One thing that the article doesn't really elaborate on is why different valuation strategies exist (and are allowed to exist) within GAAP.
Accounting should be done in a way that maximizes the usefulness of financial reporting for strategic and management decisions. In some cases, firms are required by regulators to adopt specific practices, but there is a fair bit of freedom given to the CFO.
VC firms must make wise financial decisions and satisfy their LPs with some degree of transparency. The accounting strategy chosen must accomplish both goals.
In many cases, it makes sense to be very pessimistic about valuations, and doing so often reduces tax liabilities.
On a side note, the whole "mark to market" scandal from the 2008 financial crisis was a case where firms typically marked assets in a way that matched their management goals, but at times failed to reflect short-term price fluctuations.
Regulators thought that forcing firms to mark assets to a known market price would result in better financial reporting. The problem was that the balance sheets containing those assets were also used as underwriting capital. So a market price increase (or bubble) in the assets was suddenly leveraged into a lot more risk capital by the firm (whereas before the rule, the CFO would not likely have wanted to mark the assets that high).
This resulted in industry-wide increases in risk capital for "free" because of asset price spikes, and following that it led to increased investment. The problem was, when the price fell back down, the firms were over-leveraged. It's generally a bad idea to use highly volatile assets as underwriting capital.
So while "mark to market" sounds good, it can enhance natural fluctuations (minor boom/bust cycles) in a destabilizing way.
The art of being the CFO of a VC firm is likely a very interesting thing, and it would be fascinating to learn more about how this happens across the industry.
Comments
One thing that the article doesn't really elaborate on is why different valuation strategies exist (and are allowed to exist) within GAAP.
Accounting should be done in a way that maximizes the usefulness of financial reporting for strategic and management decisions. In some cases, firms are required by regulators to adopt specific practices, but there is a fair bit of freedom given to the CFO.
VC firms must make wise financial decisions and satisfy their LPs with some degree of transparency. The accounting strategy chosen must accomplish both goals.
In many cases, it makes sense to be very pessimistic about valuations, and doing so often reduces tax liabilities.
On a side note, the whole "mark to market" scandal from the 2008 financial crisis was a case where firms typically marked assets in a way that matched their management goals, but at times failed to reflect short-term price fluctuations.
Regulators thought that forcing firms to mark assets to a known market price would result in better financial reporting. The problem was that the balance sheets containing those assets were also used as underwriting capital. So a market price increase (or bubble) in the assets was suddenly leveraged into a lot more risk capital by the firm (whereas before the rule, the CFO would not likely have wanted to mark the assets that high).
This resulted in industry-wide increases in risk capital for "free" because of asset price spikes, and following that it led to increased investment. The problem was, when the price fell back down, the firms were over-leveraged. It's generally a bad idea to use highly volatile assets as underwriting capital.
So while "mark to market" sounds good, it can enhance natural fluctuations (minor boom/bust cycles) in a destabilizing way.
The art of being the CFO of a VC firm is likely a very interesting thing, and it would be fascinating to learn more about how this happens across the industry.