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Today's only advanced comprehensive guide to private equity accounting, investor reporting, valuations and performance measurement provides a complete update to reflect the latest standards and best practices, as well as the author's unique experience teaching hundreds of fund professionals. In Private Equity Accounting, Investor Reporting and Beyond Mariya Stefanova brings together comprehensive advanced accounting guidance and advice for all private equity practitioners and fund accountants worldwide: information once available only by learning from peers.Replete with up-to-date, user-friendly examples from all main jurisdictions, this guide explains the precise workings and lifecycles of private equity funds; reviews commercial terms; evaluates structures and tax treatments; shows how to read Limited Partnership Agreements; presents best-practice details and processes, and identifies costly pitfalls to avoid.
Contents
PART IChapter 1 Private Equity Structures and Their Impact on Private Equity Accounting and Reporting 3Structuring Considerations in Private Equity 4Main Building Blocks and Vehicles of a PE Structure 6Domiciliation: Where to Form the Fund-Onshore or Offshore? 9Simple or Complex? 9Using a Combination of Vehicles 10Master-Feeder Funds 11Structures Involving Blockers 13Parallel Structures 14Master-Feeder or Parallel Structure? 15Alternative Private Equity Structures 16Summary 17Chapter 2 The Importance of Allocations and Allocation Rules 19Introduction: Why Start with Allocations and Allocation Rules? 20What Is an Allocation Rule, and Why Is It So Important in Private Equity Accounting? 20Types of Allocation Rules 21Why Are Different Allocation Rules Used? Is Excel-Based Accounting Adequate? 22How Do Inaccurate Allocations Affect Investors? 27How Can You Identify the Allocation Rules in an LPA? 27What Do You Do If the Allocation Rules Stipulated in the LPA Are Flawed? 28What Is the Best Way of Doing Allocations? 29A Word of Caution for LPs 30Summary 30Last Advice for LPs 30Last Advice for GPs 31Chapter 3 Private Equity Accounting Processes: Some Neglected Processes That Could Expose GPs 33Introduction 34Some Neglected Private Equity Accounting Processes 35Rebalancing 35Partner Transfers/Assignments 37Summary 40Chapter 4 Investor Reporting: ILPA versus IPEV IRG 41Introduction 42Existing Accounting Frameworks and GAAPs Used in Private Equity 43What Is Investor Reporting? 44Existing Reporting Framework 45Comparisons among ILPA, IPEV, and EVCA Reporting Guidelines 45Transition from EVCA RG and Other Local Reporting Guidelines to IPEV IRG 50ILPA or IPEV IRG Compliant? 51Summary 52Endnotes 52Chapter 5 ESG Reporting and Responsible Investing 53Introduction 54Why ESG and RI? 55Potential Material Impacts of ESG Factors and Value Creation 56What Are the Implementation Challenges? 57Some ESG Issues 57Sample Procedure for RI and ESG Implementation 58Stage 1: Developing an RI Policy 59Stage 2: Identifying Specific ESG Factors and Risks 59Stage 3: Implementing ESG Objectives and Putting ESG Systems and Processes in Place 61Stage 4: Assessing Existing Portfolio Companies for ESG Factors and Identifying ESG Factors and Risks 61Stage 5: Integrating ESG Management into the Future PE Investment Process: Brief Study on KKR's RI and ESG Management 61Stage 6: Implementing Specific ESG Programs for Each Portfolio Company 62Stage 7: Set Key Performance Indicators (KPIs) and Start Measuring against Them 63Stage 8: ESG Reporting 64Chapter 6 Private Equity Valuation: Taking Valuation to a Level Higher 67Why Fair Value? A Fair Value History Lesson 68Valuation Guidelines 69Fair Value Accounting Standards 71Basic Private Equity Valuation Concepts 72Basic Facts 73Calibration 73Determining Enterprise Value at a Future Valuation Date 74Market Approach 74Income Approach 74Levels 1, 2, and 3 76Selected Private Equity Valuation Nuances 76Marketability 76Unit of Account 77Valuing Noncontrolling Interest 