Interpretive Guidance for Private Equity
Introduction and Scope
1. Private equity has become an increasingly mainstream asset for sophisticated investors. Private
equity entails investment in nonpublic companies at various stages of development and encompasses
venture capital, buyout, mezzanine, and distressed securities investing. Investors typically invest in
private equity assets either through individual funds, usually limited partnerships with a specified
investment stage and geographic focus, or via a fund-of-funds, through which commitments are
made to multiple underlying funds. Some investors may also invest directly into unquoted
companies, often on a co-investment basis alongside individual funds. Secondary investment funds–
which includes acquisition of an interest in a private equity fund from the original investor before the
end of the fund’s fixed life—is also included within the broad definition of private equity.
2. When investing in private equity through funds or funds of funds, an investor makes an initial
commitment of capital that is then ―called‖ or drawn down as the investment managers of the
underlying funds find investment opportunities. Capital is returned to the investor via distributions
on the sale or recapitalization of individual unquoted companies by the underlying funds, although in
some cases investors may also receive earnings-derived distributions.
3. Private equity investment vehicles typically have a limited life (i.e., they are not open-ended) and are
generally illiquid. The ultimate return of the investment is not known until the fund or partnership is
finally liquidated. Because of the unique characteristics of this asset class, additional performance
reporting requirements are needed. The GIPS standards, which are based on the principles of fair
representation and full disclosure, seek to provide prospective clients with the critical pieces of
information needed to evaluate the firm’s performance.
18. It is important for firms to understand that compliance with the GIPS standards refer to firm-wide
compliance which required adherence not just to private equity provisions but to all provisions of the
GIPS standards unless otherwise noted.
It is important to note that the GIPS standards are primarily designed for presenting a firm’s
performance to prospective clients rather than reporting performance to an existing clienst. While
that does not preclude using these guidelines when reporting performance to existing clients, there is
not a requirement to do so. It also important to note that the GIPS standards are not requirements for
investors themselves for internal reporting. While the standards represent best practices and are
suitable for general performance reporting either to investors or internally by investors, there is no
requirement that investors use these standards for internal reporting purposes.
4. Limited Partnerships (GIPS private equity provisions are applicable)
The predominant vehicle in the global private equity industry is the independent, private, fixed-life,
closed-end fund, usually organized as a limited partnership which may be of one of many funds
managed by an investment firm. The management firm may have several funds extant at any one
time, each of which are independent vehicles from each other. These funds typically have a fixed life
of 10 years that can be extended by a pre-set number of defined periods (e.g., two one-year periods)
upon agreement of the investors. It is termed a Closed-End Fund in that the number of
investors/shares is fixed for the life of the fund and closed to new investors although partnership
interests may be transferred (sold) to other limited partners with general partner approval.
5. The limited partnership is a fund of pooled interests managed by a general partner who raises capital
(i.e., committed capital or commitments) from outside investors (limited partners). The general
partner charges an investment management fee, typically from one to three percent per annum on the
total commitments raised. Most funds require at least a nominal one percent investment by the
general partner. In addition, the general partner will take a profit split (known as the carried interest
or simply the ―carry‖) of usually 20 percent of profits.
6. The general partner will ―call‖ the capital from its investors in tranches as needed for investment into
underlying companies. These capital calls are also termed ―drawdowns.‖ Another unique feature of
these types of vehicles is that any proceeds from investments must be distributed to investors;
reinvestment is only acceptable if predefined terms appear in the contract between the general
partner and the limited partners.
7. In this type of structure the cash flows are fairly easy to enumerate as the performance is calculated
on the basis of the cash flows between the limited partner and the partnership. The investment
management fee is typically charged on the total assets committed to the fund rather than on the
value of the invested capital of the portfolio.
8. Direct Investments (GIPS private equity provisions are applicable)
Investments can be made in private equity securities directly, rather than via a fund or partnership.
Direct investments are made both by institutions and by high-net-worth individuals. Many
institutions making direct investments into unquoted companies do so on a co-investment basis
alongside private equity funds in which they are limited partners, in line with a formal pre-set co-
9. Captive and Semi-Captive Funds (GIPS private equity provisions are not applicable)
The private limited partnership is not the only investment vehicle that makes private equity
investments. Some vehicles are organized as captive vehicles or semi-captive vehicles. Captive
refers to a fund that only invests for the interest of its owner organization. This parent may be a
regular corporation, a financial corporation, insurance company, university, and so on. The salient
feature is that the fund only invests its parent’s capital—there are no outside investors. Corporate
venture groups of technology companies are examples of this type of vehicle, although several
insurance companies and investment banks also have similar vehicles.
