Business valuation is critical for transactions including fund raising, mergers & acquisitions (M&A), sale of businesses/assets, strategic business decisions like shareholder disputes, voluntary value assessment and for regulatory compliance, tax and financial reporting purposes.
The regulations on business valuation in India have evolved swiftly in the last one and a half decades and has greatly impacted transactions. The Regulators in India have framed regulations under different Laws requiring valuations to be obtained for different purposes to take care of mis-pricing concerns from Tax, Forex control and Public Shareholders perspectives. Valuation requirements are also there under the Companies Act, Insolvency Code etc. to derive the fair value of assets/liabilities. Financial Reporting also requires Valuations for Accounting of ESOP, Investments, Impairment purposes etc. so that the balance sheet represent a true and fair view of the assets/liabilities of companies.
Business valuation is required for following Transactions and Laws in India:
Valuation Requirement: Company Law, Income Tax Law and RBI FEMA Regulations
The Company Law requires a minimum value to be determined for issue of equity shares and convertible securities by IBBI Registered Valuer in accordance with Section 247 of the Companies Act, 2013 read with Companies (Registered Valuers and Valuation) Rules, 2017.
The Income Tax Law prescribes a maximum value for issue of shares at premium to be determined by Merchant Banker (in case of DCF method) or a Chartered Accountant in accordance with Section 56(2) (viib) read with Rule 11 UA (2) of the Income Tax Rules, 1962. There is also a valuation requirement under Income Tax Act for determination of minimum value of in case of transfer and issue of shares in accordance with Section 56(2) (x) read with Rule 11 UA (1) of the Income Tax Rules. Adjusted break-up value method is prescribed for this purpose.
Upon transfer of Shares/Assets, Valuation is also required under Income Tax Act for determination of Fair Value for Indirect Transfer of Assets in accordance with section 9 read with Rule 11 UB and 11UC of Income Tax Rules.
Where Non-Residents are involved, FEMA Regulations require Valuation for issue and transfer of shares and fully convertible instruments in accordance with the internationally accepted pricing methodology for FDI and ODI purposes. Very recently, the draft ODI Regulations, have put in the onus of such valuation on IBBI Registered Valuers.
Where shares of a Listed company are frequently traded, its valuation is derived basis volume weighted average market price over last 26 weeks or 2 weeks, which is higher. However, where shares of a company are Listed (but infrequently traded), its valuation is to be determined in accordance with the price of its comparable companies, book value and other valuation parameters as per Regulation 165 of SEBI (ICDR) Regulations, 2018.
In case of a merger valuation, the focus is on arriving at the “relative” values of the shares of the transferor and transferee companies to facilitate determination of the “fair swap ratio” by IBBI Registered Valuer.
SEBI has prescribed this format for disclosure of share exchange ratio where a Listed Company is involved in Scheme of Arrangement. Alongside this, reason for non-adoption of any specific valuation approach/es is also to be mentioned.
| XYZ Ltd | PQR Ltd | |||
| Valuation Approach | Value per Share | Weight | Value per Share | Weight |
| Asset Approach | X | A | Y | d |
| Income Approach | X | B | Y | e |
| Market Approach | X | C | Y | f |
| Relative Value per Share | X | Y | ||
| Exchange Ratio (rounded off) | xx |
SWAP RATIO:
X (xxx) equity share of XYZ Ltd of Rs 10 each fully paid up for every Y (yyy) equity shares of PQR Ltd of Rs 10 each fully paid up.
Purchase Price Allocation
All business combinations require the acquirer to apportion the consideration paid among tangible and intangible assets. Intangibles need to be separable and identified based on their unique characteristics. The difference amount, if any, between the consideration paid and assets acquired goes to goodwill in the Purchase Price Allocation process.
Slump Sale
In case of Slump sale, the valuation of the undertaking is to be determined in accordance with the provisions of section 50B of Income Tax Law read with Rule11UAE which prescribes the adjusted book value method factoring in the fair value of Land & building, Share & Securities, Jewellery and Artistic Property to compute the fair market value of assets in accordance with the existing Rule11 UA as applicable on transfer of equity shares.
ESOP valuation is required for Accounting and Income Tax purposes. ESOP Accounting valuation is required by the Company issuing such ESOP’s for booking compensation loss in its Profit and Loss account on account of the discount offered to the employees while granting such options. ESOP accounting valuation is performed at the date of each grant of such options (in case of Equity settled options) and is apportioned over its vesting period. However, in case of Cash settled options the valuation is required at the end of each reporting period.
Income Tax valuation is required at the time of exercise of vested options to ascertain the Tax impact in the hands of such employees as perquisites to be determined by a SEBI-registered merchant banker for valuation of underlying shares of an unlisted company in India. Sweat Equity also is taxed on same basis as ESOP’s.
In accordance with Regulation 27 of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, 2 Registered Valuers are to be appointed for determination of Fair value and Liquidation value of Assets in accordance with Regulation 35.
It is stated that the Valuation shall be done in accordance with internationally accepted valuation standards, after physical verification of the inventory and fixed assets of the corporate debtor and the average of two closest estimates of value shall be considered as fair value or Liquidation value.
Similarly, in accordance with the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016, the Liquidator shall appoint two Registered Valuers to value the Assets or Business where it is intended to be sold as such.
Fair Value is required for Financial Reporting in accordance with Indian Accounting Standards (Ind AS) which converge closely to the International Financial Reporting Standards (IFRS).
Ind AS 113 which is a dedicated standard on fair value, there are other Ind AS which guides on valuation and accounting aspects of certain transactions. These are mentioned below-
Fair Value is defined in Ind AS 113 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Fair value hierarchy is also prescribed under Ind AS 113. Preference is given to valuation methods relying on observable inputs. It states that reliance should first be made upon market price of the respective asset (Level-1) and where the market price of respective asset is not available, reliance should then be placed upon market price of the comparable assets (Level-2). However, where there is little, market activity for the asset at the measurement date, unobservable inputs may then be used by beginning with the own data but adjusting the same for the information reasonably available in market (Level-3).
CONCLUSION
The regulations on business valuation in India have evolved swiftly in the last one and a half decades and has greatly impacted transactions. The Regulators in India have framed regulations under different Laws requiring valuations to be obtained for different purposes to take care of mis-pricing concerns from Tax, Forex control and Public Shareholders perspectives. Valuation requirements are also there under the Companies Act, Insolvency Code etc. to derive the fair value of assets/liabilities. Financial Reporting also requires Valuations for Accounting of ESOP, Investments, Impairment purposes etc. so that the balance sheet represent a true and fair view of the assets/liabilities of companies.
The depth of analysis is most important in any Valuation engagement including the ability of the Valuer to follow the complete valuation process right from understanding purpose of valuation, seeking relevant and adequate information requisition from company, performing financial analysis and normalization adjustments, understanding industry characteristics and trends, forecasting and reviewing company performance, considering and applying appropriate valuation methodologies to performing scenario analysis, value adjustments, documentation and reporting while effectively utilizing professional judgement.
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