared and overseen over a thousand
valuations for M&A, tax, litigation and other matters
Matt Crow, ASA, CFA
• President
• 19 years with Mercer Capital
• Senior member of Mercer’s financial reporting
valuation group

34. 34
Senior
Professionals
Timothy R. Lee, ASA
• Managing Director
• 19 years with Mercer Capital
• Heads corporate valuation group with industry focus in
beverage, distribution, construction, retail and
transportation
Andy Gibbs, CFA, CPA/ABV
• Senior Vice President
• 14 years with Mercer Capital
• Has completed hundreds of bank and loan portfolio
valuations as head of the depository group for M&A,
ESOP, and other purposes