Company Valuation in India - beyond the statistics

Articles Mar 21, 2023 Add to Reading List

Credible appraisals are absolutely necessary for the smooth operation of the financial markets, businesses, the government, and everyone else involved in this process. Independent appraisals are becoming increasingly important around the globe, especially in India, as a result of increased levels of shareholder activism.

Valuation of securities or financial assets is essential for making strategic business decisions such as fund raising, mergers and acquisitions, sale of businesses, strategic business decisions such as family or shareholder disputes, voluntary value assessment, or possibly just to comply with certain regulatory or accounting requirements in India under the RBI, Income Tax Act, Companies Act, SEBI Laws, etc. In addition, the need for independent Company Valuations is growing as a direct result of improvements in corporate governance.

The practise of valuation in India is still in its infancy and cannot be considered an accurate science. So, the expert judgement of the valuer is absolutely necessary for every valuation process. However, due to the absence of Indian Valuation Standards and any Regulatory Authority to control, guide, and develop the practise of valuation in India, different valuers have been taking different assumptions, which has led to significant differences in the value conclusion. This situation has persisted up until this point. In many instances, there is a lack of standardisation in the value, as well as methods that are widely acknowledged on a worldwide scale.

The several regulatory bodies in India have each imposed their own unique, and in some cases even conflicting, valuation rules that must be adhered to in a variety of distinct circumstances. In more recent times, a few regulatory bodies have also mandated that valuations be carried out in accordance with internationally accepted valuation criteria, while a few others have mandated that extra requirements be met in order to adhere to worldwide valuation standards. However, there are also some circumstances in which there is a necessity for an appraisal, but the appraisal process is not regulated and is instead left up to the discretion of the valuer. These circumstances include:

Eligibility to execute valuations also differs under various legislation, and up until now, most appraisals in India have been predominately carried out by merchant bankers who are registered with SEBI and/or chartered accountants. On the other hand, as of the 1st of February 2019, the pertinent sections of the Companies Act, 2013 no longer permit anybody other than a Registered Valuer to carry out values. This restriction came into effect. The Insolvency and Bankruptcy Code, the Securities and Exchange Board of India (SEBI) ICDR Rules, 2018, and the Securities and Exchange Board of India (REIT and InvIT) Regulations, 2016, all describe a valuer as a person who is registered under section 247 of the Companies Act, 2013.

The practise of valuation as a science and a profession has become an absolute requirement in light of the rising relevance and significance of valuation in the making of choices pertaining to businesses and investments, as well as for ensuring compliance with regulations. The intricate nature of the financial markets, the emergence of a global economy, and the ever-evolving nature of India's accounting and financial reporting framework (Ind AS) have only served to reinforce the necessity of this.

The Companies (Registered Valuers and Valuation) Rules now govern the practise of valuation in India, including who can become a Registered valuer for each asset class (including the requirement of being a fit and proper person, having the appropriate qualification, experience, and having cleared the valuation examination) (Securities or Financial Assets, Land & Building and Plant & Machinery). These Rules have also covered the valuation standards that are required to be adhered to, the contents of the Valuation Report, and also the model code of conduct for Registered Valuers for the Regulation of the profession. All of this information has been covered under the heading of "Valuation Standards." After the rules for Registered Valuers have been simplified and the Indian Valuation Standards have been implemented, in our opinion, it is reasonable to anticipate that the other Regulators would likewise converge their individual legislation.

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The process of valuation consists of the following steps:

1. COMPREHENDING THE PURPOSE OF VALUATION

The first stage in the process of valuation is to get a good understanding of what the point of value is. The valuer will be assisted in contemplating, analysing, and applying the right valuation methodologies and methods to the subject interest if a proper analysis of the valuation engagement is performed. Is the valuation necessary for the Controlling Shareholders or the Minority Shareholders? Is this for the purposes of regulation? Is it a valuation of the enterprise or of the equity?

In the event that valuation is being performed for the purpose of financial reporting or regulatory compliance, the focus should be placed on the legal and regulatory requirements that may prescribe a particular valuation methodology, as well as a particular standard and premise of valuation in certain circumstances. In such a scenario, the appraiser is obligated to carry out the appraisal according to the parameters of the established framework.

The total of an organization's equity worth (also known as market cap) and debt is what constitutes an enterprise's valuation (net of cash and cash equivalents). The worth of a company as a whole, including both its tangible and intangible assets, is referred to as its enterprise value. Another name for enterprise value is company value. The valuation of the company as a whole includes the equity valuation as one of its components.

