NVCA Today

A recent flurry of media coverage has focused on the possible upcoming convergence of US and international accounting standards. Much of this coverage discusses which accounting system casts which public companies in the most favorable light. While that particular matter seems distant from the US venture capital industry, there are two key aspects of convergence that it appears we need to focus on:

• Determining which system (current US GAAP vs. International vs. neither) is the best system overall for the US business community going forward. We would expect this dialogue to center on transparency, reliability, relevance, comparability, and ongoing costs in addition to any conversion costs, which might not be insignificant.
• Addressing matters which specifically affect our funds. One area already identified is the financial statements provided by GPs to LPs under international rules -- should the international rules become the new US rules?

As a first step towards understanding and engaging in constructive dialogue in both of these areas, the NVCA CFO Task Force has appointed a subgroup to begin gathering facts, analysis, and expert opinion on what all of this means to our industry.

Why Has The Convergence Issue Come to the Surface at This Time?

For years, the United States has been developing generalized accounting principles referred to as Generally Accepted Accounting Principles ("GAAP").The keeper/arbiter/decider of GAAP is the Financial Accounting Standards Board ("FASB"). FASB develops and updates GAAP and the SEC has adopted these accounting rules for public company reporting and other situations over which the SEC has jurisdiction.

 In recent years, on a parallel track, a separate set of rules emerged from the International Accounting Standards Board ("IASB") which was Europe-centric. These rules became known as the International Financial Reporting Standards ("IFRS," pronounced "IFF-ers" or "EYE-fers").

Over recent years, the large number of multinational corporations complained that they had to endure keeping two sets of books and this prompted the concept of convergence. In early September 2008, the SEC and the FASB announced steps to pave the way for US public companies to convert from US GAAP to IFRS.The SEC "roadmap" provides for a three-year run-up to an SEC "go-no go" decision in 2011.2011 is also the year that major US trading partners, Canada, Japan, Korea and India plan to adopt IFRS. At about the same time, the FASB and the IASB met to review and re-orient their convergence plan to be consistent with the SEC's proposed schedule.The updated FASB-IASB memorandum of understanding is at http://www.fasb.org/intl/MOU_09-11-08.pdf.

Nothing in the SEC proposal or the FASB-IASB memorandum says that the US will conclusively "converge" to or switch over to IFRS. This all contemplates a well-thought-out and informed decision in three years. But large processes are being set in motion that may be difficult to stop. It is worth pointing out that the SEC roadmap refers to public company reporting; however we should logically expect alignment of private and public company rules.

What is not clear at this time is what the current global economic turmoil will do to the priority of this project or its timetable.

US GAAP vs IFRS - Never Generalize

Even viewed from 30,000 feet, it is difficult to generalize on how the two systems compare. First, while the IASB produces plain vanilla IFRS standards, there is no one flavor of IFRS in use. Much like the original UNIX kernel, each country/jurisdiction has been able to create its own version of IFRS. But unlike UNIX, sometimes the differences among the localized IFRS versions are large. So an apples-to-apples comparison of "IFRS-compliant" financials from different jurisdictions can be difficult. Second, it is true that IFRS itself is a very thin document compared to GAAP, which has grown to roughly a 2-foot stack of written rules. However, to implement IFRS, you need the implementation guide which combines with the original document to create its own 2-foot stack. Again, much of the surface comparisons are not useful.

Until this point, US venture capital firms have been using exclusively US GAAP accounting standards. However, in early November, we received a report from a member firm with international intermediaries for overseas investment where the local auditors raised the question of whether those financial statements need to be IFRS-compliant.

GP-to-LP Reporting

One area already identified as a possible problem area is GP to LP reporting. Virtually all LP agreements (or accompanying documents) require GPs to provide GAAP-compliant financial reports to LPs. Annual audits of these reports are GAAP-based. Under GAAP, the US venture capital industry provides fair-value portfolio reports under the special rules of "investment company reporting". Our early analysis of IFRS shows special investment company rules for portfolios of publicly-traded companies but no such provisions for portfolios of private companies.

Most of the SEC and FASB efforts to date have focused on public company reporting. We are very early on in verifying and creating awareness of the lack of private portfolio provisions. The initial reading is that, under IFRS, the financial statements for a number of the portfolio companies would have to be consolidated into the operating financials of the venture capital fund itself. This would create a muddled report, essentially unusable to the LPs in determining the value of their own portfolio holdings. This would mean an end to fair value reporting as we have known it. A potential further complication could arise if DOL ERISA fair value rules remain in place for the plan sponsors while accounting rules abandon the current fair value reporting requirements.

How International GPs Now Handle LP Reporting

A logical question arising from the above paragraph is how venture capital firms operating in IFRS jurisdictions are currently reporting to LPs, including those subject to DOL ERISA fair-value reporting rules. The initial, and somewhat limited, review by the NVCA CFO Task Force subgroup is that they simply are not doing so. Many international GPs continue to produce financial statements in accordance with US GAAP for both their US and international LPs. Those reporting under IFRS are incurring the additional effort and expense of also providing a separate US GAAP-type fair value schedule.

Recent Events

A full chronology of events is posted under Valuation Guidelines on the NVCA website www.nvca.org. This document is updated from the chronology in Appendix H of the NVCA 2008 Yearbook prepared by Thomson Reuters. Even as the US industry works toward compliance with the FASB's Statement 157 on fair value measurement starting with 2008 financials, dialogue has begun on convergence. In March 2008, the International Private Equity Board (IPEV) board reconstituted and re-launched itself. IPEV was expanded to include five practitioners from the United States who are familiar with the venture industry. The initial focus of the group is on convergence of US Private Equity Industry Guidelines Group ("PEIGG") and IPEV fair value guidelines. Details are online at www.privateequityvaluation.com.

Going Forward

With the international and domestic attention on other economic matters, it is not clear how quickly any accounting standard convergence activities will move. However, the NVCA CFO Task Force has begun the process of preparing for the future dialogue and the NVCA has several efforts underway to understand the implications. For more information, please contact NVCA head of research, John Taylor, This e-mail address is being protected from spambots. You need JavaScript enabled to view it .