One of the challenges with an open-ended fund is the moving valuation of the company’s assets that investors are investing into as time moves on. Because if you have investors coming in at different time periods, the investor who came in at time zero and the investor who came in two years later may have completely diluted each other. The solution to that problem is net asset value. In this video, we’re going to talk about net asset value, how it’s determined, and how you can use it for an open-ended fund.

Net Asset Value is the key tool for figuring out what the value is at any given point, so that you don’t improperly take away the rights of an investor based on time. To make that a little bit more clear, let’s look at a whiteboard example.

Let’s say you have an investor who invests with you here. He buys in and gives you $1 million. With that $1 million, you put it into a property. Maybe you did a lot of construction, kicked all the tenants out, and released it. Now, you’ve still got this property, but its value has obviously changed. There has been appreciation that has taken place over this period of time. Let’s say this is three years later.

Now you have someone else who comes to you. Let’s say the first investor owns 20% for his $1 million. The new investor says, “Here is $1 million for 20%, just like the first guy got.” Sounds fair, right? But what about all the changes that have taken place over this period of time? This building isn’t worth that $5 million anymore. It’s worth more; you’ve done a lot of work, you’ve added value, there’s been appreciation, you’ve re-tenanted the building.

This is the problem that is solved by net asset value. It’s determining what this new person needs to pay, based on what the asset’s current value is.

The challenge of figuring out net asset value is very simple in one version of it, and very complex in another. Let’s consider the classic example of a mutual fund, which is a bucket of stocks and bonds. Every day, things come in and go out. Did you know that mutual funds actually don’t trade in real time? When you buy or sell a mutual fund, you’re not doing it the minute you hit “go” from your brokerage account. You’re actually buying it at the end of the day, around 5:30 PM Eastern time.

That’s because what needs to happen before you do it is that each individual piece in this bucket is figured out for its value that day. If it holds stocks only, all the different stocks are added up together. They determine, “Okay, if we were to sell this whole bucket today, what valid price could we get it for?” Then they divide it by the number of outstanding units. That comes up with the net asset value for the day.

So net asset value is all of the assets minus liabilities, divided by the number of units, which gives you that share price.

Now, what is hard to do is when we’re not talking about a mutual fund, but about buildings and real estate. These are all purchases of different buildings with different appreciation factors, re-tenanting, and construction going on. How on earth do you figure that out? Because you can’t do that every day. There are just too many variables.

So what companies do is they allow investors in at time zero, and then they do some stuff with that money. Let’s say these are quarters: Q1, Q2, Q3, Q4, over multiple years. Every quarter, the team gets together, does an evaluation, and calculates everything.

For example, in Q1, they might determine it’s worth $100 per unit. In Q2 of Year 1, after some appreciation and purchases, they might determine it’s worth $110 per unit. Then in Q1 of Year 2, if there’s a mass downsizing where all tenants leave, management might decide the value has gone down radically to $95 per unit.

You’re only sweeping money in once that determination of the net asset value is made. Quarterly net asset value determination for real estate is still really tricky. It’s a lot of work, so most companies do it annually. Some do it quarterly still. The challenge is finding out what’s going to work the best and determining what that mechanism for valuation is.

Let’s go over some key takeaways about net asset value:

  1. Net asset value, or NAV, is a critical metric to understand the open-ended investment itself. It impacts the pricing that investors can enter and exit at.
  2. The calculation of NAV is done by taking the assets, subtracting the liabilities to create the total value, and then dividing that value by the number of shares or units outstanding.
  3. NAV can be used for assessing the performance of investments. It helps identify the true worth of the investments and aids in portfolio management.
  4. Market fluctuations change this NAV. The market is what’s actually driving the value changes over time.
  5. Transparent and accurate calculation of NAV is crucial for giving your investors not only an accurate number they can rely on, but also for transparency so they understand how it was calculated.

My name is Tilden Moschetti. I am a syndication and private equity fund management attorney for the Moschetti Syndication Law Group. If we can help you establish your own open-ended fund, or if you’re doing a closed-ended fund and need to be compliant with the SEC’s Regulation D Rule 506(b) and 506(c), we’d love to talk with you and strategize about how we can help you move from where you are today to being more successful and getting your funds put together in the right way.