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Valuations of PE-backed unicorns at risk following slated SEC scrutiny

Under the new proposal, PE managers would be required to file reports on certain events within one business day, including the removal of a fund’s general partner, the termination of a fund’s investment period and more.

By Nicholas Tsafos, EisnerAmper

With the increase in funding from private investors, startup companies are staying private longer. On the heels of this robust activity, the US Securities & Exchange Commission is planning on requiring greater transparency for both private equity fund advisers and the large private companies they fund, which has the potential to impact valuations of these so-called “unicorns.”

Nicholas Tsafos, EisnerAmper

In January 2022, the SEC issued proposals requiring both PE funds and private companies to provide enhanced disclosures. PE firms would have to provide additional information on their annual or quarterly Form PF, which would allow regulators to identify accumulating risks more easily in the private markets. Form PF was adopted by the SEC after the 2008 global financial crisis, and it requires both PE and hedge funds to disclose their net assets, derivatives holdings and more. Under the new proposal, PE managers would be required to file reports on certain events within one business day, including the removal of a fund’s general partner, the termination of a fund’s investment period and more. In addition, funds with at least $1.5 billion or more in assets under management would be subject to even greater scrutiny regarding the use of leverage and their portfolio companies, controlled portfolio companies and borrowings, portfolio companies’ restructurings and recapitalizations and others.

Private companies, including many of these unicorns, might also be impacted by the SEC’s requirement to disclose additional information about their finances and operations.

Under the microscope

Putting the recent announcements from the SEC aside, it is no secret that several unicorns had substantial success fundraising, and that the total number of companies valued at $1 billion or more has continued to grow despite the uptick in initial public offerings.

However, in our current environment, several factors are putting valuations of these private companies under a microscope. Of course, every company’s valuation can be impacted differently based on their assets, equities, debt, geographic focus and other variables.

In a higher interest rate and higher inflation environment, coupled with increased labor costs, private companies can be impacted by a deterioration of earnings that can have a negative impact on valuations. The current valuations of these companies are priced to perfection and might not be realized by investors down the road. Of particular concern to the SEC is the number of companies that went public in 2021 and are treading below their IPO prices as of December 31, 2021.

To add to the matter, the covid-19 pandemic, global supply chain issues, geopolitical concerns and the increased integration of environmental, social and corporate governance into companies might cause price inefficiencies for these private companies.

The monetary and fiscal stimulus that was provided to combat the effects of the covid pandemic have provided a significant amount of liquidity in the public and private markets. As we begin to enter the next phase of the covid economy, it is in the best interest of fund advisers and large private companies to provide greater and enhanced transparency to ensure investor trust and confidence.

Nicholas Tsafos is the partner in charge of EisnerAmper’s New York Office and an audit partner in the Financial Services Group. EisnerAmper is one of the largest accounting, tax and business advisory firms in the US.