10. The notable feature of this type of vehicle is that typically the vehicle is not a fixed-life investment
pool—it is ―evergreen‖ (i.e., a fund with no fixed cost basis as the parent can contribute additional
capital or withdraw capital from the vehicle whenever it chooses). This lack of a fixed cost basis
complicates the cash flow calculations because the cost basis fluctuates as the capital managed
increases and decreases. The other problem is that a fund of this type charges no management fee to
its owner and does not really have a ―carried interest‖ profit split, although a few creative groups
have compensation schemes for the investment officers that work in a similar manner to carried
11. Another type of hybrid vehicle, called a semi-captive fund, mixes capital from both outside investors
and the parent organization. These funds typically charge a management fee and carried interest to
the outside investors and are usually closed-ended, as the number of investors is fixed, but a number
of evergreen semi-captives also exist.
12. As such, captive and semi-captive structures are not comparable to private fixed-life limited
partnerships on a net-of-fees basis. Therefore, the scope of the GIPS private equity provisions is in
no way directed toward captive or evergreen funds within this industry. These structures must follow
the general provisions of the GIPS standards.
13. Open-End Funds (GIPS private equity provisions are not applicable)
Another investment structure is an open-end public entity that acts much like a publicly-quoted
mutual fund. The fund is a public investment vehicle traded on an exchange and priced daily. These
vehicles typically operate much like a mutual fund or publicly-traded company and are not required
to follow the GIPS private equity provisions, but must follow the general provisions of the GIPS
Side by Side Funds: (GIPS private equity provisions are applicable) There are instances in which
parallel vehicles are created that invest alongside a principal fund for either client
accommodation/jurisdiction or other reasons. Since this vehicle invests in parallel with its affiliated
principal fund, it should be included in the composite of the principal fund.
Private Equity Input Data - Fair Value 7.A.1, 7A.2, 7.B.1
There has been much discussion and attention in the media since fair value provisions came to light in the
United States via the Financial Accounting standards Board rule 157 ―FASB 157‖ which has been deemed
both boon and bane of the private equity industry and has come under fire recently as as an accelerant of
price degradation during the financial crisis starting in 2008. It has been the position of the GIPS committee
for some time that Fair Value was the only appropriate way to view private equity valuations. As the
treatment of fair value as preferred industry practice and as mandated accounting standards plus the fact
that US Private equity standards standards becoming more conguruent with standards in Europe and other
jurisdictions, GIPS continues to require fair value treatment of private equity portfolios.
Accounting standards up to through to the 1990s, were driven in considerable measure by an overriding
principle of Prudence, in effect seeking to protect investors and creditors from overstatements of asset
values and profits. Specific valuation methodologies such as historic cost, sought to place a burden of proof
on those seeking to deviate from conservative valuations. There are a number of shortcomings in such
methods which led to pressure for change and although the precise trigger for change may differ by
jurisdiction, by way of illustration, some examples can be noted which demonstrate how conservatism can
operate against the interests of some stakeholders. For example, the outward conservatism of historic cost
can become a defence against the proper write down of impaired assets, a possible factor in the prolonged
crisis in the Japanese banking system in the 1990s. Meanwhile the true value of a company’s assets may be
materially understated, leading to takeover at an undervalue. Furthermore, as investor valuation
methodologies in public markets sought to recognise more sophisticated thinking, for example cashflow,
brand values, intellectual property and earnings growth, balance sheet conservatism became a less
compelling approach. In private equity, as with other investable assets, a part of the case for institutional
investment is the correlation of returns with public markets and this is potentially obscured by a
conservative valuation methodology. The result of factors such as these was a move by accounting bodies
to force management to ask systematically what the fair value of an asset is, reflecting the value it would
attain in a willing buyer/seller transaction – the Fair Value approach. The problems of greater discretion
and subjectivity this creates were deemed outweighed by the potential for greater transparency of fair value
estimates. The result is that today the major accounting bodies use Fair Value accounting and the GIPS
guidelines sought to incorporate this as a recommendation at the last review of its guidelines in 2005?.
Although there have been mark to market issues raised in the current environment, where forced sale prices
may be evident, accounting standards board have reaffirmed the fair value approach, preferring to provide
clarification on when such forced sale values can be ignored rather than abandoning the fair value principle.
In these guidelines therefore the Fair Value approach has become mandatory
19. As noted, performance reporting is of little value unless the underlying valuations are based on
sound valuation principles. The GIPS Valuation Principles including requirements and
recommendations specific to the private equity section, establish a broad foundation for valuing
assets. These broad principles can be supplemented with more detailed valuation guidelines such
as the standardized methods used for valuing Private Equity investments developed by the British
Venture Capital Association (BVCA), European Venture Capital Association (EVCA), who have
harmonized their valuation guidelines into the so-called IPEV guidelines (International Private
Equity and Venture Capital Valuation Guidelines), and the U.S. Private Equity Industry
Guidelines Group (PEIGG), which have been endorsed by the US National Venture Capital
20. Please note that For periods ending prior to 1 January 2011, PRIVATE EQUITY investments
MUST be valued according to the GIPS Private Equity Valuation Principles. The GIPS Private
Equity Valuation Principles can be found in Appendix D of the 2005 version of the GIPS
standards on the GIPS website (www.gipsstandards.org).