78Valuing Investments in Private, Nontraded Debt 82Valuing Fund Interests 84Background 85The Future of PE Valuation 90About the Author 91Endnotes 91Chapter 7 Performance Measurement: IRRs, Multiples, and Beyond 93Introduction 94Traditional Performance Measurement in Private Equity-What Is the Status Quo? 94What Is IRR? 94Why IRR Is a Preferred Performance Measure in PE 96IRR Calculation: What Do We Need to Calculate It? 97Manual IRR Calculation 98Using a Computer to Calculate IRR 98The Difference between IRR and XIRR in Excel 98The Guess: Do We Really Need It? 99Pitfalls of Using IRR 99Other Pitfalls 102Levels and Types of IRRs Advocated by Professional Bodies-Gross and Net IRR and Multiples 103Gross IRR and Gross Multiples 103Net IRR 104Don't Forget to Strip Out Carried Interest! 105Money/Net Multiples to Investors 105Alternative Performance Metrics 105Time-Weighted Rate of Return (TWR): Is It an Appropriate Metric for Measuring Performance in PE? 106Modified IRR (MIRR) 106Benchmarking PE Performance to Public Market Returns 108Public Market Equivalent (PME) 108Other Alternative Performance Metrics 109Summary 113Chapter 8 Carried Interest and Carried Interest Modelling 115Why "Carried Interest"? 116Substance of Carried Interest 116Carry Participants 117What Is a Waterfall? 117Dual Nature of Carry 118Cumulative Basis of Calculation 118Types of Carried Interest Models/Arrangements 119Mechanics of Pure Deal-by-Deal Carried Interest Model 120Mechanics of Whole-of-Fund/Whole-Fund/All-Contributions-FirstEuropean-Style Carry Model and the Cumulative Cash Bucket Concept 122Preferred Return 128Hybrid Models 130Clawback: What Is It, and Should We Recognize It in the Financial Statements? 133Accounting for Carried Interest 133Notes on Carry to the Limited Partners 137Summary 138Chapter 9 Consolidated Financial Statements 139Background 140Introduction: Basis for Consolidation 141Does a Fund Need to Consolidate Portfolio Investments That It Controls? 142The Investment Entity Exemption 143Do Any of the Changes Impact the Issue of Consolidation of the Fund? 144Control 145Purpose and Design 146Relevant Activities 147Identification 147How Decisions Are Made 148Power 148Substantive Rights That Give an Investor the Right to Direct the Relevant Activities of the Investee 148Practical Ability 149Other Indicators 150Voting Rights 150Protective and Veto Rights 151Variable Returns 151Principal versus Agent: A Link between Power and Variable Returns 152De Facto Agents 156Putting the Consolidation Issue All Together 157Other Frequently Asked Questions 161What about the Consolidation of Master-Feeder Fund Structures? 161What about the Consolidation of Funds of Funds? 162Are Tax Blockers Treated the Same? 163So Are There Any Other GAAP Options? 164About the Author 168Chapter 10 Technology in Private Equity 169Introduction 170Technology for General Partners 171What Are the Options? 171What Are the Pros and Cons of Having a Specialist PE System? 172Beware the Pitfalls of Implementation 172What Should a Good Comprehensive Specialist PE Platform Have? 173Benefits from Having a Specialist PE System for Your Back Office, Middle Office, and Front Office 174Technology for Limited Partners 176Some Features LPs Should Expect from a Specialist System 179Summary 185EQUITY FUND ACCOUNTING 187Chapter 11 The Limited Partner's and Fund-of-Fund's Perspective on Private Equity Accounting, Reporting, and Performance Measurement 189Difference in the Legal Structure of FoFs Compared to Traditional PE Funds 190Legal Personality: Should an FoF Have One? 191Some Reporting Challenges for More Complex LP/FoF Structures 192Reporting for Master-Feeder Structures 192Reporting for Parallel Structures 193Some Accounting-, Reporting- and Performance Measurement-Related Challenges for LPs and FoFs 193Carried Interest: What Should LPs Do When Investee Funds Do Not Report Interim Carry Accruals 193Impact of Bridged Investments ("Quick Flip") on Preferred Return 195Impact of the Priority Profit