Jan 11 2008

FAS 157 – The Eternal Sunshine of the Spotless Audit

If you are a venture capitalist and you haven’t heard about FAS 157 (also known as Fair Value Accounting), I recommend you ask your accounting firm’s audit partner about it.  Today. 

Until recently, most VC firms used a straightforward and consistent method to valuing their portfolio companies.  No more – now we have to conform to FAS 157 to get a clean GAAP opinion from our auditors.  Since our LP agreements require a GAAP opinion, FAS 157 here we come.

I received the following question by email recently: How will your firm be handling the requirement to value its investments in portfolio companies under the FAS 157 fair value standard next year?  A reason I ask is that I am on a panel at an Alliance of Merger & Acquisition Advisors conference discussing this topic.  The panel includes a business appraiser (me), and auditor, and a VC.  Since I follow your blog, I was interested in your thoughts.

My partner Jason Mendelson has been responsible for our implementation of FAS 157 so I asked him to weigh in with an answer – which follows:

We’ve been FAS 157 compliant starting in Q3 2007.  We worked alongside our auditors to determine a methodology to determine fair value for each company.  We aren’t naïve enough to think this methodology won’t change, as many predict this to be a moving target at least through the first half of 2009.  In short, we’ve developed a checklist of items that we review for each company every quarter.  Some of the questions that we ask are:

  1. Has the company had a financing event during the period?
  2. Has the company experienced a material adverse or positive effect during the period?
    • Any major sales made / missed?
    • Any major deals signed up?
    • Any financial results that were materially different than plan?
  3. How have the company’s competitors fared during the period?  (Note:  this is much easier with public comparables than private)
  4. Any acquisitions in the company’s ecosystem during the period?
  5. Has the company received any acquisition interest during the period?

Along with those questions, we analyze the current capitalization table, financial results and public comparable stock prices.  It’s not a science – it’s an art, but one that we’ve had in place for a bit now and we are becoming more adapt to the process.

Who says VCs have all the fun?