These same multiples exhibited “sharp reversals” in the post-fundraising period, the report said. Then he investigated whether portfolio company earnings shot up during the same periods.Īccording to the report, funds with low reputation managers showed an increase in valuation multiples right before fundraising periods closed. Generally, Baik defined a low-reputation fund manager as one with a history of poorer performance, fewer funds, and a smaller asset base.įor all of the firms in the sample, Baik first tested if multiples increased during fundraising. To test his hypothesis, Baik separated his sample set into low-reputation and high-reputation managers. To manage the earnings of their investments, firms use a legal accounting concept called earnings management, which means managers can accelerate the recognition of revenue or delay some expenses so they can report higher earnings.īaik predicted that firms use either high multiples or inflated portfolio company earnings - or both - to inflate their NAVs during fundraising periods. Private equity firms can then apply higher multiples or “manage the earnings of their investments” to appear more valuable than they really are to investors during fundraising periods. According to the paper, private equity firms most often apply multiples to their portfolio firm earnings, usually in the form of EBITDA or sales. Net asset values are simply the sum of the value of each portfolio company held in the fund, but the calculations rely on complex assumptions.īecause most of these investments are private companies that don’t have publicly available market prices, private equity firms can use different valuation techniques to determine the value of the fund. “I examine the components of the NAVs and provide evidence that funds managed by low reputation GPs show inflated valuation multiples and inflated financial performance of their investments during fundraising, which is consistent with the manipulation hypothesis,” according to the paper.īaik looked at the NAVs of funds, and how they were calculated, during fundraising periods. Baik adds insight on a firm’s reputation to the body of research on private equity. He found that private equity fund managers with less-than-stellar reputations overstate the values of their funds during fundraising. In a paper titled “Private Equity Fund Valuation Management During Fundraising,” Brian Baik, an assistant professor at Harvard Business School, looks for evidence of manipulation by studying the extent to which firms inflate net asset values by managing the assumptions behind valuation, including the multiples used, or influencing earnings and sales of underlying companies in their portfolios. Previous research has found abnormally high private equity fund valuations during fundraising periods, leading researchers to debate whether or not firms manipulate these figures or raise money during the best performing periods. To keep up with high-performing fund managers, private equity firms with lesser reputations inflate their funds’ value during fundraising periods.
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