Living with FASB 157

1. Living with FASB 157 January 23, 2008

2. Presenters David L. Larsen, Managing Director Duff & Phelps LLC Thomas A. Ayers, Partner AERS Investment management, Deloitte Curt Buser, Managing Director & Chief Accounting Officer � The Carlyle Group Joseph Patellaro, Managing Director Citi�s Private Equity Services

3. Agenda SFAS 157 � Overview Disclosure -- Year End financial Reporting Matters PE Fair Value Issues Case Studies Look at the concept of Fair Value and its increasing importance in a wide range of areas In particular will focus on portfolio valuation And look at the guidance that is currently being implemented that covers the area of fair value which includes the IPEV and PEIGG guidelines and the recently released SFAS 157 Look at the concept of Fair Value and its increasing importance in a wide range of areas In particular will focus on portfolio valuation And look at the guidance that is currently being implemented that covers the area of fair value which includes the IPEV and PEIGG guidelines and the recently released SFAS 157

4. Polling Slide Who are you? Buyout Fund Fund of Funds Mega Fund Venture Capital Fund LP (Institutional Investor) Auditor Other Service Provider Amanda: Now, we�d like to get your view on financial projections � think about the deals you�ve been involved with, or are currently working on. [PAGE DOWN TO VOTE HERE] On deals where you wish the financial projections could have better supported your decision-making process, what aspect were you least satisfied with? Lynne: (while voting) Last year, we conducted a survey of 300 CEOs/CFOs about financial projections for $10 million+ transactions. Some of their concerns are shown on this list. After vote, if time let them know what survey of 300 CEOs said was least satisfactory. Respondents in our survey were least satisfied with: (BE CAREFUL WHAT WE SAY, not all of the items on this slide were in the web survey) Quantification of risks (36.7% not+somewhat satisfied) Ability to define multiple scenarios and evaluate the outcome in each scenario (34.6%) Level of detail in the financial projections (34.3%) and the ability to tie the projections to hard data (34.0%) Flexibility to examine alternative deal structures, terms & conditions (33.6%) More than a third of the respondents felt that their financial projections were not satisfactory in these areas. [ALSO] Receipt of a stamp of approval from an independent 3rd party (36.4%, but most thought this wasn�t important, so drop)Amanda: Now, we�d like to get your view on financial projections � think about the deals you�ve been involved with, or are currently working on. [PAGE DOWN TO VOTE HERE] On deals where you wish the financial projections could have better supported your decision-making process, what aspect were you least satisfied with? Lynne: (while voting) Last year, we conducted a survey of 300 CEOs/CFOs about financial projections for $10 million+ transactions. Some of their concerns are shown on this list. After vote, if time let them know what survey of 300 CEOs said was least satisfactory. Respondents in our survey were least satisfied with: (BE CAREFUL WHAT WE SAY, not all of the items on this slide were in the web survey) Quantification of risks (36.7% not+somewhat satisfied) Ability to define multiple scenarios and evaluate the outcome in each scenario (34.6%) Level of detail in the financial projections (34.3%) and the ability to tie the projections to hard data (34.0%) Flexibility to examine alternative deal structures, terms & conditions (33.6%) More than a third of the respondents felt that their financial projections were not satisfactory in these areas. [ALSO] Receipt of a stamp of approval from an independent 3rd party (36.4%, but most thought this wasn�t important, so drop)

5. Polling Slide Are you ready for 157? I fully understand all requirements of SFAS 157 I understand how to determine Fair Value under SFAS 157, but disclosure is problematic I am confused about what I need to do differently in a SFAS 157 World I basically understand SFAS 157 but I don�t know what my auditor�s or LP�s really want from me

6. Definition of Fair Value �Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.� Exit price: Not necessarily the price paid for an asset (for example), which is an entry price Market participants: Buyers and sellers that are independent, knowledgeable, able, and willing. Skepticism of a risk adverse buyer. Fair value should reflect how market participants would value the asset, even if market participants would use the asset differently than the owner�s intended use. SFAS 157 is principal based � Judgment is inherent in its application

