Valuation
Valuation is process of determining the value of an asset based on hypothetical price that a third party would pay for a given asset or liability. Groom Tax provides valuation service using which you can put a price on your business, asset or any liability. It is vastly used by start-ups to put a value on their business for accepting investments from venture capitals, angle investors, etc.
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Valuation under Companies act, 2013
As per section 247 of the companies’ act, where a valuation is required to be made in respect of any property, stocks, shares, debentures, securities or goodwill or any other assets or net worth of a company or its liabilities under the provision of this Act, it shall be valued by a registered valuer with IBBI.
Below are some instances where its mandatory to have registered valuer report before executing the transaction.
- Additional issue of share capital (Preferential allotment of shares or issue of share disproportionately to existing shareholders)
- Amalgamation & Merger
- Demerger & Slump Sales
- Startup Valuation for fundraising
- Conversion of Convertible debentures or preference shares into equity shares
- Valuation in case of non-cash transaction
- Issue of sweat equity shares
- Employees stock options
- Insolvency and Liquidation
Below are some instances where its recommendatory to have registered valuer report before executing the transaction.
- Consolidation of nominal value and for fractional shares
- Right issue of shares and renouncing of rights by shareholders
- Reduction of share capital
- Buy back of share capital u/s 68
- Merger of wholly owned company
- Demerger without change in shareholding pattern (same shareholder)
SEBI Guidelines in case of valuation of listed companies
Pricing of frequently traded shares
- If the equity shares listed on a recognized stock exchange for twenty-six weeks or more, the price shall not be less than higher of the following:
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- the average of the weekly high and low of the volume weighted average price during the twenty-six weeks; or
- the average of the weekly high and low of the volume weighted average prices during the two weeks preceding the relevant date.
- If the equity shares listed on a recognized stock exchange for less than twenty-six, price shall be not less than the higher of the following:
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- the price at which issued in initial public offer or
- the average of the weekly high and low of the volume weighted average prices during the period the equity shares have been listed; or
- the average of the weekly high and low of the volume weighted average prices during the two weeks.
Meaning of frequently traded shares
“Frequently traded shares” means the shares, traded turnover of which during the twelve calendar months is at least ten per cent of the total number of shares.
Pricing of infrequently traded shares
Where the shares of an issuer are not frequently traded, the price shall be determined as in case of unlisted companies.
Valuation under Income Tax Act, 1961
Section 56(2)(viib)
If any private company issues shares to any resident for a consideration that exceeds the fair market value of the shares then the difference between consideration and fair market value shall be chargeable to income tax under the head "Income from other sources". This not applicable to VC company or company registered under startup India. Fair market value can be computed as per rule 11UA(2) or as per DCF method by merchant banker.
Section 56(2)(x)
Where any person receives any property, other than immovable property without consideration or for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, then the difference between the fair market value of such property and consideration received shall be chargeable to income tax under the head "Income from other sources". Fair market value can be computed as per rule 11UA(1).
Section 50CA.
If any assessee transfer shares of a company other than quoted shares for a consideration which is less than the fair market value of such share determined as per Rule 11UA(1), the value so determined shall be deemed to be the full value of consideration received for the purposes of section 48.
| Summary of Income tax provisions | 56(2)(viib) | 56(2)(x) | 50CA |
|---|---|---|---|
| Applicability | On Issuer for fresh issue of shares | On Recipient of shares by fresh issue or transfer | On Transferrer for transfer of shares |
| Assessee | Private Company | Any Person | An Assessee |
| Fair Market Value | As Per Rule 11UA (2) | As Per Rule 11UA (1) | As Per Rule 11UA (1) |
| Unquoted Equity Share Valuation Methods | NAV or DCF Method | NAV Method | NAV Method |
| Balance Sheet | As on valuation date or preceding the valuation date | As on valuation date | As on valuation date |
Valuation under FEMA
Capital instruments issued by a company to a person resident outside India
The price of the capital instrument should not in any case be lower than the fair value worked out at the time of issuance in accordance with the extant FEMA regulations.
Capital instruments transferred by a person resident in India to a person resident outside India
The price of capital instruments transferred by resident person to a non-resident person should not be less than:
- In case of a listed Indian company, the price in accordance with the relevant SEBI guidelines; or
- In case of a company going through a delisting process price should be as per the SEBI (Delisting of Equity Shares) Regulations, 2009.; or
- In case of an unlisted Indian Company, the valuation on an arm’s length basis as per any internationally accepted pricing methodology duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant.
