The NVCA CFO Task Force comprised of around 100 CFOs from NVCA member firms has long played a critical role in driving our work with auditors and the various regulatory bodies that shape auditing and accounting policies and practices related to the VC industry and its portfolio companies.
A recent focus of this important NVCA peer group has been closely following the implementation of new Fair Value accounting rules since 2008. Specifically, they have concentrated on how auditors of venture funds treat the values assigned to investments classified as “Level 3 assets,” a category that includes nearly all venture funds assets.
The 2008 audits generally went as smoothly as could be expected given the downdraft in the economy at the time. However, in ensuing years, a number of NVCA members found their audit fees and staff time requirements double, or even triple, to audit the same funds under the same fair value accounting rules. Clearly something other than the rules had changed. One explanation for this trend was the fact that the Public Company Accounting Oversight Board (PCAOB), the federal regulator of the audit profession, had found deficiencies in unrelated fair value audits by a few audit firms and the auditors were responding with more intensive audit procedures.
We fully support the auditors’ role and the need to ensure that financial reports are complete, that fair values are properly stated, and the information conveyed with the statements is informative and responsive to limited partners’ needs. Audits give assurance to limited partners and other stakeholders that venture fund financial statements meet these objectives. But such audits can and must be properly done without unduly impairing the ability of the fund managers to focus on what they should be doing: building great companies.
We believe that increased analysis and documentation requirements and the dramatic increase in audit fees associated with Level 3 fair value determinations are not the result the Fair Value accounting standards set forth by the Financial Accounting Standards Board (FASB). Instead, they resulted from misinterpretation of the FASB’s rules and the unrelated scrutiny that auditors have received from regulators. Therefore, the NVCA CFO Task Force and its members have been engaged in committees, roundtables and other groups in an effort to focus the attention of regulators and policymakers on the adverse and unnecessary impact on our industry.
I’m proud to report that NVCA engagement has been welcomed and is working. Our Task Force and its leading members have participated in initiatives aimed at clarifying the requirements of the rules and educating auditors, valuation specialists, regulators and policymakers. Our message has been simple: fair values are based on the assumptions used by actual investors in setting transaction prices, not on auditors’ needs for documentation using theoretical methods. We have also worked directly with the FASB to identify specific requirements for disclosures on fair value that are costly to produce and to have audited, which limited partners do not find valuable.
I’m delighted to report that we are making progress with both accountants and policymakers. For example, the FASB appears to be moving toward eliminating some of the most onerous disclosure requirements for Level 3 assets. In addition, the FASB recently issued draft rules that should allow for more judgment in making disclosures based on materiality. These moves represent both a success in our efforts and a new opportunity for the NVCA CFO Task Force to continue its constructive dialogue with the FASB.
On the audit regulatory front, we have begun a constructive dialogue with the PCAOB. In November 2014, we submitted a comment letter to the PCAOB on the process of auditing fair value and the use of estimates. Our more recent letter to the PCAOB is another step in this ongoing dialogue. Our letter reviews the intent of the Fair Value accounting standards, provides examples and case studies of where auditors and valuation specialists misapply the standards, and suggests ways to clarify and communicate PCAOB expectations and standards.
Although very technical and not always top of mind for everyone in your firm, the work of the CFO Task Force on the audit process is critically important to an efficient and well-functioning venture capital industry and entrepreneurial ecosystem. To learn more about the critical work of the CFO Task Force on this and other important issues, I encourage you to check in with your firm’s CFO. And if you find your CFO is not part of the CFO Task Force or you don’t have an in-house CFO but still want to get involved, please get in touch with us!