21. The GIPS standards require that portfolios be valued monthly for periods beginning on or after1
January 2001, and that portfolios be valued at the time of all large cash flows for periods
beginning on or after 1 January 2010.,. In a calculation where time-weighted measures are made,
these valuations at key cashflow events are needed as those cashflow events become terminal
values in the time-weighted approach to performance calculation. In a time-weighted return
calculation, typically sub-period time-weighted returns are calculated between each significant
cashflow and chained together to calculate a total return. As the Private Equity Standards require
a SI-IRR to be calculated for private equity investments, the increased frequency in valuations will
not result in increased accuracy of the required return calculation. As a result valuation in practice
private equity portfolio is typically done on a periodic basis no more frequently than quarterly.
22. The Private Equity Standards require at least annual valuations and recommend quarterly
valuations. Firms must value portfolios as of the calendar year-end or the last business day of the
year for period beginning on or after 1 January 2011. More frequent valuations are generally
required for client reporting purposes and are considered good business practice thus the standards
for private equity recommend quarterly valuations. .
23. When calculating the SI-IRR, periods beginning prior to 1 January 2011 MUST be calculated
using either daily or monthly cash flow
20. Verification should be in accords with the overall GIPS standards – in the case of Private equity
verification, frequency must be done at least annually.
Calculation Methodology (7.A.3-7.A.6)
The IRR is the annualized implied discount rate (effective compounded rate) that equates the present value
of all of the appropriate cash outflows (paid-in capital such as drawdowns) associated with an investment
with the sum of the present value of all the appropriate cash inflows and outflow (such as distribution)
accruing from it and the present value of the unrealized residual portfolio (unliquidated holdings). The
subperiod IRR, r, is calculated generically as follows:
0 CFi (1 r ) i
i 0 (1 r ) i i 0
where CF is the cash flow for period i, n is the total number of cash flows, i is the period of the cash flow,
and r is the subperiod IRR.
For private equity investments measuring the IRR on an interim cumulative return, the IRR depends upon
the valuation of the residual assets. This can be formulated as a special case as the Residual Value is not a
true cashflow but is treated as a cashflow equivalent terminal value:
0 n ,
i 0 1 r 1 r
where CF is the cash flow at period i, n is the total number of cash flows , RV is the residual value
(Net Asset Value) of the fund at period i is the period of the cash flow, and r is the subperiod IRR.
The in either the general or special formulation daily IRR is converted to the annualized IRR, R, as
If daily cash flows are used, the annualized IRR, R, is:
R (1 r ) 365 1
If monthly cash flows are used, the annualized IRR, R, is:
R (1 r )12 1
The internal rate of return (IRR) reflects the effects of the timing of cash flows in a portfolio. As
discussed, the predominant private equity investment vehicle is the independent private fixed-life
fund. The cash flows are easily identified and enumerated as the fund has a fixed-cost basis of
investment. It is reasonable to assume that because this type of fund has a fixed life, the return on
investment is fairly easy to calculate.
24. One of the reasons IRR is preferred is that this type of partnership generally has a fixed number of
investors and a fixed commitment basis and proceeds cannot be reinvested so the cost basis of
investment does not increase and decrease as it would with an evergreen or open-end fund. An open-
end fund can find its investment pool increased (decreased) as investors invest (withdraw) more
capital or by the addition (withdrawal) of investors.
25. One of the basic tenets of performance attribution is that the manager not be rewarded or penalized
by decisions outside of their control. In an open-end fund as mentioned previously, the timing of
cash flows in and out of the fund is totally at the discretion of the investors. As a result, a time-
weighted rate of return will (paradoxically) remove timing of the cash flows out of the performance
calculation. Accordingly, open-end funds must follow the provisions of the general GIPS standards
and report a time-weighted rate of return.
26. In a independent, fixed-life private equity fund, the decisions to raise money, take money in the
form of capital calls, and distribute proceeds are totally at the discretion of the private equity fund
manager. Therefore, timing is part of the investment decision process and thus the manager should
be rewarded or penalized by those timing decisions—thus the need for a time-value of money
measurement such as the IRR.
Although the GIPS private equity provisions advocate that the IRR is the most accurate measure of
performance for an individual private equity manager, it may not be so at higher levels of
aggregation. At larger levels of portfolio aggregation, the timing of cashflows may not be under
control of the manager being measured. For example, In the case where an investor (e.g., a limited
partner) is trying to calculate the return at an aggregate portfolio level, including a number of private
equity funds, that investor has no control over the timing of any cash flows thus the IRR may not be
the best measure for calculating returns nor measuring performance. In this situation of an aggregate
portfolio, a TWRR may be more applicable and will provide a comparability measure at a portfolio
level with other private equity portfolios as well as other asset classes. This is not to prohibit the use
of an IRR by investors who may want to use it, but to note that the rationale for using the IRR at a
fund level may not be the same at an aggregate investor portfolio level. This clarification is provided
in recognition that the main purpose for the GIPS private equity provisions is to provide
comparability between private equity firms when presenting performance to invesetors and not
necessarily to standardize the performance presentation of the investors themselves.
