March 2023
Article

Valuing private companies – our approach

The Scottish Mortgage Team

Key Points

  • Our process is robust and our approach is proactive – we regularly update valuations with the aim of holding our private companies at ‘fair value’
  • During H1 2022, 585 revaluations have been performed on the private companies held by Scottish Mortgage
  • There are other factors to consider in our valuation approach such as our liquidation preferences – high ranking preference stocks typically offer a higher degree of downside protection

All investment strategies have the potential for profit and loss. The Trust has a significant investment in private companies. The Trust’s risk could be increased as these assets may be more difficult to sell, so changes in their prices may be greater.

1. Our process

We take a proactive approach and regularly update valuations with the aim of holding private companies at 'fair value' ie the price that would be paid for them in an open market transaction.

The valuation process is managed by the Valuations Team and overseen by the Valuations Group, which takes advice from an independent third party, S&P Global (formerly IHS Markit). To ensure this process is entirely independent of the portfolio managers, the managers only receive valuation notifications once changes have been applied to any private companies in the portfolio. 

As part of our valuation process, we assess the fair value of the private companies on a rolling three-month cycle. That does not mean the entire portfolio is assessed once at a quarter-end, as is the case for some other investment vehicles (not managed by Baillie Gifford). Instead, we value a third of the private component of the portfolio each month.

Process in action

Instruments valued 92
Revaluations performed 585
Percentage of portfolio revalued 2+ times 95.0%
Percentage of portfolio revalued 5+ times 78.0%
Data reflecting period from 1 January 2022 to 31 December 2022
Source: Baillie Gifford. Scottish Mortgage private company valuation changes vear to date to end December 2022 *Source: Morningstar. Total return for NASDAO composite. 12 month to 31 December 2022, US dollars.

For all investment trusts, the prices of the private assets are subject to an additional review, twice a year by the respective boards. Private asset valuations are subject to the scrutiny of external auditors as part of the annual audit process.

The regular cycle outlined above is the bare minimum. In practice, the pricing of private companies is monitored continually by the Valuations Team who are alert to ‘trigger events’ that might prompt a revaluation, outside the auspices of the three-monthly cycle. Such trigger events might include:

  • a change in company fundamentals
  • a follow-on funding round
  • a takeover approach
  • an intention to carry out an Initial Public Offering (IPO)
  • any relevant news identified by the Valuations Team
  • any relevant news that is flagged by the portfolio managers in relation to the holdings
  • changes to comparator indices when there are no publicly listed peers
  • changes to valuations of publicly listed comparator companies


The last trigger event on this list has been particularly relevant over the last six months. Given the recent volatility in public markets, the Valuations Team has been closely tracking valuations within the private company portfolio in order to ensure that there is no significant divergence between carrying value and assessed fair value. While the valuation reviews have been mindful of the direction of travel evident in public markets, importantly they have avoided applying broad-brush adjustments to the private portfolio.

While the individual circumstances of each company are assessed within their own individual valuation model, the overall aim is to remain consistent with the valuation approach that has been most recently applied by S&P Global, having been challenged and approved by the Valuations Group.

Any ad hoc change to the fair valuation of any holding is implemented swiftly and reflected in the next published Net Asset Value (NAV). There is no delay. 

This valuation process ensures that private companies are valued in both a fair and timely manner.

2. How our process differs from others

In the wider private equity industry, the concept of a valuation lag is well known and widely accepted. Typically, private equity funds work on a quarterly or monthly valuation cycle. It is accepted practice for them to hold onto existing valuations while monitoring how new trends take hold, and to use hindsight when striking valuations to be included in quarterly reporting. Likewise, it is still commonplace for valuations to be driven almost exclusively by transactions, such as a new funding round, and for valuations to remain unadjusted until another transaction is observed.

In our view, this is inadequate for a daily traded fund. While the valuation associated with a transaction may be a very strong indicator of value at a certain point in time, it will quickly become stale – particularly against a backdrop of volatile public equity markets and/or a market climate, where fewer equity transactions are taking place.

That is why our process differs considerably. For us to be able to circulate a reliable daily NAV, our valuations need to be as up-to-date as possible. We have implemented a number of valuation models and developed a significant level of in-house expertise that allows us to process trigger events quickly and efficiently. Our models are consistent with the approach to the valuation proposed by S&P Global, the external independent valuer. They allow us to update valuations in a consistent fashion while accounting for movements in the wider market. We assess the output from the models frequently especially in times of high volatility. We make price adjustments wherever they are felt to be needed and follow the required governance dictated by our valuation policy.

3. Other factors to consider

Liquidation Preferences

Baillie Gifford typically holds preference stock, and often the highest-ranking preference stock levels by virtue of us being a late-stage private investor. High-ranking preference stock typically offers a higher degree of downside protection. The value of such protection may mean that it is appropriate for the share prices of preference shares to be written down less than ordinary shares in a ‘mark down’ environment.

The table below illustrates how this dynamic played out for the three holdings that experienced the most significant valuation falls during 2022.

Holding Movement in company valuation Price movement on (highest ranking) preferred stock Price movement on the common stock that we also held
1 -78.0% -36.0% -88.8%
2 -75.0% -51.0% n/a
3 -62.0% n/a -64.8%

 

Data reflecting period from 1 January 2022 – 31 December 2022

While there was a marked reduction in the valuation of each company as a whole, for each of the highest-ranking lines of preference stock, the impact on share price performance was tempered by the liquidation preferences. Conversely, where the lowest-ranking stock, such as common equity, was also held, the downside impact was more pronounced as these instruments do not benefit from downside protection in the same way.

