Private Equity Accounting, Investor Reporting, and Beyond

by Mariya Stefanova

Overview

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.

Product Details

ISBN-13:	9780133761528
Publisher:	Pearson Education
Publication date:	02/26/2015
Sold by:	Barnes & Noble
Format:	eBook
Pages:	320
Sales rank:	557,753
File size:	8 MB

About the Author

Mariya Stefanova is a founding partner of Private Equity Accounting Insights (PEAI), a private equity training and consultancy firm, providing specialist training and technical advice to GPs, LPs, and fund administrators. She has more than eleven years of experience in private equity accounting and investor reporting and more than seven years of experience in training, during which period she has trained over a thousand fund accountants and senior executives on the GP, LP, and fund administration side. PEAI Group is also providing specialist PE publications such as the PEAI Private Equity Technical Journal.  Mariya is also the author of the bestseller Private Equity Accounting: The Global Guide (https://www.privateequityinternational.com/peaccounting/), published by PEI Media in October 2011.
     Previously, Mariya worked in the technical department of Augentius Fund Administration LLP, a premium provider of fund administration services specialized in private equity and real estate funds. She was in charge of the technical training of the client services accountants and keeping them up-to-date with the industry and accounting developments. Mariya also provided advice to clients and client-services accountants in resolving complex technical issues, as well as performed technical reviews of accounts, quarterly investors’ reports, and complex calculations.
     Before joining Augentius in 2008, Mariya worked for fund administrator Mourant International Finance Administration (now State Street) looking after a portfolio of private equity clients. Before joining Mourant in 2006, Mariya worked for Calyon, a French investment bank; and before Calyon, she worked for Patron Capital Partners, a leading European opportunistic real estate manager.
     Mariya started her career with a large chemical company in Bulgaria, where she was chief accountant and was subsequently a financial controller for a Belgian industrial catering company.
     Mariya holds a Masters in Finance and Accounting from the University of National and World Economy (UNWE).
Web: http://peaccountinginsights.com

Contributors: Yasir Aziz and Ramon Louw, Deloitte; David L. Larsen, Duff & Phelps; Roland Mills, PwC; Stephanie Coxon, PwC; Henry Todd, KPMG; Graeme Faulds, TopQ

 