27. Firms are required to deduct investment management fees, carried interest, and any transaction
expenses when calculating net-of-fees returns. As noted, the carried interest can often have a
greater impact than the actual investment management fees. In the case of investment advisors
that have discretion over the selection of venture capital or private equity funds or partnerships for
their clients, the investment advisor must calculate all returns net of all the fund or partnership
investment management fees and carried interest. Investment advisor net-of-fees returns must, in
addition, be net of all the investment advisor’s actual investment management fees, expenses, and
Performance is required to be calculated using daily cashflows. This is a departure from prior guidelines
where daily cashflows were recommended but monthly cashflows were required. Daily cashflows provide
the most accuracy in performance calculations. Historically this accuracy came at a price as technology was
not widely available to process cashflows on such a frequent basis except by the most advanced
software/hardware. As a result, monthly cashflows are been a standard practice in the financial industry.
Recognizing the increased accuracy of daily cash flows,but also recognizing the intractability of the same,
there were several methods developed over the last four decades to day weight monthly cashflows to create
some synthetic accuracy. Even with the advent of the financial spreadsheet, calculating daily cashflows was
intractable for all but the smallest number of cashflows. With the introduction of the XIRR function in
Excel, daily cashflows analysis is not intractable. . Unlike public equity investment management, private
equity investment are typically marked by relatively few transactions making the use of daily cashflows a
reasonable approach. Given the accuracy gained by daily cashflows and given that modern portfolio
manage software is very well capable of aggregating daily cashflows, the GIPS standards require daily
cashflows for periods after 1-Jan-2011 and recommend daily cashflows for periods prior to that date.
Composite Construction (7.A.7-7.A.8 and 7.B)
28. Funds/Partnerships vs. Composite
The GIPS standards are structured around the concept of composites. A composite is an aggregation of
portfolios with a similar investment style or strategy. The intent is to provide potential investors with
the results of the investment decisions made by the investment manager. In the case of private
equity, the investor typically has no say in which portfolio companies the funds are invested in thus
all the investments made in a particular fund are ―the composite‖. Since the fund is typically formed
at a fixed point in time and the investor stays in that fund for the life of the fund, the required
composite is this vehicle which is characterized by its vintage year (year of formation—see section
below on vintage year disclosure) AND by its strategy. Thus in relation to private equity funds, the
composite is an aggregation of funds/partnerships with the same strategy and ―vintage year‖ Thus a
typical investor would see a ―1998 venture fund‖, a 2001 buyout fund, a 2003 distressed fund. These
would all be examples of composites. It is only appropriate to create composites that show a firm’s
capabilities or past performance with regard to a particular investment strategy. Firms must also
separate funds with different vintage years into different composites. The following hierarchy may
be helpful as firms consider how to define private equity composites:
Strategy (venture, buyout, generalist, mezzanine, other private equity)
Substrategy (size of fund, stage, etc.)
Provision 7.A.7 also requires that these classifications of vintage year and strategy remain consistent
through the life of the fund. Thus a composite cannot change from being classified as a generalist
private equity fund to a venture focused fund even though it may have invested in more venture
deals as the fund evolved. Since there are two methods od classifying funds by vintage year (see
secion on vintage year defintion), the vintage year selected for the composite must be consistent
through the lfe of the fund to avoid gaming. In most cases, a composite will contain only one
fund/partnership. If a firm has multiple funds/partnerships with the same vintage year and strategy,
they must be combined into a single composite. A co-investment fund will most likely be placed in a
separate composite from the related fund—QUESTION FROM JESSE: DO WE REALLY MEAN
THIS—SIDE BY SIDE FUNDS ARE TYPICALLY CONSOLIDATED INTO THEIR RELATED
FUND ARE THEY NOT?>.
COMPOSITE CONSTRUCTION FOR FUND OF FUNDS 7.A.9
In the case of private equity fund of funds, the GIPS standards have created more flexibility in
composite construction based on practitioner experience with prior standards and investor feedback..