Share (PPS) on the LP's Capital Account 195Treatment of Management Fees and Fund/Partnership Expenses Paid to Investee Funds 198Management Fees and Fund/Partnership Expenses Called before Year-End but Due in the Next Accounting Period 199Treatment of Deal Expenses Associated with Acquiring a Fund Investment as of the Year-End 200Carried Interest Charged by Carried Interest Partner of Investee Funds 200Administration, Tracking, and Treatment of Drawdowns and Distributions 201Recapitalizations 203Accounting Treatment of Recaps 203Treatment of Distributions from Dividend Recaps at the LP Level 204Performance Measurement 204Impact of Recapitalizations on Performance 205Impact of Netting Off Drawdowns against Distributions on Performance 205Impact of Temporary Distributions on Performance 206Stripping Out Carried Interest for the Purposes of IRR Calculation 206Challenges Associated with Secondary Investments 206Summary 208Chapter 12 Real Estate Funds 209Introduction 210Key Real Estate Accounting Requirements and Options 210Investment Property, or Property, Plant and Equipment (PP&E)? 210Asset Revaluations 211Rental Income 212Service Charges 213Lease Structures 213Managing Agents and Advisers 217Mind the GAAP 217What Different Frameworks Are There? 217Which One Should I Use? 218How Are They Different? 219Some Tax Considerations 222Other Common Accounting Mistakes 222Stripping Out Lease Incentives from Valuations 223Grossing Up of Head Lease Liabilities 223Bad Debt Expense Presentation 224Service Charge Recording and Monitoring 224Summary 225About the Author 225Chapter 13 Infrastructure Funds 227Introduction 228Investor Base 229Assets Held 230Exit Routes 231Structure of Infrastructure Funds 231Closed-Ended vs. Open-Ended 231Unlisted vs. Listed Infrastructure Funds 232Fee Structures 232Market Trends 233Infrastructure Funds and the Wider Economy 233Future of the Industry 234Role of Infrastructure Debt Funds 234Public-Private Partnerships and Private Finance Initiatives 235Accounting for Infrastructure Funds 236Reporting under IFRS 237Consolidating Investments 237Consolidation and the Investment Entity Exemption 238Application of the Investment Entity Exemption to Infrastructure Funds 239Investment Strategy 239Service Concession Arrangements 240Divergence between IFRS and U.S. GAAP 240Investment Company Exemption 241Nonstatutory Financial Statements 242Investment Valuations 242Performance Measurement for IFs 243Summary 244About the Authors 244Chapter 14 Private Debt Funds 245Debt Funds in General 246How Debt Funds Differ from Private Equity Funds 246Liquidity, Risks, and Rewards Associated with Differing Debt Instruments 247Secured or Unsecured 248Senior Debt 248Mezzanine Debt 249Corporate Bonds 249Asset-Backed Securities 250Infrastructure Debt 251High-Yield Securities 251Distressed Debt 252How Are Debt Funds Structured? 253Debt Funds and Financial Reporting 255Using IFRS or U.S. GAAP As a Debt Fund's Financial Reporting Basis 256U.S. GAAP 256IFRS 256Differences between IFRS and U.S. GAAP 257Measuring Debt Instruments at Fair Value 258Measuring Debt Instruments at Amortized Cost 259Challenges 260Summary 262About the Authors 263Endnotes 263Chapter 15 Mezzanine Debt Private Equity Funds 265Introduction 266What Is Mezzanine Debt? 266Why Mezzanine? 267Main Uses of Mezzanine 267Key Features of Mezzanine Debt 269European and U.S. Mezzanine Debt: Similarities and Differences 270Rise of Mezzanine Debt within Private Equity 271Structuring of a Mezzanine Fund 271Accounting for Mezzanine Instruments 271Investment Instruments 271Payment in Kind (PIK) Notes 271Arrangement Fee 272Warrants 272Accounting for Financial Assets 274Accounting under IFRS 274Challenges to Applying the Business Model Test 276Arrangement Costs 277Interaction between the Investment Entity Exemption and IFRS 9 277U.S. GAAP Considerations 277Valuation of Mezzanine Loans for PE Houses 280Unit of Account for Mezzanine Instruments 280Summary 281About the Authors 281Endnotes 282Index 283