Table of Contents

PART I:  PRIVATE EQUITY ACCOUNTING, INVESTOR REPORTING, AND BEYOND     1
Chapter 1  Private Equity Structures and Their Impact on Private Equity Accounting and Reporting     3
Structuring Considerations in Private Equity     4
Main Building Blocks and Vehicles of a PE Structure      6
    Domiciliation: Where to Form the Fund—Onshore or Offshore?     9
    Simple or Complex?     9
Using a Combination of Vehicles     10
    Master-Feeder Funds     11
    Structures Involving Blockers     13
    Parallel Structures     14
    Master-Feeder or Parallel Structure?     15
Alternative Private Equity Structures     16
Summary     17
Chapter 2  The Importance of Allocations and Allocation Rules     19
Introduction: Why Start with Allocations and Allocation Rules?      20
What Is an Allocation Rule, and Why Is It So Important in Private Equity Accounting?      20
    Types of Allocation Rules     21
Why Are Different Allocation Rules Used? Is Excel-Based Accounting Adequate?      22
How Do Inaccurate Allocations Affect Investors?      27
How Can You Identify the Allocation Rules in an LPA?      27
What Do You Do If the Allocation Rules Stipulated in the LPA Are Flawed?     28
What Is the Best Way of Doing Allocations?      29
    A Word of Caution for LPs     30
Summary     30
    Last Advice for LPs     30
    Last Advice for GPs     31
Chapter 3  Private Equity Accounting Processes: Some Neglected Processes That Could Expose GPs     33
Introduction     34
Some Neglected Private Equity Accounting Processes     35
    Rebalancing     35
    Partner Transfers/Assignments     37
Summary     40
Chapter 4  Investor Reporting: ILPA versus IPEV IRG     41
Introduction     42
Existing Accounting Frameworks and GAAPs Used in Private Equity     43
What Is Investor Reporting?     44
Existing Reporting Framework      45
Comparisons among ILPA, IPEV, and EVCA Reporting Guidelines     45
Transition from EVCA RG and Other Local Reporting Guidelines to IPEV IRG     50
ILPA or IPEV IRG Compliant?      51
Summary     52
Endnotes     52
Chapter 5  ESG Reporting and Responsible Investing     53
Introduction     54
Why ESG and RI?      55
Potential Material Impacts of ESG Factors and Value Creation     56
What Are the Implementation Challenges?      57
Some ESG Issues     57
Sample Procedure for RI and ESG Implementation     58
    Stage 1: Developing an RI Policy     59
    Stage 2: Identifying Specific ESG Factors and Risks     59
    Stage 3: Implementing ESG Objectives and Putting ESG Systems and Processes in Place     61
    Stage 4: Assessing Existing Portfolio Companies for ESG Factors and Identifying ESG Factors and Risks     61
    Stage 5: Integrating ESG Management into the Future PE Investment Process: Brief Study on KKR’s RI and ESG Management     61
    Stage 6: Implementing Specific ESG Programs for Each Portfolio Company     62
    Stage 7: Set Key Performance Indicators (KPIs) and Start Measuring against Them     63
    Stage 8: ESG Reporting     64
Chapter 6  Private Equity Valuation: Taking Valuation to a Level Higher     67
Why Fair Value? A Fair Value History Lesson     68
Valuation Guidelines     69
Fair Value Accounting Standards     71
Basic Private Equity Valuation Concepts     72
    Basic Facts     73
    Calibration     73
Determining Enterprise Value at a Future Valuation Date     74
    Market Approach     74
    Income Approach     74
Levels 1, 2, and 3     76
Selected Private Equity Valuation Nuances     76
    Marketability     76
    Unit of Account     77
    Valuing Noncontrolling Interest     78
Valuing Investments in Private, Nontraded Debt     82
Valuing Fund Interests     84
    Background     85
The Future of PE Valuation     90
About the Author     91
Endnotes     91
Chapter 7  Performance Measurement: IRRs, Multiples, and Beyond     93
Introduction     94
Traditional Performance Measurement in Private Equity—What Is the Status Quo?      94
What Is IRR?      94
Why IRR Is a Preferred Performance Measure in PE     96
IRR Calculation: What Do We Need to Calculate It?      97
    Manual IRR Calculation     98
    Using a Computer to Calculate IRR     98
The Difference between IRR and XIRR in Excel     98
The Guess: Do We Really Need It?     99
Pitfalls of Using IRR     99
Other Pitfalls     102
Levels and Types of IRRs Advocated by Professional Bodies—Gross and Net IRR and Multiples     103
Gross IRR and Gross Multiples     103
Net IRR     104
Don’t Forget to Strip Out Carried Interest!      105
Money/Net Multiples to Investors     105
Alternative Performance Metrics     105
Time-Weighted Rate of Return (TWR): Is It an Appropriate Metric for Measuring Performance in PE?      106
Modified IRR (MIRR)      106
Benchmarking PE Performance to Public Market Returns     108
Public Market Equivalent (PME)      108
Other Alternative Performance Metrics     109
Summary     113
Chapter 8  Carried Interest and Carried Interest Modelling     115
Why “Carried Interest”?      116
    Substance of Carried Interest     116
    Carry Participants     117
    What Is a Waterfall?     117
    Dual Nature of Carry     118
    Cumulative Basis of Calculation     118
    Types of Carried Interest Models/Arrangements     119
    Mechanics of Pure Deal-by-Deal Carried Interest Model     120
    Mechanics of Whole-of-Fund/Whole-Fund/All-Contributions-First
    European-Style Carry Model and the Cumulative Cash Bucket Concept     122
    Preferred Return     128
    Hybrid Models     130
Clawback: What Is It, and Should We Recognize It in the Financial Statements?     133
    Accounting for Carried Interest     133
    Notes on Carry to the Limited Partners     137
Summary     138
Chapter 9  Consolidated Financial Statements     139
Background     140
Introduction: Basis for Consolidation     141
Does a Fund Need to Consolidate Portfolio Investments That It Controls?      142
The Investment Entity Exemption     143
Do Any of the Changes Impact the Issue of Consolidation of the Fund?      144
Control     145
Purpose and Design     146
Relevant Activities     147
    Identification     147
    How Decisions Are Made     148
Power     148
    Substantive Rights That Give an Investor the Right to Direct the Relevant Activities of the Investee     148
    Practical Ability     149
    Other Indicators     150
    Voting Rights     150
Protective and Veto Rights     151
Variable Returns     151
Principal versus Agent: A Link between Power and Variable Returns     152
De Facto Agents     156
Putting the Consolidation Issue All Together     157
Other Frequently Asked Questions     161
    What about the Consolidation of Master-Feeder Fund Structures?     161
    What about the Consolidation of Funds of Funds?     162
    Are Tax Blockers Treated the Same?     163
    So Are There Any Other GAAP Options?     164
About the Author     168
Chapter 10  Technology in Private Equity     169
Introduction     170
Technology for General Partners     171
    What Are the Options?     171
    What Are the Pros and Cons of Having a Specialist PE System?     172
    Beware the Pitfalls of Implementation     172
    What Should a Good Comprehensive Specialist PE Platform Have?     173
    Benefits from Having a Specialist PE System for Your Back Office, Middle Office, and Front Office     174
Technology for Limited Partners     176
    Some Features LPs Should Expect from a Specialist System     179
Summary     185