Fund of funds by their nomenclature is a vehicle that invests in private equity funds as a limited
partner. These underlying fund investments are not typically in the same vintage year nor may not
necessarily share the same strategy. Thus a fund of funds might be comprised of a 1998 venture
fund, a 2003 buyout fund, and a 2004 buyout fund and a 2006 distressed fund. In addition a fund of
funds manager may have separate managed accounts that mimic this investment style – different
vintage years and strategies. Applying the same vintage year AND strategy requirement of 7.A.7
were found to be impracticable, intractable and not congruent with the information that investors
required for their fund of funds investments.. Therefore fund of funds may choose to create
composites by either vintage or strategy or may choose to create a composite which encompasses
both. In either case all discretionary investments must be included in at least one composite of
vintage or strategy. As guidance as how fund of funds could report their composite performance
refer to EXHIBIT XXX
Firms should realize that all provisions and guidance related to composites apply to funds. For
example, when the Standards state that the cumulative annualized SI-IRR (since inception—internal
rate of return) must be presented for the composite, because each composite will typically contain
only one fund or partnership, this will be the same as the annualized SI-IRR for the fund or
As discussed above, fund of funds may create composites either on a vintage year or a strategy basis
or on the basis of both. (see exhibit XXX for one example of how fund of funds could report
composites and performance)
16. Within the private equity asset class, the GIPS concept of ―carve-outs‖ is not applicable.
A carve-out is a subset of a portfolio’s assets used to create a track record that reflects a narrow
segment of a broader mandate. What is to be avoided is the appearance of carve outs or cherry
picking. Take for example the case where a private equity fund formed in 1998 engaged in making
leveraged buyouts made investments not only in control-leverage buyouts but was caught up in the
internet craze of the 1990s and made some interent media investments. In raising its next buyout
fund, the firm might be tempted to separate the buyout investment and internet investments into
separate composites as its primary performance presentation because the internet investments ―aren’t
relevant to the proposed new vehicle‖. That separation is not allowed except as supplemental
information. In the above example, those investments both buyouts and internet investments are
required to be included in the same composite if they were made in the same investment
Firms must remember that the GIPS standards have formal requirements in place regarding composite
construction, which can be found in Section 3 of the Standards. (In order to fully understand
composite construction topics one should also read the Guidance Statement on Composite
Definition). Of most importance, ―firms are required to include all discretionary fee-paying
portfolios (funds/partnerships) in at least one composite that is managed according to a particular
strategy or style.‖ Creating meaningful composites is critical to the fair representation, consistency,
and comparability of performance results over time and among firms.
It is also important for firms to realize that provision 3.A.1 states in part that, ―All actual fee-paying
discretionary portfolios must be included in at least one composite.‖ Firms must understand that the
GIPS standards are aimed at a firm-wide level of compliance and not just selected composites/funds.
30. 7.A.10 Firms are required to disclose the vintage year of the composite and how the vintage year is
defined. The disclosure of the vintage year increases comparability by allowing prospective clients
to understand the time frame when the fund was initiated or locked up. Note that vintage year
denotes year of formation-through long standing industry practice, the vintage year was typically
defined by the date of the first close of a fund as ostensibly, that was the date the fund was formed,
the date it executed its first commitments and made its first capital calls for investments. However as
the industry developed, there were more and more cases where the first claose did not include actual
capital calls but were ―dry closes‖. Assuming that performance eis measured by the date a manager
has control of an investment, and that the IRR needs cashflows to be calculated, vintage year has
also been defined as the date cashflows actually occurred –i.e. the calendar year of date of the first
capital call or draw down of capital by the private equity fund. Both definitions are in use in the
industry and there is enough dissension in the industry to warrant disclosure rather than mandating
one treatment or the other.
31. 7.A.11 In addition, firms are required to disclose the final date of all liquidated private equity
composites. Similar to the vintage year statistic, the final liquidation date also aids in determining
the time frame that the fund was in existence in order to determine the appropriate comparability of
one investment to another.
32. 7.A.12 Firms are required to disclose the composite’s cumulative unrealized appreciation or
depreciation. In practice this is simply the total increase/decrease in net asset value from the prior
reporting period. This disclosure helps prospective clients determine the potential for returns to
change in the future based on the potential changes in the valuation of the investments within the
composite. The Standards require the firm to disclose if the compliant presentation complies with
any other valuation guidelines (e.g., BVCA or EVCA) in addition to the GIPS Valuation Principles.
Furthermore, Firm must disclose the valuation methodologies used to value private equity
investments and any material changes to the methodologies. Disclosure of which valuation
guidelines help to determine the comparability of different returns and other important statistical
information and disclosure of valuation methodologies enables evaluation of investments from one
to another with proper adjustments .