7. Changes to Practice � The Fair Value Measurement Approach

8. Standards, Regulations & Best Practices FASB SEC AICPA SAS 101, SAS 113, Interpretation 1 of SAS 101, AS 5 Alternative Investments � Audit Considerations A Practice Aid for Auditors Audit and Accounting Guide � Investment Companies PCAOB CAG (Center For Audit Quality) � Measurements of Fair Value in Illiquid (or less liquid) Markets www.thecag.org PEIGG (US Private Equity Industry Guidelines Group) www.peigg.org ILPA (Institutional Limited Partners Association) IASB/IFRS (International Accounting Standards Board / International Financial Reporting Standards) IPEV (International Private Equity Valuations Board) 3rd Party Valuation Experts

9. New Disclosures Designed to increase transparency regarding how fair value is determined Applies to both recurring (e.g., trading securities) and non-recurring (e.g., goodwill) fair value measurements of assets and liabilities Tabular disclosure of which level in the hierarchy a fair value measurement falls by major category In the period of adoption (annually thereafter), describe the valuation techniques and any changes to the valuation techniques Additional disclosures for Level 3 (non-market data) measurements FASB objective to segregate items measured at fair value based on the reliability of the measurements. The Statement requires disclosures that are mostly tabular, supplemented by some narrative explaining the tables. The tables are split into tables for nonrecurring assets and liabilities and recurring assets and liabilities. FASB objective to segregate items measured at fair value based on the reliability of the measurements. The Statement requires disclosures that are mostly tabular, supplemented by some narrative explaining the tables. The tables are split into tables for nonrecurring assets and liabilities and recurring assets and liabilities.

10. Fair Value Hierarchy � Levels 1, 2, and 3 Level 2 - Start with item you can see trading in the market and adjust for differences. Level 3 - 25 year energy contract in order to value it a company would need to forecast things like weather patterns, etc. What if you have inputs from both level 2 and level 3? A fair value measurement is classified with in the hierarchy based on the lowest level input that has a significant effect on the measurement (so level 3 if level 3 has a significant effect). Start at the top and move down The purpose of the hierarchy is to impress upon companies that they should use market based information over non market based information, if it is available. In other words, in valuing an asset or liability you start at the top of the hierarchy and move down. If you are valuing a share of IBM stock, since it has a quoted price in an active market, you would use that price. If a quoted price in an active market does not exist, you move down the hierarchy and use market based information, to the extent available before defaulting to unobservable information. For example, if you were valuing a privately placed bond of Company Z, and Company Z also has a similar publicly traded bond, the publicly traded bond could be used as a market based comparable for valuing the privately traded bond. Other market information such as publicly quoted interest rates, yield curves, royalty rates, etc., are also considered level 2, market based information. If no market information exists for certain attributes of the asset or liability being measured, you default to using the entity�s unobservable assumptions about value. Level 2 - Start with item you can see trading in the market and adjust for differences. Level 3 - 25 year energy contract in order to value it a company would need to forecast things like weather patterns, etc. What if you have inputs from both level 2 and level 3? A fair value measurement is classified with in the hierarchy based on the lowest level input that has a significant effect on the measurement (so level 3 if level 3 has a significant effect). Start at the top and move down The purpose of the hierarchy is to impress upon companies that they should use market based information over non market based information, if it is available. In other words, in valuing an asset or liability you start at the top of the hierarchy and move down. If you are valuing a share of IBM stock, since it has a quoted price in an active market, you would use that price. If a quoted price in an active market does not exist, you move down the hierarchy and use market based information, to the extent available before defaulting to unobservable information. For example, if you were valuing a privately placed bond of Company Z, and Company Z also has a similar publicly traded bond, the publicly traded bond could be used as a market based comparable for valuing the privately traded bond. Other market information such as publicly quoted interest rates, yield curves, royalty rates, etc., are also considered level 2, market based information. If no market information exists for certain attributes of the asset or liability being measured, you default to using the entity�s unobservable assumptions about value.

11. Example Disclosure � Recurring* 25 � exchange traded futures contracts 15 � most standard interest rate swaps 20 � highly structured derivatives like the 25 year energy contract25 � exchange traded futures contracts 15 � most standard interest rate swaps 20 � highly structured derivatives like the 25 year energy contract

12. Example Disclosure � Level 3 Recurring

13. Polling Slide What is your number one open question concerning SFAS 157? What is an �active� market? When can I take a discount to the public market price and how do I determine/support said discount? How do I treat transaction costs? How do I value mezzanine debt? How do I value warrants or preferred stock? How do I determine Level 1, 2, 3? What level of support will I be expected to come up with for my auditors and investors?