PART II:  ACCOUNTING FOR DIFFERENT TYPES OF FUNDS: BEYOND TRADITIONAL PRIVATE EQUITY FUND ACCOUNTING     187
Chapter 11  The Limited Partner’s and Fund-of-Fund’s Perspective on Private Equity Accounting, Reporting, and Performance Measurement     189
Difference in the Legal Structure of FoFs Compared to Traditional PE Funds     190
Legal Personality: Should an FoF Have One?      191
Some Reporting Challenges for More Complex LP/FoF Structures     192
    Reporting for Master-Feeder Structures     192
    Reporting for Parallel Structures     193
Some Accounting-, Reporting- and Performance Measurement–Related Challenges for LPs and FoFs     193
Carried Interest: What Should LPs Do When Investee Funds Do Not Report Interim Carry Accruals     193
    Impact of Bridged Investments (“Quick Flip”) on Preferred Return     195
    Impact of the Priority Profit Share (PPS) on the LP’s Capital Account     195
    Treatment of Management Fees and Fund/Partnership Expenses Paid to Investee Funds     198
    Management Fees and Fund/Partnership Expenses Called before Year-End but Due in the Next Accounting Period     199
    Treatment of Deal Expenses Associated with Acquiring a Fund Investment as of the Year-End     200
    Carried Interest Charged by Carried Interest Partner of Investee Funds     200
    Administration, Tracking, and Treatment of Drawdowns and Distributions     201
Recapitalizations     203
    Accounting Treatment of Recaps     203
    Treatment of Distributions from Dividend Recaps at the LP Level     204
Performance Measurement     204
    Impact of Recapitalizations on Performance     205
    Impact of Netting Off Drawdowns against Distributions on Performance     205
    Impact of Temporary Distributions on Performance     206
    Stripping Out Carried Interest for the Purposes of IRR Calculation     206
Challenges Associated with Secondary Investments     206
Summary     208
Chapter 12  Real Estate Funds     209
Introduction     210
Key Real Estate Accounting Requirements and Options     210
    Investment Property, or Property, Plant and Equipment (PP&E)?     210
    Asset Revaluations     211
    Rental Income     212
    Service Charges     213
    Lease Structures     213
    Managing Agents and Advisers     217
Mind the GAAP     217
    What Different Frameworks Are There?     217
    Which One Should I Use?     218
    How Are They Different?     219
    Some Tax Considerations     222
Other Common Accounting Mistakes     222
    Stripping Out Lease Incentives from Valuations     223
    Grossing Up of Head Lease Liabilities     223
    Bad Debt Expense Presentation     224
    Service Charge Recording and Monitoring     224
Summary     225
About the Author     225
Chapter 13  Infrastructure Funds     227
Introduction     228
    Investor Base     229
    Assets Held     230
    Exit Routes     231
Structure of Infrastructure Funds     231
    Closed-Ended vs. Open-Ended     231
    Unlisted vs. Listed Infrastructure Funds     232
    Fee Structures     232
Market Trends     233
    Infrastructure Funds and the Wider Economy     233
    Future of the Industry     234
    Role of Infrastructure Debt Funds     234
    Public-Private Partnerships and Private Finance Initiatives     235
Accounting for Infrastructure Funds     236
    Reporting under IFRS     237
    Consolidating Investments     237
    Consolidation and the Investment Entity Exemption     238
    Application of the Investment Entity Exemption to Infrastructure Funds     239
    Investment Strategy     239
    Service Concession Arrangements     240
    Divergence between IFRS and U.S. GAAP     240
    Investment Company Exemption     241
    Nonstatutory Financial Statements     242
Investment Valuations     242
    Performance Measurement for IFs     243
Summary     244
About the Authors     244
Chapter 14  Private Debt Funds     245
Debt Funds in General     246
How Debt Funds Differ from Private Equity Funds     246
Liquidity, Risks, and Rewards Associated with Differing Debt Instruments     247
    Secured or Unsecured     248
    Senior Debt     248
    Mezzanine Debt     249
    Corporate Bonds     249
    Asset-Backed Securities     250
    Infrastructure Debt     251
    High-Yield Securities     251
    Distressed Debt     252
How Are Debt Funds Structured?      253
Debt Funds and Financial Reporting     255
Using IFRS or U.S. GAAP As a Debt Fund’s Financial Reporting Basis     256
    U.S. GAAP     256
    IFRS     256
    Differences between IFRS and U.S. GAAP     257
Measuring Debt Instruments at Fair Value     258
Measuring Debt Instruments at Amortized Cost     259
Challenges     260
Summary     262
About the Authors     263
Endnotes     263
Chapter 15  Mezzanine Debt Private Equity Funds     265
Introduction     266
What Is Mezzanine Debt?      266
    Why Mezzanine?     267
    Main Uses of Mezzanine     267
    Key Features of Mezzanine Debt     269
European and U.S. Mezzanine Debt: Similarities and Differences     270
Rise of Mezzanine Debt within Private Equity     271
    Structuring of a Mezzanine Fund     271
Accounting for Mezzanine Instruments     271
    Investment Instruments     271
    Payment in Kind (PIK) Notes     271
    Arrangement Fee     272
    Warrants     272
Accounting for Financial Assets     274
    Accounting under IFRS     274
Challenges to Applying the Business Model Test     276
    Arrangement Costs     277
    Interaction between the Investment Entity Exemption and IFRS 9     277
    U.S. GAAP Considerations     277
Valuation of Mezzanine Loans for PE Houses     280
Unit of Account for Mezzanine Instruments     280
Summary     281
About the Authors     281
Endnotes     282
Index     283