Introduction
Valuation of Assets is crucial for strategic business decisions including Fundraising, Merger & Amalgamation, Sale of businesses, Insolvency proceedings under CIRP, Strategic business decisions like family or shareholders dispute, Voluntary value assessment or may be just to comply with certain regulatory or accounting requirements in India under RBI, Income Tax Act, Companies Act, SEBI, FEMA etc.
The process of valuation typically involves obtaining information from outside sources, working with few inputs, and estimating the entity's or asset's future viability. Each of these introduces an element of uncertainty into the context of appraisal. Addressing concerns about valuations in the Indian Market is essential.
The act of calculating an asset's fair market or current value through the use of comparable, absolute valuation methodologies such as discounted cash flow analysis, option pricing models, or book values is known as asset valuation. These assets can be investments in marketable securities like bonds, stocks, and options; they can also be tangible assets like machinery and buildings; or they can be intangible assets like patents, trademarks, and brands.
In recent times, the startup ecosystem in India has witnessed a surge in registration of Foreign Subsidiary Company or Registration of wholly owned Subsidiary company in India and an increasing inflow of Foreign Direct Investment (FDI), While this trend underscores the vibrancy and potential of the Indian entrepreneurial journey in Startups, also brings to light certain problems, particularly in the realms of compliance with the Foreign Exchange Management Act (FEMA) with the filing of FC-GPR or FC-TRS or Overseas Direct Investment etc. and the need for Valuation Reports under FEMA or companies Act 2013 or as per Income Tax.
Requirement of Valuation under various Laws
- Under Companies Act, 2013 and Rules made thereunder
- As per Insolvency & Bankruptcy Code, 2016 and Regulations thereunder
- Under SEBI - SEBI (Listing Obligations and Disclosure Requirement) Regulations 2015 (LODR), SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR), SEBI (Employee Stock Option Scheme) Regulations, 2014 (ESOP)
- As per the Reserve Bank of India (RBI) - Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI) and Fixed Income Money Market and Derivatives Association of India (FIMMDA)
- As per the Income Tax Act, 1961
The best practices that valuers should adhere to
A great emphasis is being placed on the best practice to be followed by Valuers because the outcome and process of valuation holds a pivotal stand in the entire decision-making as the outcome relies heavily on it and as such, it concerns and impacts the community of stakeholders and society at large.
In cases of Amalgamation and Merger, the stakeholders' decisions are based on the value established by the valuer. However, valuation is crucial for several reasons, including share transfers, loan applications, the purchase or transfer of real estate, ownership etc.
Definition of best practice as put forth by Merriam Webster online says it to be a procedure that has been shown by research and experience to produce optimal results and that is established or proposed as a standard suitable for widespread adoption.
Further, Valuation under the DCF method (which is the commonly used method) is essentially based on estimated future project ions only and thus hindsight view should not be adopted to compare the projections with the actuals to expect the same figures as were projected, since future projections cannot be evaluated on purely arithmetic precision and rather a reasonable approach to determine the factors affecting projections must be adopted.
Best Practices to be ensured at the time of Initial Engagement
A signed and dated copy must always be maintained on file in a suitable location; in other words, it must be appropriately recorded.
A Registered Valuer shall accept only those assignments under the asset class (es) in which he is registered.
Before accepting the engagement for valuation, the valuer should identify and address the following issues:
- Scope of work
- Purpose of valuation
- Assumption, Limiting conditions and scope limitations
- Knowledge of the Industry
- Governing Laws and Regulations
- Nature of Business
Best practices to follow when working on an assignment
Valuer should understand the following:
- Past business
- Accounting analysis
- Length of financial history
- Regulatory framework for the industry
- Company Risk Analysis
- Assets and liability analysis including contingent assets and liabilities
- Income and expenses analysis
- Ratio analysis
- Cash flow analysis
- Use of Valuation models
One of the most important rules that must be followed during the appraisal process is appropriate documentation. Complete records of all the papers that influenced the evaluation must be kept in order to support and fully explain the valuation in the case of a future claim.
Documentation serves as the most vital evidence to defend the Valuer against any future claim.
Best practices that should be followed while reporting
The valuer should confer with any experts as needed. His appointment date must fall before these two dates, and he must obtain precise dates for reporting and valuation. His report must be founded on an exhaustive analysis, examination, and inspection. He must include warnings, limitations, and disclaimers in the report.
Conclusion
Valuers must exercise reasonable care in the performance of their duties, base their conclusions on the applicable requirements of the relevant Act, and behave with the highest integrity and fairness in all of their dealings with clients and other valuers.
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