While funds like yours are likely to be above-board, to play by the rules, and to be as conservative as possible, IMHO it's just a matter of time before an LP sues a less-than-stellar VC for valuing their portfolio companies too aggressively (and thus creating misleading expectations about returns, causing investment in a new fund that wouldn't have otherwise happened, etc etc).

Not to sound snide but you might want to put IFRS on your radar if you haven't already.

Have you ever seen a case where an up round did NOT include a new investor?

If not, why not, and if so, how do you value that asset?

Dean Leffingwell

A public company I work with has a convert outstanding which is very illiquid. Because of a depressed stock price and the state of debt market, the occasional small trade takes place at around 70. Since the bond trades deep under par, FAS 157 forces this company to create a significant intangible asset, to be written down over the years until the convert is due. Net results: (1) the company's balance sheet will be misleading with that asset that has no real value, and (2) net income (for those who care) will be depressed by the writedowns.

Weren't accounting rules supposed to give a clear and fair view of a company's financial situation???

FAS 157 doesn't do or cause anything… it's simply a disclosure standard that categorizes and defines three levels of measurements of fair value. It doesn't require the use of fair value accounting at all. In fact, it doesn't even tell you how to calculate fair value for anything.

The real financial accounting standards that are causing you heartburn are ones like FAS 133, FAS 141 and others that prescribe fair value accounting.

1. Uncertainty- as you correctly point out FAS 157 (and the accounting firms themselves) doesn't tell you HOW to calculate fair value. What the accountants WILL tell you is that they expect to see changes in the portfolio values each quarter, as "it's unlikely there is no change." In essence, you are forced to prove a negative to your auditors in that you must justify the absence of changing each company's valuation. For example, the auditors will tell you that in order to comply with FAS 157 you must make discretionary write ups (and write downs) based on one quarter's revenue of a startup company that has just started shipping product. Bottom line, I have no idea how the market values a single quarter of revenue and how that would change the the acquisition price of a company. But my auditors may not let me leave the value as is because "something has changed."

2. Volatility – Much because of #1, above and also due to the fact that under FAS 157 valuations are changed outside of funding events, valuations change much more often and the volatility of the portfolio asset valuations have dramatically increased. I'd have no issue with this if I thought they were more accurate than the "old days," but it definitely feels strange to me that a much more discretionary and arbitrary valuation methodology is also adding to volatility.

3. Reliance – "Simply a disclosure standard" is not correct. LPs / investors are relying on these numbers as the correct valuation of the assets. Our VC track records and fund raising presentations are showing these numbers. People rely on these numbers, get paid bonuses per these numbers and their potential inaccuracies and / or volatility can have material liability issues.

I could go on for a while – I won't. But as the guy sitting in the audit committee meetings with the auditors, I've seen this up close and personal and besides the frustrations and costs associated with FAS 157, there are real, material effects.