33. If valuation basis other than fair value was used for period beginning prior to 1 January 2011, firm
must justify why fair value is not applicable. Firm must also explain and disclose the impact of
material difference between valuations used in performance reporting and the valuation used in
7.A.15 It is inappropriate to directly compare IRR and TWRR figures to each other
directly. There are methods that create synthetic comparisons hich can be used to
make comparisons with caveat. Firms are required to disclose the calculation methodology
used for the benchmark and the index used if public market equivalent (―PME‖) of a composite is
presented as a benchmark. Public market equivalent (PME) is the performance of a public market
index in IRR terms calculated by adding (investing) each drawdown of a private equity investment
or portfolio into the public market index of interest on the same date the drawdown occurred and
substituting (distributing) each distribution of the private equity investment or portfolio from the
same index on the same date the distribution occurred in order to determine the terminal value of
that index on the terminal date of the private equity investment, then subtracting the terminal value
of the index for the residual value or ending value of the private equity investment in order to
calculate the IRR of the index using the same flows with the same timing as those of the private
equity investment over the same time period. The PME can be used as a benchmark by comparing
the IRR of a private equity investment with the PME or a public market index. (See Appendix for
detailed numerical example)) Firms are required to disclose the calculation methodology used for the
benchmark and the index used if the public market equivalent of a composite is presented as a
35. 7.A.18 FIRMS MUST disclose the frequency of cash flows used in the SI-IRR calculation if daily
cash flows are not used for periods beginning prior to 1 January 2011. However, recognizing that
firms may not be able to gather historical valuations and/or records for transactions of private equity
investments for periods prior to 1 January 2006, firm may present and link the non-compliant
performance with appropriate disclosure as to why the performance is not in compliance with the
Presentation and Reporting
Requirements before and after 1-Jan-2011
37. Note that there are there are different requirement for periods before 01-jan-2011 and after that
date. The effect of these reporting time period differences is more relevant for asset classes
other than private equity. Other asset classes are reporting periodic performance. As a result
reports before and after the effective date may have different requirements an dhave different
results or items reported. However, In the case of private equity, the difference of reporting and
requirements before and after the effect compliance period is more subtle as private equity
performance is being reported as cumulative since-inception performance. Thus any
requirement to have different inputs/outputs before/after the effective compliance date in
practice will not really have any effect in day to day reporting.
Firms are required to present the annualized Since Inception IRR (SI-IRR) for private equity composites.
The firm is required to present an annualized SI-IRR for each year since composite inception and at
least 5 years of performance (or a record for the period since firm or composite inception if the firm
has been in existence less than five years) Periods less than one year must not be annualized. Instead,
firms must present the SI-IRR from the composite inception through the initial year end.
38. Unless disclosed, calendar year period-ends are assumed. For example, assume a composite has a
vintage-year date of 1 January 2006. As shown in the table below, the firm would present the SI-IRR
for 2006, the annualized SI-IRR (covering 2006 and 2007) for 2007, the annualized SI-IRR
(covering 2006–2008) for 2008, and the annualized SI-IRR (covering 2006–2009) for 2009, and the
annualized SI-IRR (covering 2006-2010) for 2010.
Gross-of-Fees SI- Net-of-Fees
Year (%) (%)
2006 –5.2 –8.2
2007 10.3 7.3
2008 29.6 25.6
2009 22.4 18.3
2010 22.4 18.3
39. When presenting private equity performance, firms are required to present both gross-of-fees and
net-of-fees returns. Net-of-fees returns must be net of actual investment management fee and
transaction expenses. Investment management fee includes carried interest,the management firm’s
portion of any realized gains as well as the implied carried interest component of any unrealized
gains in the portfolio.. All returns must be net of all underlying partnership and/or fund fees and
carried interest. In addition, if any fees are paid outside of the fund vehicle, they still must be
incorporated in the net-of-fees return. Firms must disclose when fees are paid outside of the fund
40. Reporting other performance metrics 7.A.20-7.A.25
For each year presented, Firms are required to present as of each period end, the since-inception total of:
Cumulative Committed Capital (amount of capital invetors have agreed to invest)
Cumulative Paid-in Capital (Capital calls from Investors for either investment or fees)
Cumulative Invested Capital (Amount of paid-in capital actually invested)
Cumulative Amount realized (proceeds obtained form the liquied of investments)
Cumulative Distributions to Investors (amount of principa, capital gains and income returned to
Period ending Net Asset Value
41. The internal rate of return is not the only useful metric used to gauge performance. It assumes, for
example, that the residual value of a composite is totally liquid, whereas in reality, the residual value
is the unrealized (and often illiquid) portion of the composite. For performance calculation there are
one non-cash-flow item—residual value (net asset value which is net of investment management
fees and carried interest)—and two cash flow items—drawdowns from limited partners (also
referred to as capital calls or paid-in capital) and distributions (cash and/or stock) to limited partners.
42. These three components can be used to calculate the internal rate of return assuming the residual
value is taken as a terminal cash flow value. Only part of the return, however, is actually realized
(i.e., the distributions). Accordingly, realization multiples (such as the Distributions to Paid-In
Capital or DPI) provide additional information as to how much of the return has actually been
realized and how much is still unrealized.