Capital instruments transferred by a person resident outside India to a person resident in India
The price of capital instruments transferred by a non-resident person to a resident person should not exceed:
- In case of a listed Indian company, the price in accordance with the relevant SEBI guidelines; or
- In case of a company going through a delisting process price should be as per the SEBI (Delisting of Equity Shares) Regulations, 2009.; or
- In case of an unlisted Indian Company, the valuation on an arm’s length basis as per any internationally accepted pricing methodology duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant.
Swap of capital instruments
Valuation should be done by a SEBI registered Merchant Banker or an Investment Banker registered with the appropriate regulatory authority outside India.
Subscription to Memorandum of Association
Where shares are issued at the time of company incorporation to a person resident outside India by way of subscription to Memorandum of Association, such issue shall be made at face value according to entry route and sectoral caps.
Investment in an LLP
Investment in an LLP either by capital contribution or by acquisition/ transfer of shares in profit should not be less than the fair price worked out as per internationally accepted/ adopted and a certificate for the same should be issued by a Chartered Accountant or by a practicing Cost Accountant.
Transfer of capital contribution/ profit share of an LLP
- In case of transfer of capital contribution/ profit share in an LLP from a resident person in India to a resident person outside India, the consideration for transfer should not be less than the fair price of capital contribution/ profit share of an LLP.
- In case of transfer of capital contribution/ profit share in an LLP from a resident person outside India to a resident person in India, the consideration for transfer should not be more than the fair price of capital contribution/ profit share of an LLP.
Non-applicability of pricing guidelines
The pricing guidelines will not apply for investment by a person resident outside India on non-repatriation basis.
Valuation of Startups
Value of a startup business is often required for bringing in funding either by way of debt or equity. There are some peculiarities involved in valuation of a startup business arising from the fact that there is no historical data available on the basis of which future projections can be drawn.
In the initial stage of business products are generally untested and do not have an established market. Entire valuation depends on the reliable future projections as no historical data available and very difficult to find comparable companies or transactions. The value of start-up firm can be the present value of the expected future cash flows from its business operations.
The value of almost any asset today is directly or indirectly related to the future cash flows that the asset can produce. If a company expects to have positive and growing cash flow, investors will be willing to pay a lot of money for that business. However, if the business is going to have no future cash flows and investors see no potential in future, it probably has little value other than in liquidation.
So if an entrepreneur has a well-drawn business plan, and little else, one can realistically develop a value of a new business. But the main issue here would be the believability/reasonability of the business plan. Every entrepreneur foresees high profits from its venture, but if investors cannot see that positive cash flow, then it possible that business will not survive and investors will not put in money.
A major problem in valuing a start-up business is that the sometimes entrepreneurs want high values demonstrated for the business as a whole, in order to bring in investments. They want high values for the company’s assets. While at the same time they want low values to save Income and other taxes.
Now it is very difficult for one appraisal report to show high values in order to attract outside investors and lenders, and low values to comply with Tax provisions. In such cases, appraisers are usually called upon to submit a formal valuation that supports the low price and then the value as per the owners of the business for the purpose of Venture Capital and other equity investors. We have different types of valuation method for different nature of startup.
Discounted Cash Flow Method
Start-up businesses can be valued by discounted cash flow method due to lack to historical data or comparable companies or transactions. In DCF method, we need to calculate the future free cash flows on the basis of projected financial statement by applying the discount rate on the basis of risk in the business. Higher the risk, higher will be discount rate and lower will be the value of the business. DCF is most suitable or appropriate method for start-ups.
Comparable Transactions Method
The Comparable Transactions Method is one the most popular startup valuation method. In this method, we should find the similar business line company who got the funding earlier. We can relate the funding amount with the scale of business, no. of users, no. of app downloads, revenue multiples according to the nature of business. We should adjust the multiplier factor according to the major differences between the company like technology, growth rate etc.
Scorecard Valuation Method
The Scorecard Method is another good option for pre-revenue start-up businesses. In the also, comparable start-ups need to be found which already got the funding and calculate the average pre-money valuation of comparable companies. Then have to assign the grading to your business in comparison to comparable companies according to the following qualities.
- Strength of the team: 0-30%
- Size of the opportunity: 0-25%
- Product or service: 0-15%
- Competitive environment: 0-10%
- Marketing, sales channels, and partnerships: 0-10%
- Need for additional investment: 0-5%
- Other: 0-5%
If you are better than your comparables then your grading will be more than 100% or if not better than grading will be less than 100% or if at par then grading also will be same as 100%. For example, you give your marketing team a 125% score because it’s complete, fully trained, and has experienced. Do this exercise for each startup quality and find the sum of all factors. Finally, multiply that sum with the average valuation in your business sector to get your pre-revenue valuation.
