Fair Value

Fair value solves a pricing problem

An exchange-traded stock can usually be observed at a current market price. A privately held company cannot.

Fair value is the measurement process used when an investment must be valued without simply reading a quoted market price from an active market.

That makes fair value especially important in private equity, venture capital, private credit, real estate and other illiquid strategies.

Fair value is an estimate, not a promised exit price

A private asset can be assigned a fair value of $50 million and later sell for $42 million or $65 million.

The earlier mark was a measurement under the information and assumptions available at that time. It was not a contractual guarantee of future sale proceeds.

SEC Rule 2a-5, which governs fair-value determinations for registered investment companies and business development companies, emphasizes valuation risks, appropriate methodologies, testing and oversight when market quotations are not readily available.^[1][2]

Private funds are not all governed by that rule, but the valuation principle is useful for investors: a fair-value mark should be understood together with the method used to produce it.

Common private-market valuation approaches

Depending on the asset, valuation work can consider:

• recent financing rounds
• comparable-company trading multiples
• precedent transactions
• discounted cash-flow analysis
• revenue or EBITDA multiples
• debt levels and capital structure
• company-specific operating performance
• market conditions
• liquidity and transfer restrictions

ILPA’s glossary describes private-equity valuation as the process of assigning value and notes methods such as discounted cash flow and comparables.^[3]

No single method is automatically correct for every investment.

Fair value affects reported fund performance before cash is realized

Suppose a fund invests $20 million in a company.

One year later, the GP marks the position at $28 million based on updated operating results and comparable-company multiples.

The fund now reports an $8 million unrealized increase in value even though the company has not been sold.

That higher mark can increase:

• fund NAV
• RVPI
• TVPI
• interim IRR

If the mark is later reduced to $23 million, those reported measures can fall even without a cash transaction.

This is why interim private-fund performance mixes realized cash outcomes with valuation estimates.

Valuation frequency can make private assets look smoother

Public securities reprice continuously. Private assets may be revalued monthly, quarterly or at another reporting interval.

Less frequent marking can make reported private-market volatility appear lower than the economic volatility of the underlying businesses.

A smooth quarterly valuation series should not be interpreted as proof that the asset itself is low risk.

Fair value and NAV serve different roles

Fair value generally applies to individual assets or liabilities.

NAV is an aggregate fund measure:

assets at their reported values − liabilities

A change in the fair value of a portfolio company can therefore change fund NAV, but the two terms are not synonyms.

Common mistakes

“Fair value means the price is objectively known.”

No. The need for fair-value work often exists precisely because an observable market price is unavailable.

“A higher valuation creates cash.”

No. A mark changes reported value. Cash generally requires a distribution, refinancing or exit.

“The latest financing round is always fair value.”

Not automatically. The round may have occurred under different market conditions or with security terms that differ from the fund’s holdings.

“Fair value eliminates valuation risk.”

It does not. Methodology, inputs and judgment remain important.

When a private fund reports a material change in fair value, the useful questions are not limited to the percentage change. Investors should ask what changed in the company, what valuation method was used, whether leverage changed, whether a third-party transaction supports the mark and how sensitive the result is to the selected assumptions.