Accounting Capers at American Capital

Editor's Note: This Herb Greenberg column is a special bonus for RealMoney subscribers. It first appeared Wednesday on Street Insight. To sign up for Street Insight, where you can read Herb's commentary regularly, please click here.

---

A rival's books are giving foes of American Capital Strategies (ACAS - commentary - Cramer's Take) more fodder.

One of the issues at business development companies such as American Capital is how they value their private investments. Critics have suggested these methods -- done mostly in-house -- are inherently subjective, enabling the companies to assign whatever values they want.

Want proof? Just look at the way American Capital and Gladstone Capital (GLAD - commentary - Cramer's Take), another business development company, value their respective investments in the Inca Group, a Texas steel products company.

While American Capital values its Inca debt above cost, Gladstone last quarter sliced its Inca valuation by 11% below cost.

That's noteworthy for two reasons: First, Gladstone is Inca's senior lender. If a senior lender cuts a valuation, subordinated lenders should be expected to reduce their values by at least as much -- and possibly more.

Second, and perhaps more important: Gladstone broke ranks from the other major business development companies by hiring an independent third party -- in this case, Standard & Poor's Evaluation Services -- to value its loans. While companies like Gladstone and American Capital might have a good handle on valuing a company's stock, Gladstone CEO David Gladstone told me that "putting a value on private debt is a whole different area, and we didn't think we were qualified to do that."

So, he says his company spent "a long time with S&P" to make sure the two would make a good fit. "This is just another way to ensure that valuations are correct," he says. (Leave it to someone like David Gladstone, who is considered an innovator in the industry, to come up with something as sensible as that.)

Meanwhile, in its 10-Q, Gladstone says it would've devalued Inca a quarter earlier, but it had a deal to sell its Inca stake to American Capital. The deal to sell the stake, CEO Gladstone said on a recent earnings conference call, occurred after his company "had some difficulty with the numbers that we got from American Capital," which controls Inca.

---

Herb Greenberg writes regularly for Street Insight. In keeping with TheStreet.com's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to Herb Greenberg. Greenberg also writes a monthly column for Fortune.

Herb Greenberg is a regular contributor to TheStreet View, TheStreet.com's professional trading newsletter. For more information on this product, please click here.

Brian Harris and Mark Martinez assisted with the reporting of this column.