BEST PRACTICES IN PRIVATE EQUITY VALUATION: Helping Private Equity Maximize Investment Returns A CohnReznick LLP White Paper OCTOBER 2015 . Preface The competition for high-quality investment opportunities is significant as strategic buyers are driving record levels of M&A activity and are willing to pay premiums to secure their intended targets. Valuations for middle market deals have reached pre-recession levels sparked by lower financing rates, a growing economy, and market supply and demand forces. To meet investor expectations in this environment, it is even more important that Private Equity groups employ a uniform and consistent set of valuation guidelines in order to make informed investment acquisition and exit decisions. Jeremy Swan Christopher Aroh CohnReznick’s Private Equity Industry Practice has assembled this list of valuation best practices as a means to engage clients in discussions as to how they value assets and debt. As such, this document is not intended to provide specific technical guidance to a private equity group, portfolio company, or company seeking equity investment. Jeremy Swan, Principal Private Equity and Venture Capital Industry Practice Leader Christopher Aroh, CPA, Partner cohnreznick.com | 1 . Do the right deal. Do the deal right. See the deal through. These three keys to value creation guide private equity firms in maximizing investment returns. Given the complexities of today’s equity markets, creating a decisive competitive advantage means identifying wise investments, securing them at the right price, providing financial and operational insight to maximize value, and realizing that value upon sale. CohnReznick understands the issues private equity groups face when acquiring, holding, and exiting equity positions. Our valuation experts help many of the nation's leading private equity groups assess their value conclusions for potential and current investments, so they can make informed investment and disposition decisions. CohnReznick’s specialists have assembled this list of best practices addressing internal controls, financial performance, market- and income-based approaches to valuing assets, and valuing debt. INTERNAL CONTROLS The fundamentals for a successful valuation start with a system of internal control that governs procedures and ensures that the valuation process is consistently applied across all holdings within a fund’s portfolio. Further, these procedures consider other indicators of value such as goodwill impairment analyses, stock options, warrants, and any additional valuations performed by the portfolio company as part of its year-end valuation conclusion. • Ensure Alignment to Generally Accepted Valuation Guidelines: Determine if the current year methodology is in-line with generally accepted valuation guidelines and is appropriate considering the nature of the investment and the stage of operations of the portfolio company. • Document Methodology Changes and Valuation Responsibility: If there have been any changes in the valuation methodology or implementation as compared to prior periods, document the reasons for the change.

Further, document who is responsible for preparing the valuations, how frequently they are prepared, and the approval process. • Explain Valuation Techniques Utilized Considering the Nature and Characteristics of Each Investment: Pursuant to ASC 820, use multiple valuation approaches to arrive at the value conclusions. The approaches would include the Income Approach (discounted cash flow / capitalization or earnings), Market Approach (both guideline companies and M&A transactions), and Cost Approach (net asset value or restated balance sheet). Explain valuation approaches considered, but not utilized, and explain why a specific valuation method was given a particular weight.

Consider selecting the weighting of each valuation technique based on facts and circumstances, quality of available data, the performance of the company, and other factors. The fundamentals for a successful valuation start with a system of internal control that governs procedures and ensures that the valuation process is consistently applied across all holdings within a fund’s portfolio. • Scrutinize Interim Valuations: If valuations are performed as of an interim date, obtain and review financial performance through year-end and evaluate the impact on the valuation, if any. If actual performance significantly changes in comparison to budgets or forecasts, review the analysis to incorporate the results. Consider if any facts, market conditions, or other material circumstances changed after the date of the valuation and consider their impact on the current valuation.

Do the same for material events that occurred after the balance sheet date and consider whether or not they were knowable as of the valuation/measurement date. 2 | Best Practices in Private Equity Valuation . • Analyze Current Year Investments: For investments made less than six months from the balance sheet date, compare trailing twelve month (TTM) performance at entry to TTM at the valuation date. Determine whether there were any significant transactions in the business that would result in a valuation change since initial investment. Determine if there were any additional equity financing rounds since the initial investment. If so, how was the transaction/financing round considered in the current valuation? For investments made more than six months from the balance sheet date, generally, a full valuation analysis should be performed for all assets acquired over six months from the valuation date. • Consider Additional Factors: Does the fund follow its written valuation policy? How does the current fair value footnote disclosure compare with the written valuation policy? Are there additional details to be added to the disclosure regarding the process and methodologies used? • Establish a Valuation Committee: All valuation recommendations should be presented to and approved by a valuation committee.

