“Valuation is neither science nor an art; it is a craft, i.e., a skill that one learns by doing. The more one does it, the better one gets at it”
– Professor Aswath Damodaran, Stern School of Business, New York University.
Changing business dynamics and regulatory requirements make it imperative for companies to seek valuations for various reasons. Valuation of a business, asset or liability is critical for strategic business decisions including M&A (Buy side and Sell side), Restructuring, Fund Raising (Equity, Quasi Equity, Debt), Investments, internal management decisions, voluntary value assessment, ESOPs and also for applicable Regulatory, Tax or Financial reporting requirements in India including for commercial and legal aspects like Dispute resolution (Litigation and Arbitration). Regulatory valuations include valuations under Companies Act, FEMA, Income Tax, SEBI, Ind-AS including Valuation reports required from IBBI Registered Valuers, Chartered Accountants and SEBI Registered Merchant Bankers.
VALUATION APPROACHES
There are three approaches to valuation:
- Asset approach: Asset-based valuation approach values a company based on its underlying assets. The net asset value reflected in books do not generally include intangible assets of the business and may also be impacted by discretionary accounting policies. Asset value is thus not perceived as a true indicator of the fair assessment of value. However, it is often used to ascertain the minimum value of a business and is also considered appropriate for matured companies, those with asset-heavy businesses and also Investment holding companies.
- Income approach: Income-based valuation approach values a business based on its inherent business potential / fundamental value and underlying operational cash flows and profitability. It is generally considered as the best valuation methodology for going concern businesses. Under Income approach, discounted cash flow (DCF) method is the most frequently applied valuation method as it is futuristic and also considers the time value of money. DCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes and necessary investments in working capital and capital expenditure are being met.
Similar to the uncertainty involved in forecasting cash flows for enterprise/equity valuation, uncertainty exists in estimating an appropriate rate at which these cash flows should be discounted as there is no fixed rate of return like the coupon rate in case of bonds. Thus, for determination of cost of equity, both systematic (market linked) and non-systematic (company-specific) risks are considered over and above the risk-free return to arrive at the risk adjusted discount rates.
However, DCF method brings its own challenges and is quite sensitive to its underlying factors. Sensitivity and Scenario analysis is thus advised while applying DCF valuation by making cash flow forecast and adjusting the cost of capital and growth rate assumptions under different scenarios including conservative, aggressive and optimistic scenarios. DCF method results in controlling stake valuation.
Market Approach: Market based valuation approach values a business based on the relative valuation by benchmarking the company vis-a-vis its peers in the same industry and after doing appropriate adjustments for size and marketability. Peer comparison can be with trading valuation multiples of Listed Companies or transaction valuation multiples of Private Companies.
Comparable (guideline) companies market multiples (CCM) method
Trading/Market valuation multiples of comparable listed peer companies are computed and applied to the subject company after doing appropriate adjustments for size and marketability to arrive at a trading multiple based valuation. This method results in minority stake valuation.
- Comparable transaction multiples (CTM) method
This technique is used for valuing a subject company for M&A, based on the valuation multiples of similar M&A transactions that have taken place in recent past in the industry between independent parties at arm’s length price. It is observed that most of the private investment transactions take place in closely held companies as investors prefer to keep stringent terms including restrictions on sale of shares, liquidation preferences etc., which may not be possible in case of a listed company. For listed companies, the open offer price can be considered for benchmarking as it takes into account the control characteristics resulting in controlling stake valuation.
Valuation Standards in India
At present there are no Government prescribed Valuation Standards in India due to which the valuation reports lack the uniformity and generally accepted global valuation practices.
The Institute of Chartered Accountants of India has come out with Valuation Standards, 2018 which is mandatory for its RVO members. This ICAI valuation standard guides on Valuation for Asset Class – “Securities or Financial Assets” including manner of preparation of Valuation Report and ancillary aspects.
The Central Government is also in the process to frame Valuation Standards in India. The Ministry of Corporate Affairs (MCA) had formulated a “committee to advise on Valuation matters” which had also made recommendations in formulation and laying down of valuation standards and policies for compliance by companies and registered valuers. However the same are yet to be finalised and approved.
CONCLUSION
The art of valuation lies in the ability to apply the valuation principles effectively, utilizing professional judgment. Transique Valuation Advisors have built this insight over years of experience across the spectrum of company life cycles, industries, jurisdictions, varied valuations and also having a deep understanding of regulators’ and other stakeholders’ requirements and expectations. We work with our clients with a motive to ensure that the stakeholders and also the regulators understand the basis of valuation including the valuation methodologies adopted and the value conclusions.
