4.1 PECCS™ Overview

Why a new classification is needed?

Precise classification of private companies is important as it underpins the whole investment process in private markets. For example, investment screening by industrial activity needs a clear activity classification scheme. Also, a company’s stage of growth, like being a startup or mature company, is a key consideration for the investment strategy, thereby requiring a classification that can differentiate companies on their lifecycle stages.

Although the capital structure of a private company is similar to that of a publicly listed company, and includes equity, equity-like, and debt securities, the key difference between them is that private companies are not traded in continuous markets. This lack of frequent trading can prevent market participants from clearly understanding the risk-factors of investing in a private company in an objective manner. For example, common factors such as value and size factors, which are taken for granted in public markets, are difficult to measure in private markets due to a lack of high frequency price information.

Thus, investors need additional proxies of the risks that private companies are exposed to, including but not limited to their industrial activity. To understand key private market dynamics, for example, it is necessary that the classification scheme should also group companies by their lifecycle stages, as startups face different systematic risks when compared to mature or established companies. Similarly, the classification should consider whether the companies sell their output to individual consumers (i.e., B2C) or to other companies (i.e.,B2B), as B2B companies may have sales that are less volatile, less price sensitive and repetitive than their B2C peers.

What is PECCS™?

The objective of the PrivatE Company Classification Standard taxonomy, or PECCS™, is to organise private companies in the universe of private capital investments, and create homogeneous groups of companies that are subject to similar systematic risks and have closely related risk and return profiles.

PECCS™ achieves this goal using objective criteria and principles that are relevant to private market investors, and by grouping companies along their industrial activity, phase of growth, type of revenue model, position in the value chain, and output characteristics. These dimensions, or pillars, are based on prior academic work, which is detailed in subsequent sections, and also on a survey of Private Equity investors conducted by the EDHEC Infra and Private Assets Research Institute in 2023. Survey respondents indicated that a private company classification can be impactful by focusing on private market-specific characteristics such as lifecycle phases, types of revenue models, and product market characteristics.

PECCS™ offers multiple benefits to investors which include but are not limited to aiding the valuation, monitoring, and benchmarking, of equity and debt investments in private companies.

How is PECCS™ Different

The PECCS™ taxonomy targets the private company rather than a security or a specific investment. Since the starting point for the valuation of any security is the company (or more specifically its cash flows), PECCS™ is built from the perspective of the private company rather than assessing it as an asset, security, or investment. This gives the taxonomy the flexibility to accommodate any kind of asset, security, or investment, which lays a claim to the company’s cash flows. How PECCS™ differs from other classification schemes currently available to market participants, and why PECCS™ is the most capable at classifying private companies, is described below.

First, private capital classification schemes already available in the market may sometime be unclear and incomplete. For example, one such popular classification scheme confuses investment, holding, and company, interchangeably. If an investment is held out by a VC fund in a mature company, the popular scheme can end up with no classification, thereby confounding the interpretation of any of the performance metrics for buyout or VC category itself.

Moreover, there are no classifications that consider revenue models or customer models, and value-chain, all of which are key risk factors for investments in private companies. Also, several classification schemes over-emphasise the industrial activity, completely ignoring other dimensions of risks in private markets. Doing so in public markets is acceptable, as long valuation histories make it feasible to understand several dimensions of risks quite easily, but in private markets that lack such rich valuation histories, it would be a cardinal sin to ignore such risk dimensions.

Thus, PECCS™ covers several additional risk factors relating to private companies, and offers the flexibility to be adapted to different security types. The analyses of valuation of different securities can be stacked over PECCS™ by combining it with information on a company’s capital structure, security characteristics, etc. Moreover, even if not explicitly included as a pillar, geography remains an implicit component of PECCS™ as private companies can be grouped by geography to examine their performance by regions.

PECCS™ Pillars

PECCS™ taxonomy is organised into multiple pillars, each of which captures an independent facet of the private company. Within each pillar the classes (or categories) and subclasses (or subcategories) are exhaustive, i.e., they cover all private companies. Also, in creating the taxonomy, it has been ensured that a company, with the exception of multi-segment private companies, can only belong to one class and one subclass in each pillar, i.e., the classes are mutually exclusive.

However, it is possible for private companies to have different segments, each of which, operate as independent units (e.g., subsidiaries), in which case they can belong to different classes or subclasses under each pillar of PECCS™. An example would be a diversified conglomerate whose industry spans more than one PECCS™ activity class. Similarly, some private companies might engage in complex activities that cannot be assigned to a single subclass and might need a “sum of the parts” approach, whereby an analyst breaks down the business into different segments. In such cases, it is recommended to assign each of the identifiable distinct units of the private company and their subdivisions to the appropriate class or subclass and rely on weighting these different units based on assets or sales, as appropriate. This enables the classification to remain clean and fit for purpose while enabling subjective application based on each asset’s characteristics.

Moreover, the PECCS™ framework remains flexible when applied to publicly listed companies for purposes such as finding suitable public comparables for private companies. Private companies share a high degree of commonality with public companies, clearly observable during initial public offerings (IPOs), de-listings, and private investment in public entities (PIPEs), thus making PECCS™ relevant to public companies. However, note that the objective of PECCS™ is not to group or analyse the performance of publicly listed companies.

A Rationale for Identifying PECCS™ Pillars

When performing the valuation of a company, an analyst may use information relating to the company such as its regulatory environment, the type of technology used in production, the barriers to new entrants, strategic complementarities, availability or threat of substitutes, capital intensities of businesses, and various other criteria. In the PECCS™ framework, the question then arises as to whether all these dimensions of information on the private company should be considered as separate pillars in PECCS™. However, as described below, inclusion of additional pillars require satisfying the below criteria.

1. Does the proposed pillar add new information that is not captured by current pillars?
   Some of the potential pillars may not capture enough additional information over the current five pillars. For example, the activity pillar may already capture differences in companies in their capital intensities and degree of competition. To illustrate, private companies operating in the “Information and communication” sector can be reasonably expected to face higher competition and be less capital intensive. Thus, these proposed dimensions may not add substantial new information to the risk factors of these private companies that is not already captured by its activity.

2. Applicability:
   Any new pillar should also apply to the entire spectrum of private companies, rather than only subsegments. For example, infrastructure companies can be classified into regulated (prices determined by authority), merchant (market determined prices), or contracted (prices are contracted at the beginning) based on their business risk. But such a classification might be less meaningful for a non-infra company.

3. Objectivity and Measurements:
   Also, the potential new pillars should not be based on subjective criteria, which allow users to arrive at different assignments for the same private company, thereby reducing the objectivity and the utility of PECCS™. Moreover, any new pillar proposed needs to be able to support quantitative measurements which can lead to the objective groupings of classes.

Given these considerations in addition to a preference for simplicity, PECCS™ pillars are restricted to activity, lifecycle phases, revenue model, customer model, and value chain types, the choice of which is also supported by the survey done by EDHEC Infra and Private Assets Research Institute in 2023.

PECCS™ Structure and Methodology

PECCS™ has multiple pillars to classify private companies, including:

• 12 classes and 67 subclasses of activity

• 3 classes and 7 subclasses of lifecycle phase

• 4 classes and 14 subclasses of revenue model

• 2 classes and 8 subclasses of customer model

• 3 classes and 6 subclasses of value chain.

Each private company can be mapped to a single class and a single subclass in each of these pillars based on qualitative and quantitative criteria, including their business activity, founding histories, characteristics of their revenue, value chains, and output.

The figures below provide a preview of the classes and subclasses in the PECCS™ classification.