43. The Standards require firms to report the investment multiple (Total Value to Paid-In capital or
TVPI) and the realization multiple (DPI) as of each period end presented. The investment multiple is
calculated by dividing the residual value plus cumulative distributions by the paid-in capital. The
TVPI gives prospective clients information regarding the value of the composite relative to its cost
basis. The realization multiple (DPI) is calculated by dividing the cumulative distributions by the
paid-in capital. The DPI is a measure of how much of the return has actually been returned to
44. In the early life of an independent fixed-life fund, the DPI will be zero until distributions are made.
As the fund matures, the DPI will increase. Once the DPI is greater than one, the fund has broken
even on a cash basis. A DPI of greater than one means that the fund has generated capital gains. In
addition, firms must present the ratio of Paid-In Capital to committed capital (or PIC multiple). This
ratio gives prospective clients information regarding how much of the total commitments have been
45. The private equity provisions also require the presentation of the Residual Value to Paid-In capital
(RVPI). The RVPI is calculated as the residual value divided by cumulative paid-in capital. RVPI is
a measure of how much of the return is unrealized. As a fund matures, the RVPI will increase to a
peak and then decrease as the fund matures and eventually liquidates to a residual market value of
zero. At that point, the entire return of the fund has been distributed.
46. Firms are required to presentthe annualized SI-IRR benchmark that reflects the same strategy and
corresponds to the same time period as the composite. Firms must disclose the calculation
methodology of the benchmark (e.g., monthly/daily cash flows) and if a custom benchmark is used,
how that benchmark is constructed. If no benchmark is presented for periods beginning prior to 1
January 2011, the firm must disclose why no benchmark is presented.
If a custom benchmark is used, then the firm must describe the benchmark creation and rebalancing
1. What was the process for developing the GIPS private equity provisions and who was consulted?
The GIPS Private Equity Subcommittee was drawn from professionals around the world with private
equity experience in a range of industry roles. The provisions have circulated for public comment
amongst investors, private equity firms and organizations, as well as other professionals with a private
2. How do the GIPS private equity valuation provisions relate to those of regional private equity
organizations such as the EVCA, BVCA, PEIGG, etc.?
The GIPS standards seek to encourage convergence of performance standards globally and find
common ground in the difficult and subjective area of private equity valuations. The GIPS private
equity provisions include a commitment to the fair value approach and provide guidance on a number
of issues but do not seek to develop independently a full set of guidelines on valuation methodology.
The harmonization of European standards from the three major European privae equity associations
and independent but congruent development of valuation standards in the United States means that
convergence of Fair Value applicability to private equity has significan momentum
3. If my firm only manages private equity must I comply with the GIPS standards in its entirety to
The claim of compliance with the GIPS standards is voluntary. However, claiming compliance
requires adherence to all aspects of the Standards. Firms managing private equity assets will want to
pay particular attention to provisions contained in the Fundamentals of Compliance section of the
4. Will the GIPS private equity provisions provide assurance of comparability between funds?
The provisions should ensure consistency in the presentation of the most important performance
measures. Interim valuations will remain subjective and precise comparability cannot be assured.
Marking to Fair Value is, however, designed to give a much more consistent approach to valuation and
thereby improve comparability.
5. Will the GIPS Standards private equity provisions be endorsed by trade associations?
The BVCA, EVCA and NVCA all had representatives on the private equity committee and assisted in
dialogue, drafting and comment. during the development of the private equity provisions and they are
expected to support the new provisions.
6. Do the GIPS private equity provisions override accounting requirements and standards?
The GIPS private equity provisions are a minimum level of reporting to investors. They do not
override any statutory obligation or accounting standard that may arise in any particular jurisdiction.
7. How should tax payable be treated?
In general, any taxes payable by the investors should be ignored in calculating the returns both net- and
gross-of-fees. Some small withholding tax or income tax deducted prior to receipt by the fund or
payable by the fund may arise and the net- and gross-of-fees cash flows should be reduced by these
8. How is fair value defined and how does this compare with accounting standards?
The concept of fair value used in the GIPS private equity provisions mirrors the fair value principles
used in international accounting standards. Fair value is the amount at which an asset could be
acquired or sold in a current transaction between willing parties in which parties each acted
knowledgeably, prudently, and without compulsion. Fair value does not assume an intention or ability
to sell at the date of valuation but is an estimate of the likely exchange price involving subjective
judgments, which must be based on reasonable estimates of the company’s current and future
performance. In sales of private company holdings, a buyer is likely to reflect in the price any
restrictions applying to the asset, including the extent to which liquidity can be achieved in any
subsequent resale. <COMMENT FROM JESSE: we need this reviewed by valucation group to make
sure the definion is congruent with current industry and accounting provisions>
9. Can managers value investments on a cost basis and still be compliant with the fair value
A general policy of holding investments at cost is not compliant with the GIPS standards. In some
circumstances, cost is the best estimate of fair value, for example, where it reflects a recent arm’s
length transaction with no subsequent events or information affecting its validity. There may also be
circumstances where a fair value estimate is not reasonably ascertainable and in these circumstances
cost less a reduction for any value impairment is the only practical option.
