Need greater transparency, rigour in valuations

The valuation processes of private equity (PE) firms are facing heightened scrutiny, driven by expanding portfolios, efforts to attract new investor types, and shifting market dynamics. 

In particular, a slowdown in exit activity has raised concerns about the long-term justification of valuations, as fewer liquidity events make it more challenging to benchmark valuations against market transactions.

As a result, both regulators and investors are closely examining PE firms’ valuation processes to ensure greater transparency and rigor in their valuations.

Sluggish PE exit activity

In 2024, PE exit activity in the Unites States (US) rebounded, following two consecutive years of decline from the peak in 2021, led by a more favorable financing environment. The cost of financing a buyout decreased due to three Federal Reserve rate cuts totaling 100 basis points. 

As 2025 began, the PE industry was optimistic due to a surge in exits in the fourth quarter of 2024 (+79% on-year). Many anticipated PE activity would remain robust, driven by a continued improvement in the financial environment. Although interest rates had been cut in 2024, it remained significantly higher than the 10-year average.

However, the optimism was short-lived, as US PE exits declined to 323 in the first quarter of 2025, from 578 in the year-ago period, due to uncertainty around tariffs, which hit consumer and business confidence, and persistently high long-term interest rates. 

Consequently, many PE market observers have reversed their outlook for 2025. Pitchbook, in its latest US PE Pulse report, expects a tougher exit condition owing to “meaningful macroeconomic threats” and a potential delay in interest rate reductions.

The exit backlog for sponsors remains at a record high, both in terms of count and value. As of 31 December 2024, US PE funds had a backlog of close to 12,000 unsold companies. At 2024 rates, it would take PE funds nearly eight years to offload all of these companies.

Valuation standards under increasing pressure

Limited partners (LPs) are subjecting PE valuations to growing scrutiny, particularly as they assess their capital commitments to new funds. 

Recently, there have been numerous instances where PE firms have rapidly devalued their investments, raising concerns among both existing and potential investors.

For instance, in late 2024, Goldman Sachs privately wrote down its $900 million investment in Swedish battery manufacturer Northvolt, which had filed for bankruptcy protection, to zero. Earlier in 2024, it had informed its LPs that the investment was performing well and was valued at four times its original amount. 

Other examples of rapid, significant devaluations by PE firms/ institutional investors

Reliable, periodic PE valuations critical for transparency

Valuations provide LPs with a snapshot of their investment performance over time and against expectations, enabling them to monitor risks and gain insight into potential exit outcomes and market sentiment. 

Amid limited liquidity and fewer realizable exits, LPs are increasingly reliant on interim valuations, which are periodically provided by general partners (GPs), to assess the health and potential of their PE investments.

GPs typically value their PE investments using one or a combination of the following three widely accepted valuation methodologies:

Both the DCF and GPC methodologies are inherently anchored to publics markets, relying on either public company-derived discount rates and beta inputs (in DCF) or trading multiples (in GPC).

Hence, during periods of heightened public market volatility or dislocation, these methods may not accurately capture the idiosyncrasies of private market assets.

Given this limitation, the comparable transaction method takes on increased significance. It enables the direct calibration of private company valuations to actual private market purchase prices. 

Unfortunately, current market conditions pose a challenge to this method. In a merger and acquisition (M&A) environment with limited deal flow, it becomes increasingly difficult to find truly comparable and recent transactions, leading to greater uncertainty in valuation estimates.

Conclusion

As PE investment opportunities become increasingly competitive, both prospective and current LPs are asking more sophisticated questions during their due diligence process. A key area of focus is how a PE firm manages its valuation practices. 

The key questions include: 

• What are the firm’s formal valuation policies? 
• Are these policies aligned with industry best practices? 
• Does the firm utilize a third-party valuation service provider to independently assess portfolio company valuations? 
• Is the valuation process dynamic and scalable to adapt to growth in assets under management and changes in regulations?

In LP-GP dialog, transparency, consistency, objectivity and independence of valuation processes have become prominent topics. 

This has put pressure on GPs to adopt best-in-class valuation governance, including enhanced documentation, to build trust with LPs and boost creditability of the PE firm. 

Over the next few years, firms that demonstrate disciplined and transparent valuation practices will be better positioned to attract capital, navigate audits, and respond to market scrutiny.