A valuation backtest on ten exits, with the reference mark that matters, the statistics to compute, and what a persistent uplift says about interim NAV.
To backtest a manager's valuations, compare each exit's proceeds with the mark the manager carried before a sale was in prospect, the last quarter end before the process began or before signing, not with the last mark before closing. On the illustrative ten exits below, proceeds of $851.4m against unaffected marks of $700.0m show a weighted exit uplift of 21.6 per cent. Against the last mark before closing, the same exits show 2.1 per cent and look perfectly calibrated.
Worked in full in Operational Due Diligence in Private Equity by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Valuation is the domain where operational due diligence most often accepts a policy document as evidence. The policy says fair value under the accounting standard, a valuation committee, perhaps a third-party review. None of that shows whether the marks were right. The exits do. Every realised deal is a free test of the mark that preceded it, and a manager with a decade of exits has run that test dozens of times whether or not it has looked at the results.
For every exit in the period: the exit proceeds, the fair value at the last quarter end before closing, and the fair value at the last quarter end before the sale process began or before signing, whichever is earlier. The third figure is the one most managers do not volunteer, and the one that matters.
| Exit | Unaffected mark | Last mark | Proceeds | Uplift on unaffected | Uplift on last |
|---|---|---|---|---|---|
| 1 | 82.0 | 101.0 | 104.0 | 26.8% | 3.0% |
| 2 | 45.0 | 52.0 | 53.5 | 18.9% | 2.9% |
| 3 | 120.0 | 150.0 | 151.0 | 25.8% | 0.7% |
| 4 | 30.0 | 33.0 | 31.5 | 5.0% | −4.5% |
| 5 | 64.0 | 80.0 | 83.2 | 30.0% | 4.0% |
| 6 | 25.0 | 21.0 | 20.0 | −20.0% | −4.8% |
| 7 | 150.0 | 172.0 | 178.5 | 19.0% | 3.8% |
| 8 | 38.0 | 47.0 | 49.4 | 30.0% | 5.1% |
| 9 | 56.0 | 60.0 | 58.8 | 5.0% | −2.0% |
| 10 | 90.0 | 118.0 | 121.5 | 35.0% | 3.0% |
| Total | 700.0 | 834.0 | 851.4 | 21.6% | 2.1% |
Uplift per deal = proceeds ÷ reference mark − 1
Weighted uplift = Σ proceeds ÷ Σ reference marks − 1
In Excel, with marks in B2:B11 and proceeds in D2:D11:
=SUM(D2:D11)/SUM(B2:B11)-1 for the weighted uplift, and
=MEDIAN(D2:D11/B2:B11-1) for the median, entered as an array in older versions.
| Statistic | On unaffected mark | On last mark |
|---|---|---|
| Weighted uplift | 21.6% | 2.1% |
| Median uplift | 22.4% | 2.9% |
| Mean absolute error | 21.6% | 3.4% |
| Exits below the mark | 1 of 10 | 3 of 10 |
| Exits within 10.0% of the mark | 2 of 10 | 10 of 10 |
| Dollar uplift, $m | 151.4 | 17.4 |
Measured against the last mark, the manager's valuations are within 10.0 per cent on every exit. That is the figure a manager will offer, and it proves very little: by the last quarter end before closing, the price has usually been signed, and the mark has been moved to it. Of the net $151.4m by which proceeds exceeded the unaffected marks, $134.0m had already been written into the last marks before closing. The test is measuring the manager's ability to copy a signed price into a valuation.
Measured against the unaffected mark, nine of ten exits came in above, seven by more than 10.0 per cent, with a median of 22.4 per cent. That is a consistent pattern, not noise.
A persistent positive uplift on unaffected marks says the manager values conservatively, or lets marks go stale, until a buyer appears. Many investors regard that as a virtue. In operational due diligence it is a finding, for three reasons.
The opposite pattern, exits regularly below the unaffected mark, is the more serious finding: it means interim NAV has been overstated, and with it any performance reported to raise the next fund. Exit 6 is the single example here, sold 20.0 per cent below the mark that preceded the process.
| Variant | Weighted uplift |
|---|---|
| All ten exits | 21.6% |
| Excluding the largest exit, deal 7 | 22.3% |
| Simple mean of the ten uplifts | 17.6% |
| Measured on the last mark before closing | 2.1% |
The result is robust to dropping the largest exit and to weighting. It is not robust to the choice of reference mark, which is why that choice must be specified in the information request, not left to the manager.
Accepting a backtest against the last mark. It is the default in most manager presentations, and it will show calibration whatever the policy is. Ask for the mark at the last quarter end before the process began, deal by deal, and compute the uplift yourself.
Request three numbers per exit, compute weighted and median uplift on the unaffected mark, count exits below it, and record the result in the valuation section of the report. Here the answer is 21.6 per cent, with one exit in ten below its mark. For how the entry price should anchor the first marks, see how to calibrate a valuation to the entry price; for scoring the finding without averaging it away, why refining an ODD rubric makes it weaker. The rating model this finding feeds is in the free workbook for this case.
The fair value at the last quarter end before the sale process began or before signing, whichever is earlier. The last mark before closing usually already reflects the signed price. In the worked case that choice moves the weighted uplift from 21.6 per cent to 2.1 per cent on the same ten exits.
Not necessarily. A consistent uplift means interim marks are conservative or stale, so interim NAV is understated and returns look smoother than they are. In the worked case the median exit came in 22.4 per cent above the unaffected mark. That flatters the exit record and distorts anything priced on NAV, such as secondaries and NAV facilities.
Enough to see a pattern rather than an anecdote; ten is a workable minimum, and the test improves with every exit. Report the weighted and median uplift, the number of exits below the mark, and the result without the largest deal. Here dropping the largest exit moves the weighted uplift only from 21.6 to 22.3 per cent.
This article is one calculation from Operational Due Diligence in Private Equity. 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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