LPs and GPs wrestle with how and when to mark down portfolios

Net asset values of venture portfolios may come down by 20 to 30 percent, says a public pension LP.

Public equities fell off a cliff in March amid the coronavirus outbreak. Now VCs are tasked with the question of whether and when to adjust the values of portfolio companies, many of which are losing revenue and slashing growth projections.

“Marks is a huge issue for LPs and GPs now. Those marks determine what people can do going forward,” says an LP in charge of private equity investments at a public pension fund.

LPs could find themselves in breach of allocation policy if illiquid assets are not adjusted downward after the public side of the portfolio has had a significant decrease, he says. In those cases, LPs may have to forgo making further commitments to private managers or even worse, be forced to sell their stakes on secondary markets.

In a recent Duff & Phelps-hosted webinar titled “Coronavirus: How should institutional investors be valuing fund interests,” portfolio valuation practitioners advised LPs to review Q1 net asset values submitted by GPs with additional scrutiny.

“Last round of financing should no longer be a default value,” Ryan McNelley, managing director with Duff & Phelps tells Venture Capital Journal. Under the recently updated private equity and VC valuation guidelines, GPs are required to go through a proactive valuation process each quarter, McNelley says.

This process called recalibration does not usually result in a change to fair value for early-stage companies, according to McNelley. But now that the economy has gone into a downturn, GPs are required to think critically if the value of portfolio companies have changed from the last valuation reporting date, he says. 

Accounting guidelines ask investors to consider if revenue, customers, supply chain and operations of the business have been impacted by the crisis.

“Different GPs come to the table with different narratives around valuation,” McNelley says. “Some early-stage VCs say that we have a 10-year horizon, and this is just a ‘blip’ for their companies. Other investors may use this as an excuse to reset expectations and knockdown portfolios by 20 percent.”

While Duff & Phelps is emphasizing the importance of March 31 marks because that is the first reporting period after the start of the crisis, some GPs are not ready to adjust net asset values as of Q1.

“We are not going to make any changes to values until June 30,” says Jeff Ransdell, founding partner at Rokk3r Fuel, a venture capital firm based in Miami. “Things only changed in March. We need more time to understand how our companies are impacted by the crisis.”

Laura Thompson, a principal with Sapphire Partners, an LP division within Sapphire Ventures, says: “GPs should adjust marks for the crisis when they feel that they have enough information to do so accurately. If they believe they need to wait for a quarter or two to understand the impact and accurately capture it, that makes sense to me.”

While it may take several quarters for venture valuations to adjust to the new economic environment, the resulting decreases will likely be significant.

“I fear that eventual markdowns will be 20 to 30 percent,” says the LP at a public pension fund. “I am concerned that some companies don’t have liquidity and we will see some zeroes in Q3.”

As for now, his pension fund is estimating that its venture portfolio will be marked down by 10 percent in Q1 and another 10 percent in Q2, the LP says.