What Valuation Methods Should a Fund Use for Illiquid Holdings?

A fund should use a valuation method that fits the asset and can be explained with evidence available at the reporting date. For illiquid holdings, the estimate depends on selected methods and assumptions, so review how those choices were made and how they changed over time.

Choose a Method Suited to the Asset

A private operating company may be valued using comparable transactions, market multiples, or expected cash flows. The fund should explain how it selected comparisons and adjusted for the company's circumstances, including operating results. It should also explain how the capital structure affected the estimate. Forecast-based methods need assumptions that can be tied to actual operating evidence.

Real estate may call for an appraisal, comparable sales, rental income, or occupancy data. Property condition may also affect the estimate. A fund interest or other complex holding may require attention to its governing terms, underlying assets, and transfer restrictions. No single method fits every asset. Ask why the chosen approach is appropriate and what other reasonable methods were considered.

Examine the Inputs and Changes

Request the valuation date, principal inputs, source data, and assumptions. Find out whether forecasts, market comparisons, or appraisals were used, and when the underlying information was gathered. Compare the assumptions with available operating results or transaction evidence. If the method relies on forecasts, ask which outcomes must occur for the estimate to hold.

Compare each reporting period with the prior one. Ask what changed in operating performance, market evidence, capital structure, or expected cash flows. A value that stays flat while performance weakens needs an explanation. A sharp increase should be supported by an identifiable event or change in evidence. Request a bridge that separates asset performance from changed assumptions or a changed method.

Understand Review and Approval

Ask who prepared the valuation and who reviewed it. Find out who approved it. A manager may know the holding well, but the process should document review and any conflicts. If a third-party specialist was engaged, ask what scope they were given, what information they received, and whether management adjusted or rejected the conclusion. The fund should explain exceptions to its normal method.

Valuations should be recorded consistently in the accounting records and investor reporting. If a method changes, the fund should show how the change affects the reported value and explain why it was made. For evidence that a holding exists and that the fund owns it, see how to check fund assets and valuations. The related accounting disclosures are covered in what to examine in audited financial statements.

Questions to Put to the Manager

• "Why does this method fit this specific holding?"
• "Which inputs have the greatest effect on the reported value, and what supports them?"
• "What changed from the prior valuation date, and can you provide a value bridge?"
• "Who prepared the estimate, and who reviewed and approved it?"
• "What independent work was commissioned, and what was its scope?"

For a material holding with unclear inputs or inconsistent treatment, request the work supporting the estimate and consider an independent valuation professional. Talk with your CPA about tax reporting consequences and your attorney about rights in the fund documents. Record unresolved assumptions so they remain visible in the investment review.

Checklist

• Match the method to the asset type and available evidence.
• Obtain the date, inputs, and assumptions. Request the source data as well.
• Compare material assumptions with operating or transaction evidence.
• Review changes in method and value across reporting periods.
• Identify who prepared the valuation, who reviewed it, and who approved it.

Read next: How can investors test whether a fund's returns are net of all fees and expenses?

Traditional accounting is more challenging for a family office than a typical business because of illiquid assets such as real estate, operating businesses, large public stock market investments, hedge fund allocations, and venture capital or private equity commitments.

Sources: Family Office Club investor due diligence framework, How to Start a Family Office, The Single Family Office. Informational only, not financial, legal or tax advice.