10. Should early-stage venture investments be treated differently than more mature investments?
More mature investments with established profit, growth, and cash flow characteristics are in practice
easier to benchmark against quoted market multiples for valuation purposes than are early-stage
investments. In principle, early-stage investments should also be valued at fair value, although it is
recognized that there will be instances where fair value cannot be estimated with any reasonable
accuracy. In these instances, cost less estimated impairment needs to be used. Where early stage
investments have raised material amounts of further funding on an arm’s length basis, this practice
does provide a market-based value.
11. Please clarify the recognition of management fees and carried interest accrual.
In constructing cash flows for calculating performance, management fees should be recognized as
dated cash flows accrued at the quarterly, annual, or other periodic date when such management fees
are payable. This method is in contrast to the occasional practice or treatment in which management
fees are simply subtracted from the ending net asset value used in calculating performance. This latter
treatment delays recognition of the management fee and thus artificially increases the rate of return
calculated by an IRR calculation.
Carried interest accrual creates another problematic treatment. The net asset value used at the end of
the period for which performance will be made up of largely unrealized and some realized investments
yet to be distributed. The net asset value should have subtracted actual carried interest for realized
investments that have not been distributed and should have fair value estimates of accrued carried
interest subtracted for any investments that have yet to be realized. The intent is to provide an estimate
of what the limited partner would receive if the unrealized portfolio were liquidated and distributed at
the date of performance calculation.
12. Must all private equity funds be included in at least one composite?
Yes. Firms are required to include all discretionary, fee-paying portfolios (funds/partnerships) in at
least one composite that is managed according to a particular strategy or style. Firms must also
separate funds with different vintage years into different composites.
13. What are composites and how do they relate to private equity?
The GIPS private equity provisions follow the terminology of the broader GIPS standards in using the
concept of a composite. In practice, for most private equity investment firms, secondary investment
firms, and fund of funds, individual funds are raised from time to time with a specific investment
strategy and a vintage year defined by reference to the date of the first investment drawdown of cash
for either investment of fee. Thus, each fund is a composite, and the terms are interchangeable. More
complex situations may arise where managed accounts exist, if these have the same mandate and
vintage year, they should be aggregated.
14. How should side-by-side funds be handled?
For funds that may have an auxiliary parallel or ―side-by-side‖ fund vehicle, that vehicle should be
included in the performance calculation for the entire fund. An acid test for deciding whether to
include such a vehicle in the performance calculation is:
If a parallel or side-by-side vehicle’s capital is included to determine the entire fund’s
capitalization (so called ―capital under management‖) then that parallel or side-by-side vehicle
should be included in the performance calculations of the entire parent fund. Performance can be
calculated separately for the fund vehicle as additional information but is required to be included
in the calculation for the parent.
15. What disclosures at the company or holding level are required by GIPS private equity provisions?
16. Why show both gross-of-fees and net-of-fees returns?
The gross-of-fees return is designed to show how well the invested capital performed, with the net-of-
fees return reflecting the impact of management fees, performance fees (carried interest), and certain
other costs. The investor needs an appreciation of both to understand the dynamics of the asset class.
17. What is a proper benchmark?
Investors in private equity are generally looking to outperform comparable quoted indices. Examples
of relevant benchmarks would be a small-capitalization index (covering the same countries as the fund)
for funds investing in comparably sized companies or a quoted technology index for those investing in
venture funds. The index chosen will need to be a total return index (e.g., including dividends
reinvested). The preferred calculation methodology involves notionally investing/divesting the fund
cash flows into/out of the appropriate index and using the index cash flows and computed valuation to
calculate an IRR.
In addition, many private equity associations and some specialist performance measurement firms
provide data on median-and top-quartile performance for different classes of private equity. These
returns for the same vintage year can be useful benchmarks. Although benchmarks are quite individual,
the best benchmark for the composite should reflect the overall composite strategy, not necessarily
individual clients’ benchmark preferences.
18. Which fees are not deducted from the gross-of-fees and net-of-fees returns?
All fees associated with making, managing, and divesting an asset (defined as transaction expenses in
the GIPS glossary) must be deducted from the gross-of-fees return. management fees, carried interest
and transaction expenses must be deducted from the net-of-fees return. In line with the general GIPS
provisions, fees relating to the expenses incurred in running the fund itself, defined as administrative
fees, and including custody fees and fund legal and accounting fees, do not have to be deducted in
calculating the gross- or net-of-fees returns.
19. Why are fund of funds allowed more flexibility in creating composites.?
As the guidelines have been adopted by the industry, there is has been significant feedback from fund
of funds and investors that the requirements for a private equity fund do not scale reasonably when
applied to a fund of funds vehicle. In particular, given how fund of funds typically invest, createing
composites for every vintage year and strategy combination was difficult to comply with and did not
provide investors with meaningful representation of performance. As much discussion, fund of funds
were given the flexibility of creating composites on either a vintage year or strategy basis or as a
combination of both. However all investments must be included in at least one composite.