A signed price is the best evidence a valuation team gets, but it is not yet cash: here is the bridge from the term sheet to the mark.
When a sale has been signed but not closed at the reporting date, start from the fund's share of the agreed equity price, then take off what the fund will not receive on day one, discount for the wait, value the earn-out separately and weight the result by the probability that the deal closes. On an illustrative 480.0 enterprise value deal for a 62 per cent stake, that turns a headline share of 217.0 into a fair value of 208.5, 3.9 per cent below the price on the term sheet and 22.3 per cent above the previous mark of 170.5.
Worked in full in The Private Markets Valuation Specialist by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A signed sale and purchase agreement is the best evidence a valuation team ever gets: an arm's length buyer has committed to a price for the very asset being marked. Fair value is still the price at the measurement date, though, and on that date the fund holds a contract that pays later, pays partly in escrow and contingent consideration, and may not complete. Marking straight to the headline number is a common error that valuation committees are asked to sign off.
| Input | Value |
|---|---|
| Enterprise value in the agreement | 480.0 |
| Net debt at the locked-box date | 130.0 |
| Equity price | 350.0 |
| Fund's stake | 62.0% |
| Escrow, share of price, released 18 months after the reporting date | 5.0% |
| Expected release of the escrow | 80.0% |
| Fund's share of transaction costs, on its proceeds | 1.8% |
| Expected time to closing (regulatory approval) | 4 months |
| Discount rate for the wait | 9.0% |
| Earn-out, total for all sellers, payable in 2 years | 40.0 |
| Probability the earn-out target is met | 45.0% |
| Discount rate for the earn-out | 14.0% |
| Probability the deal closes | 90.0% |
| Enterprise value if the deal fails (pre-signing market approach) | 405.0 |
(480.0 − 130.0) × 62% = 217.0. This is the number on the term sheet, and the one to move away from.
Escrow 217.0 × 5% = 10.85 and costs 217.0 × 1.8% = 3.91 leave 202.24 paid at closing.
Four months at 9 per cent: 202.24 ÷ 1.094/12 = 202.24 ÷ 1.0291 = 196.52.
Excel: =202.24/(1+9%)^(4/12)
Expected release 10.85 × 80% = 8.68, received in 18 months: 8.68 ÷ 1.1380 = 7.63.
Fund's share of the face value: 40.0 × 62% = 24.80. Expected payment 24.80 × 45% = 11.16, discounted two years at 14 per cent: 11.16 ÷ 1.2996 = 8.59.
If it closes: 196.52 + 7.63 + 8.59 = 212.73.
If it fails: (405.0 − 130.0) × 62% = 170.50.
Fair value = 90% × 212.73 + 10% × 170.50 = 191.46 + 17.05 = 208.51.
The earn-out is valued on its own expected outcome, not at face value, and with a higher rate than the closing cash because it depends on the company hitting a target under the buyer's control. The method for a more complex earn-out is in how to calculate the fair value of an earn-out.
| Step | Amount |
|---|---|
| Fund's share of the agreed equity price | 217.00 |
| Escrow: haircut for claims and the 18-month wait | −3.22 |
| Transaction costs borne by the fund | −3.91 |
| Time to closing on the cash paid at completion | −5.73 |
| Earn-out at expected present value | 8.59 |
| Closing risk: 10% × (212.73 − 170.50) | −4.22 |
| Fair value at the reporting date | 208.51 |
Two things stand out. The earn-out offsets most of the escrow, cost and closing-risk deductions, which is why the fair value lands close to the headline share. And the probability of closing matters less than people expect at 90 per cent: the closing-risk line is only 4.22, because the fallback is not zero but the value the business had before anyone signed. The mark moves 38.0 above the previous quarter's 170.5, and the bridge shows exactly where that movement came from.
Should transaction costs come off fair value? Under IFRS 13 and ASC 820, fair value is not reduced by transaction costs to sell. Many funds still deduct costs that are contractually agreed and will certainly be paid out of the fund's proceeds, because the fund will never receive that cash. Whichever reading the policy takes, write it down and apply it to every signed deal, and show the 3.91 as a separate line so the committee sees the choice.
The fallback value is where judgement bites. A deal that fails on regulatory grounds may leave the business where it was. A deal that fails because the buyer walked away after diligence tells the market something, and the fallback should fall with it.
| Probability of closing | Fallback EV 405.0 | Fallback EV 380.0 | Fallback EV 355.0 |
|---|---|---|---|
| 100% | 212.7 | 212.7 | 212.7 |
| 95% | 210.6 | 209.8 | 209.1 |
| 90% | 208.5 | 207.0 | 205.4 |
| 80% | 204.3 | 201.2 | 198.1 |
| 70% | 200.1 | 195.4 | 190.8 |
The fund's share of each fallback is 170.5, 155.0 and 139.5. Across the whole grid the value stays between 190.8 and 212.7, a range of about ten per cent, while the earn-out alone swings it from 200.8 if the target is judged out of reach to 218.0 if it is judged certain. On most signed deals the earn-out assumption deserves more of the committee's time than the closing probability.
Treat a signed sale as the anchor and build the bridge to it: share of the equity price, escrow, costs if the policy deducts them, time, earn-out at expected value, closing risk against a fallback that is itself a fair value. On this case the answer is 208.5, and every line between it and 217.0 can be challenged on its own. The calibration logic behind the fallback mark is in how to calibrate a valuation to the entry price, and the market approach and roll-forward workbook is on the free workbook page for this book.
You can anchor on it, but not copy it. The signed price is the strongest evidence of fair value available, yet the fund holds a contract that pays later and may fail. In the illustrative case the fund's share of the price is 217.0 and fair value is 208.5, after escrow, costs, the wait to closing, an earn-out at expected value and a 90 per cent closing probability.
Separately from the closing cash, at expected value and with a higher discount rate, because payment depends on performance after the buyer takes control. Here the fund's share of a 40.0 earn-out is 24.80; at a 45.0 per cent chance of payment in two years, discounted at 14.0 per cent, it is worth 8.59, not 24.8.
The fair value of the business without the deal, measured on the same date, usually the pre-signing market approach. Here that is 170.50 for the fund's stake. Weighting 212.73 if it closes and 170.50 if it fails at 90 and 10 per cent gives 208.51. If a failed deal would damage the business, lower the fallback: at a 355.0 enterprise value the mark falls to 205.4.
This article is one calculation from The Private Markets Valuation Specialist. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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