Segregation of duties between investing, valuation, and financial reporting should be created and a check-and-balance system established. FINANCIAL PERFORMANCE Provide an overview of financial performance that covers the subject company and the underlying investment. Describe the financial performance and expectations for the future. Also, describe whether the company is in compliance with debt covenants and, if there have been recent rounds of financing, how they were considered in the analysis.

Make sure to: • Explain Shortfalls: Consider if the company is on-target to hit milestones and overall budgeted financial performance. Explain year-to-date budget shortfalls and the company’s plans to meet budget and evaluate whether the company has fallen short on past budgets. • Analyze Liquidity: Evaluate the company’s liquidity position and its cash burn rate relative to funds available as of the valuation date. • Identify the Principal Market: Consider overall trends in the industry and discuss whether the company is experiencing these trends. Prepare a comparison between the subject company and the overall industry in terms of key financial performance metrics, including revenue growth, EBITDA or EBIT margins, EBITDA or EBIT growth, liquidity ratios, leverage ratios, and other relevant financial ratios. MARKET APPROACH The most critical factors in obtaining an accurate valuation using a market approach relate to the selection of guideline companies and the methods for determining the appropriate multiple. Explain decisions, taking specific care to document any adjustments made when refining the valuation analysis. • Explain Comparisons: Explain which guideline companies compete directly with the subject company and why specific public companies and/or M&A transactions are valid comparisons. Ensure each guideline company operates in a similar industry, pursues similar market opportunities, and is subject to similar risks.

Provide the market research and industry reports to support the comparable data utilized within the analysis. cohnreznick.com | 3 . • Select the Specific Multiple: Document the factors considered to determine the multiple. Consider factors such as size, growth, profitability, financial leverage, product diversification, and a general comparison of performance and risk factors between the subject and guideline companies. If the enterprise value is being derived from historical results, use historical multiples. If the enterprise value is being derived from future expected results, use multiples derived for future expected results. If the Fund uses a blend of historical and projected performance measures, the multiples should be similarly weighted. Document how these factors were quantified in the valuation and ensure the multiple is reasonable based on the current performance of the subject company. • Calibrate Discounts: At the original investment date, the implied multiple should equal the transaction price through calculating a calibration discount.

Identify the factors included within the calibration discount (size, profitability, growth, etc.) in the implied multiple. The calibration should be periodically revisited to determine whether the implied multiple/factor should be adjusted for changes in market conditions or the performance of the subject company. • Apply the Multiple: Explain any adjustments made to the performance measure to which the multiple is being applied (EBITDA, Revenue, etc.). Provide additional documentation/ support for significant adjustments to EBITDA (or other performance measure) to support the valuation.

Compare the multiple applied in the current year to the entry multiple at initial investment or to the multiple used in the prior year remeasurement. Consider the reasons why the company’s performance is in-line with the fund’s initial expectations when it first entered into the investment. Also consider whether any adjustments should be made to the valuation measurement to simulate the planned exit. INCOME APPROACH When using an income approach to evaluate a potential/existing investment, don’t ignore the basics.

Provide the current year financial data of the subject company as well as the most recent audited financial statements (unaudited if no audited statements are available). Detail any adjustments to the financial data and provide the market research utilized to form assumptions and support them from a market participant perspective. Also consider: • Detail Key Assumptions: Identify assumptions used within the discounted cash flow analysis, such as growth rate and discount rate, and describe the factors considered when arriving at the assumption used.

