In an evolving investment landscape, Alternative Investment Funds (AIFs) are key drivers of India’s startup growth. They support startups from the seed stage through various funding rounds, even leading them to IPOs. AIF investment managers not only invest strategically but also mentor and guide startups to help them scale. Their success, reflected in metrics like
- Gross IRR of the fund,
- Distribution to Paid-In Capital (DPI),
- Residual Value to Paid-In (RVPI), and
- Total Value to Paid-In (TVPI), showcases the managers’ expertise and is closely tied to accurate portfolio valuations and exits that happened, which attract further investments from High Net-Worth Individuals (HNIs).
Increased traction in this space leading the investor capital commitments to AIFs stood at INR 11,78,479 crore (about $142 billion) as of Jun’2024. (Source: SEBI) and total number of registered AIFs at the end of March 31, 2024, increased to 1,283, compared to 1,088 at the end of March 31, 2023 and adding more, resulting in SEBI closely monitoring its regulation.
In a significant step towards enhancing transparency and fairness, SEBI released a circular on June 21, 2023, mandating Alternative Investment Funds (AIFs) to conduct valuations of their portfolio companies to ensure –
- Consistency,
- Accuracy, and
- Fairness in its valuation activities.
Historically, AIF Regulations focused on valuation disclosures to investors without prescribing any specific principles or methodologies to be adopted. The June 2023 circular now mandates AIFs to follow the guidelines and methodology, which are designed to streamline how these funds assess their portfolio companies to ensure fair disclosure to the investors.
A standardised approach regarding valuation principles and methodology recommended International Private Equity and Venture Capital Valuation Guidelines (“IPEV Guidelines”), which serve as a standard for valuing portfolio investment of Private Equity / Venture Capital (PE/VC) funds across various jurisdictions.
The IPEV Guidelines specify that the valuer should use one or more of the following valuation techniques as of each measurement date –
- Market Approach — based on
- Multiple of earnings or revenue
- Industry Valuation Benchmarks
- Market Prices available for instruments quoted on an active market
2. Income Approach — based on Discounted Cash Flows
3. Replacement Cost Approach — based on Net Asset Valuation techniques
Key Changes in SEBI’s Approach
- Independent Valuation Requirement: AIFs must engage Independent Valuers registered with Insolvency and Bankruptcy Board of India (IBBI) for valuations to ensure that assessments are objective and free from internal bias.
- Consistent Valuation Methodology: AIFs must adopt uniform methodologies across asset classes in their portfolios, ensuring that all portfolio companies are valued consistently.
- Reporting and Compliance: AIFs must transparently communicate valuations to investors, particularly when there is a change of more than 20% between consecutive valuations or more than 33% within a financial year.
Impact of Circular
Under SEBI’s new guidelines, an independent valuer would assess the companies based on standard metrics like ARR (Annual Recurring Revenue), churn rate, and customer lifetime value. These factors provide a more accurate evaluation of the business’s existing situation. Following that, investors would benefit from an objective and realistic assessment of the startup’s value, enabling better-informed investment decision.
Outlook
SEBI’s new valuation guidelines represent a welcome step towards strengthening transparency and consistency in the India’s AIF landscape. By mandating independent valuations of portfolio companies, SEBI ensures that investors have access to standardized and reliable information. For AIFs, adopting these processes will build stronger trust with investors and create a healthier investment environment.
Author:
Rakesh Rana
