Before pricing a secondary sale, a fund manager records a portfolio company's quarterly mark. An LP update might show $24.50 per share, based on the last funding round and adjusted for comparable company multiples. An employee may use that figure to gauge a sale, but it is the wrong starting point. The mark is an accounting estimate for preferred shares, not an indication of what a buyer will pay for common shares today.
The rules governing portfolio marks
US investment funds that report under GAAP measure private portfolio positions at fair value under ASC Topic 820, Fair Value Measurement. The standard has a three-level hierarchy of valuation inputs. Level 1 uses quoted prices observable in active markets. Level 2 uses observable prices for similar assets or liabilities. Level 3 uses unobservable inputs based on the reporting entity's assumptions and models.
Private equity and venture holdings are generally Level 3. Managers estimate value through their assumptions and models instead of observing a market quote. ASC 820 says fair value should represent the amount received in an orderly sale between market participants at the measurement date. That is a theoretical exit price, not a cost or held-to-maturity value. Applying it to illiquid private holdings calls for substantial judgment.
External auditors assess Level 3 marks for reasonableness and consistency with the disclosed method. Auditing a judgment-based estimate is materially different from checking a market quote. A mark may pass audit while exceeding what any secondary buyer would pay.
Three valuation methods and their limits
Managers usually choose among three principal approaches and may use multiple methods as a cross-check.
Calibrated price of recent investment. When a company raised a round within the past 12 to 18 months, managers commonly begin with the price implied by that round. They then adjust for observable performance changes and shifts in comparable company multiples since closing. Its strength is the anchor of a recent arm's-length transaction. Its weakness appears when multiples have contracted in the company's sector: the calibration may not capture the full shift, leaving fair value materially overstated.
Market approach: comparable company analysis. Managers select publicly traded comparables and apply current trading multiples to the private company's estimated metrics. This responds more quickly to current conditions than relying only on last-round calibration. Results depend on choosing appropriate comparables and having dependable internal metrics. Strong portfolio monitoring supports rigorous use. Other funds may rely on stale estimates or companies that do not closely match the portfolio company's business model.
Income approach: discounted cash flow. A DCF based on management projections and a market-derived discount rate supplies an independent mark that does not rely entirely on public multiples. Its weakness is sensitivity to terminal value assumptions. Private-company projections are also inherently optimistic by selection. Using management's base case with a discount rate calibrated to peak-market conditions can produce a mark far above what current market participants would pay.
Why sticky marks matter
Portfolio marks usually trail market conditions in either direction. They decline slowly as conditions worsen and respond slowly to real improvement. This is partly structural: managers have no regulatory duty to update them more often than quarterly, and compelling evidence is generally needed before writing assets down aggressively. Audit materiality thresholds can let modest overstatement remain.
That lag affects two groups. For limited partners assessing exposure, both carried interest and NAV-based fees rely on the marks. Overmarked holdings can make performance look better and, in some structures, speed carried interest distributions that may later require clawback if the company exits below the mark. For secondary participants, the disclosed mark is a reference that many shareholders mistakenly read as a market price.
What the gap between marks and secondary prices reveals
The difference between a fund's carrying value and a secondary buyer's price for common shares has several causes. Share class economics come first. A fund generally owns preferred shares with full liquidation preferences, while employees and founders sell common shares or options with a different cap table payout. Even with identical enterprise values, preferred and common shares are not economically equivalent.
Market conditions create another difference. If a mark was set six months ago and public comparable multiples have fallen since, a current secondary buyer will price in that decline. Liquidity creates a third: capital committed to an illiquid position is discounted because there is no guaranteed exit.
These are structural, not arbitrary, differences. They explain why common shares can clear well below a preferred share mark even when both parties share the same view of the company's fundamental quality.
Why this context matters to secondary participants
We are not saying portfolio marks are unreliable or that managers misrepresent values. We are saying the marks serve accounting and LP reporting purposes, not secondary pricing. Treating one as a reference for a common-share sale can systematically mislead a shareholder about the amount buyers will pay. The mark asks, "what is this preferred share worth for accounting?" The secondary price asks, "what will a buyer pay for this common share today under current conditions?" For example, an employee considering a sale may see the $24.50 mark and still need a separate estimate for the common shares.
An independent secondary price reference must account for share class, current comparable multiples, and liquidity conditions. That is the only way to see the difference between those answers for a particular company and position.
Important: Note: This article is informational only. AI outputs are informational tools, not investment advice or formal appraisals. Private markets carry risks including illiquidity and loss of capital. Consult qualified financial and legal advisors before transaction decisions. ASC 820 references are educational, not authoritative guidance.