Consider whether the model forecasts a discrete period and a terminal year. Does the terminal year capture what is considered to be a normalized level of performance for the company? Capital expenditures in the terminal year could equal the depreciation expense or could be higher, as would be the case in a high-growth industry. • Complete Waterfall Analyses: Make certain that the waterfall analysis (if appropriate for the unit of account in the subject investment) includes all debt balances and equity classes. Equity classes should reflect the liquidation preferences, conversion rights, participation rights, and accrued dividends. Apply consistent methodologies for accounting for cash, working capital needs, and non-operating assets or liabilities across all portfolio valuations. 4 | Best Practices in Private Equity Valuation When using an income approach to evaluate a potential/existing investment, don't ignore the basics. .

OTHER ADJUSTMENTS TO EQUITY VALUE When valuing an equity investment, it is important to detail and explain any adjustments made to equity value, including discounts and variances caused by the valuation approach or the nature of the investment. • Explain Variances based on Approach: Determine whether any significant variances in implied enterprise value result from the valuation approach and consider revising assumptions used or weighting percentages applied. • Implied Equity Value from Recent Equity Transactions: Determine whether recent rounds of financing represent arm’s length third party transaction that can be used to infer the fair value of total equity of the company. • Consider Discounts: Consider applying discounts for lack of control and/or lack of marketability to the equity value. Quantify the discounts and explain why the discount was or was not considered within the analysis. If the deal was performed cohesively with a sponsor, a discount for lack of control may not be considered necessary. Depending on the unit of account for the subject investments (e.g., both equity and debt positions reported in aggregate or separate reporting of debt investments versus equity investments in the same company) as well as the investment rationale for minority holdings if part of investment club/sponsor deal, the estimation of fair value should differentiate between a controlling position and minority non-marketable position.

The application of a discount for lack of control for minority non-marketable positions requires additional support to demonstrate that minority shareholders receive a lower pro-rata value than a controlling shareholder. • Equity Allocation Methodologies: In estimating the value of the subject equity investment, all economic terms of the outstanding securities should be considered in concluding on appropriate allocation methodology. Both expected exit/deal type and anticipated future market transactions should be considered to arrive at a reasonable conclusion of the subject security payout proceeds. FAIR VALUE OF DEBT Properly valuing debt in a transaction requires the investor to consider a number of factors beyond whether the company is in compliance with its debt covenants, including: • Debt Coverage: Start by demonstrating that there is sufficient enterprise value to cover the face value of the loan • Debt Performance: Determine if the debt is performing as of the valuation date. Include a summary of the terms and rates of the various tranches of debt as of the valuation date • Market Rates: Explain how current market rates were considered in the analysis and the conclusion of the fair value of the fund’s debt investment.

Further explain how any changes in market interest rates, if any, were factored into the analysis. • Credit Risk: Has the credit risk of the borrower changed since the original issuance of the debt or the prior valuation date? LEARN MORE To learn more about our how CohnReznick helps private equity groups value current and potential investments, contact your local CohnReznick professional or visit www.cohnreznick.com. cohnreznick.com | 5 . COHNREZNICK'S SBIC TEAM Our SBIC team is exclusively located in our Hartford, Connecticut office. We find that this centralized approach to servicing our SBIC clients results in increased efficiencies and high levels of client satisfaction. Each SBIC client works with a committed team of accounting, tax, and advisory professionals who design and utilize a unique client service plan to detail client expectations and track results. We immerse ourselves in the SBIC industry and understand SBIC financial reporting and compliance requirements.

Our partners are empowered decision makers who draw on the firm’s resources to lead each client relationship. Better yet, they are accessible and responsive. SBIC clients benefit from work that is prepared efficiently and intelligently. Christopher Aroh CPA, Partner Kevin Hoagland Manager Dana Beierle Manager 959-200-7284 chris.aroh@cohnreznick.com 959-200-7099 kevin.hoagland@cohnreznick.com 959-200-7117 dana.beierle@cohnreznick.com Jonathan Collett CPA, Partner Brian Newman CPA, Partner James Fedeli Manager Avery Toppino Senior Associate Jay Civittolo Senior Associate Torrie Lalime Associate CohnReznick LLP © 2016 This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice.

No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. cohnreznick.com CohnReznick is an independent member of Nexia International .