14. SFAS 157 PE Questions Mezzanine Debt; Enterprise Method vs Interest (bond) Method Discounts; What is the meaning of �legally restricted�? What does �Active� market mean? Transactions Costs�Is the treatment clear? Principal Market Contingent Consideration, Contingent Liabilities, Imbedded Derivatives Control Premium vs Minority Discount NAV (net asset value) is it equal to Fair Value? How do you value Preferred Stock, Warrants, other complex securities? Others

15. Case Study � 1 Publicly Traded Security ABC Buyout Fund Purchases 85% of outstanding shares of ABC at an average price of $ 6. 10% of ABC shares are owned by 2 hedge funds Remaining 5% of ABC shares are actively traded (trades occur every day), but volume is thin (hedge funds appear to be holding out for a premium price). Market Price (given thin volume) is $ 4. Buyout Fund plans to exit investment through sale to a strategic buyer (95% of prior PIPES have been exited in such a fashion) Fair Value Determination P X Q using $ 4 market price? Multiple of EBITDA Other?

16. Case Study � 2 Life Science Company; Important Clinical Data will be received in 4 months. VC Fund Initial Investment 12/06 Series C Preferred Stock purchased at $ 0.50 per share VC Fund Provides additional Bridge Financing in 12/07 $ 500K; 10% Promissory note convertible at the election of the investor into 1,250,000 shares of Series C Preferred stock at $ 0.40 per share or price of next round if lower 25% warrant coverage to purchase 312,500 shares of Series C preferred Stock at $0.40 per share or price of next round if lower; Warrant Contractual Price = $ 10. Market interest rate for similar notes at 12/31/07 is 9 %

17. Case Study � 2 (continued) How should each security be valued at 12/31/07? Existing Series C Valued at $ 0.50?; $ 0.40?, or some other value? Promissory Note Valued at $ 500,000; face value? or $ 625,000 (given the $ 0.50 initial valuation X 1.25 m shares)?, or $ 525,000 (impact of interest rate change 9% vs 10%)? or some other value? Warrant Valued at $ 10 contractual price? Valued based on mathematical model? Or some other value? Contingent Claim Analysis?

18. Case Study � 3a Buyout Fund Invests $100 for 100% of the Equity of HLPC (Highly Leveraged Portfolio Company) $100 EBITDA at date of acquisition, 10/06 Debt $ 900; implied acquisition multiple 10 Mezzanine Fund provides entire debt financing of $ 900 at 10% fixed rate. At 12/31/07 EBITDA is $50. Using entry multiple of 10, Enterprise value is $500. Debt at 12/31/07 is $ 900. Interest rate is now 8%

19. Case Study � 3a (continued) How should each security be valued at 12/31/07? Buyout Fund Equity At 0 (debt exceeds enterprise value)? At $100 (not much time has passed and investor expected low performance in early years)? Some Other Value? Mezzanine Fund Debt $ 400 (utilizing the enterprise method)? $ 300 (estimated liquidation value)? $ 1000 (adjusted for decrease in interest rate; investor expected early losses)? Other?

20. Case Study � 3b Buyout Fund Invests $100 for 100% of the Equity of HLPC (Highly Leveraged Portfolio Company) $100 EBITDA at date of acquisition, 10/06 Debt $ 900; implied acquisition multiple 10 Mezzanine Fund provides entire debt financing of $ 900 at 10% fixed rate. At 12/31/07 EBITDA is $95. Using entry multiple of 10, Enterprise value is $950. Debt at 12/31/07 is $ 900. Interest rate is now 8%

21. Case Study � 3b (continued) How should each security be valued at 12/31/07? Buyout Fund Equity $50 (EV $950 minus debt of $ 900)? $ 0 (EV $ 950 minus debt of $ 1000 adjusted for interest rate movements)? Other? Mezzanine Fund Debt Debt $ 900 (Par Value utilizing the enterprise method)? $ 1000 (reflecting the decrease in interest rates)? Other?

22. Questions