 

Public market movements

In volatile markets, movements in the valuations of the private companies will not be exactly aligned with those of the public holdings in the portfolio (or indeed the public markets more broadly).

By way of example, over the past couple of years, we have often seen a temporary surge in the valuation of a number of private companies when they have made the transition to the public markets via SPAC or IPO transactions.

Cognisant that these valuation surges could be short-lived, we took the approach of not immediately marking up the valuations of their private peer group in response. This conservative and prudent approach meant that our privately held stocks did not typically increase to the same extent as some of the publicly listed holdings during the market highs last year, and so intuitively they shouldn’t necessarily fall to the same extent either.

 

Changes in fundamentals

It is important to incorporate company-specific fundamentals into valuation assessments. In the examples below, the valuations of private portfolio holdings fell less than their peers due to superior revenue growth.

Holding Movement in market multiple LTM revenue growth Movement in company valuation Peers mean growth
1 -63.4% 45.0% -37.0% 5.4%
2 -40.5% 94.8% -3.0% 20.0%
3 -40.5% 30.5% -27.0% 26.5%
Data reflecting period from 1 January 2022 – 31 December 2022

While a number of holdings have seen superior growth which can temper a movement compared to peers, the inverse can also apply. In the examples below, the valuations of private portfolio holdings fell more than their peers due to inferior revenue growth.

Holding Movement in market multiple LTM revenue growth Movement in company valuation Peers mean growth
1 -38.7% 15.0% -62.0% 21.7%
2

-40.5%

10.1% -75.0% 19.0%
3 -77.0% 27.0% -78.0% 37.0%
Data reflecting period from 1 January 2022 – 31 December 2022

Lack of listed comparators

Many of the private companies that we hold are disruptive businesses that are defining and shaping huge new markets. They are often in the very early stages of addressing multi-decade opportunities. As a result, they will often have no obvious comparators in public markets and the valuation adjustments applied to them will not always be in step with the overall direction of public markets. A handful of companies in the portfolio who have successfully raised capital at an increased valuation in the first half of 2022 reflect continued strong progress, despite the challenging market backdrop.

 

Trigger events during periods of heightened volatility

Valuation models are maintained internally for each private company holding. They can be updated for the latest market data inputs and any recent company reporting, but as noted above, the pricing of private companies is monitored by the Valuations Team who are alert to ‘trigger events’ that might prompt a revaluation.

The output from this assessment allows for a targeted approach to assessing individual holdings on a more granular basis where there is evidence of a significant movement in fair value. In such instances, the valuation is reassessed following an approach that is consistent with our external independent valuer’s (S&P) most recent valuation report, unless there is a suitable reason for diverging.

The Valuations Team monitors the performance of relevant indices and peer groups on a weekly basis. In more stable conditions a movement of ±10 per cent in a relevant index or peer group would be considered sufficient grounds for assessing the valuation model with a view to adjusting a private company valuation. However, in the current market conditions, this threshold has been reduced to ±5 per cent to account for the fact that daily movements have been less isolated and are indicative of a shift in market sentiment in general.

This ongoing monitoring and assessment of valuation adjustments has meant that the pricing of the holdings in the portfolio have moved much more frequently than they would in the usual quarterly valuations cycle.

The Private Companies Valuations Team and their oversight

The Private Companies Valuations Group (‘the Valuations Group’) is the primary governance body with oversight of the private company valuation process and responsibility for determining the pricing of private assets within Baillie Gifford.

The Valuations Group is comprised of five voting members, all independent of the investment floor and from different departments around the firm. All members have experience in dealing with private asset valuations, and the chair of the Valuations Group is a director in the funds operation department who has been involved with valuations for many years.

The Private Companies Valuation Team (‘the Valuations Team’) is responsible for the day-to-day management of the valuation process, liaising with the external independent valuer and maintaining our in-house valuation models. The team of four is also independent of the investment floor.

Most of the team have a background in audit with many years of experience in the assessment of private valuations. The Valuations Team reports to the Valuations Group which has oversight of the valuations.

Annual Past Performance to 31 December Each Year (Net %)

  2018 2019 2020 2021 2022
Scottish Mortgage Investment Trust 4.6 24.8 110.5 10.5 -45.7

Source: Morningstar, share price, total return, sterling. Past performance is not a guide to future returns.

Risk factors           

The specific risks associated with the trust include:

  • The Trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment (and any income it may pay) to go down or up.
  • The Trust invests in emerging markets where difficulties in dealing, settlement and custody could arise, resulting in a negative impact on the value of your investment.
  • The Trust can borrow money to make further investments (sometimes known as “gearing” or “leverage”). The risk is that when this money is repaid by the Trust, the value of the investments may not be enough to cover the borrowing and interest costs, and the Trust will make a loss. If the Trust's investments fall in value, any invested borrowings will increase the amount of this loss.
  • The Trust has significant exposure to private companies. The Trust’s risk could be increased as these assets may be more difficult to buy or sell, so changes in their prices may be greater.
  • The Trust can make use of derivatives. The use of derivatives may impact performance.

About the author - The Scottish Mortgage Team

The Scottish Mortgage team are dedicated to servicing existing and prospective shareholders of the trust.

Important information

This communication was produced and approved at the time stated and may not have been updated subsequently. It represents views held at the time of production and may not reflect current thinking.

This content does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). The investment trusts managed by Baillie Gifford & Co Limited are listed on the London Stock Exchange and are not authorised or regulated by the FCA.

A Key Information Document is available by visiting our Documents page.

Any images used in this content are for illustrative purposes only.