Even after determining the worth of the equity in the company, it is necessary to distribute that value among the various shareholders. Some of the shareholders can be considered minority shareholders, while others might be considered controlling shareholders. These distinct types of shareholders might have different or preferential rights in terms of liquidation, voting rights, management control, and other factors. The worth of each shareholder will, of course, be unique, and it will be necessary to determine how that value should be distributed among the shareholders based on the precise contractual conditions and intricate valuation procedures.

Each appraisal is completed at a certain moment in time. The valuation date is the particular date at which the valuer arrives at his conclusions on his appraisal of the value of the subject interest and identifies the valuation date. The date is extremely important for any valuation engagement since relative valuation (as determined by benchmarking of comparable peer firms or transactions) is highly reliant on the external market circumstances of the industry, economy, and other factors on that specific day. We found that all start-up values were driven by enthusiasm, which had a significant impact on how these companies were valued during the past three years. Likewise, discounted cash flow valuation takes into account estimates based on the valuation date itself.

Before to engaging in any Valuation work, it is essential to identify the Standard of Value and the Basis for the Valuation.

Standard of Value" is the essential criterion for valuing a firm.

Types of Standard of Value:

Fair Market Value : Fair Market Value is defined by the Organization for Economic Cooperation and Development as the amount a willing buyer would pay a willing seller in an open market transaction.
Fair Value : Fair value is defined by 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 on the measurement date."
Investment Value : One definition of investment value is the worth that an individual investor places on a given investment based on the criteria and expectations the person has for the investment.

The "assumptions upon which the valuation is founded" are what are referred to as the "premise of value."

Types of Premise of Value:

Going Concern : Value in the context of a continuously active corporate operation.
Liquidation : Valuation at the time the firm is dissolved.
Liquidation Value is defined as the amount that would be realised when an asset or collection of assets are liquidated on a piecemeal basis by the International Valuation Standards (IVS), which may be found in section 104, paragraph 80.1.
It also adds that the Liquidation Value may be calculated based on two alternative premises of value, which are as follows:

(a) a transaction that is conducted in an orderly manner and has a normal marketing period,

or

(b) a coerced sale that takes place during a condensed marketing window.

2. INFORMATION REQUISITION FROM COMPANY

The following factors will determine the type of data and the scope of the information that will be required to carry out the analysis:

Nature of the valuation engagement
Scope of the valuation engagement
Valuation date
Intended use of the valuation
Applicable standard and premise of value
Assumptions and limiting conditions; and
Applicable laws, regulations and professional standards

Such information includes:

Non-financial information (Promoters, Management, Products, Industry, Competition, Strategy)
Shareholders information (Equity Shares v. Preferred Shares with contractual rights, Minority v. Control)
Financial information (Historical Annual Reports, Future Projections, Non Operating Assets)

3. FINANCIAL ANALYSIS AND NORMALISATION ADJUSTMENTS

In order to accurately predict a company's future financial success, it is important to do an analysis of the company's historical financial performance.

The annual report of a firm contains a lot of information that is regarded vital for the study of the company. This information is included with the financial statements. Among these are:

Management discussion and analysis report (MDA)
Independent auditor’s report
Accounting policies and disclosures
Related party transactions
Segment reporting and
Other aspects.

Closely held companies require significant adjustments to estimate the normalised earnings of the company due to presence of related party transactions and the non-recurring and non-operating items also need segregation from the financial statements

4. BEING AWARE OF THE PATTERNS AND CHARACTERISTICS OF THE INDUSTRY

Because different industries have varying risk and return characteristics as well as competitive advantages, knowledge of the sector is vital and crucial for the production and revision of financial predictions for each organisation.

When making projections, historical data might serve as a useful basis. Nonetheless, developments in technology and adaptions in regulatory frameworks at the national and international levels may have a considerable influence on the ways in which businesses operate.

It is necessary to have a solid understanding of the foundation for the classification of industries, which is based on the primary products and services offered by firms as well as their respective contributions to income.

The Global Industry Classification Standard (GICS), which was designed by Standard & Poor's and Morgan Stanley, is the standard that is relied on internationally for the categorization of industries. The Global Industry Classification Standard (GICS) groups together the firms that operate within a sector, industrial group, industry, and sub-industry. The S&P BSE indexes in India have also developed a system of industry classification that is comparable to the GICS.

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5. FORECASTING AND VALIDATING COMPANY PERFORMANCE

Forecasting performance requires first establishing a premise, which may be accomplished by doing a study of the market, the competition, and the company's own financial performance. The majority of valuation models include projections of sales and expenses as well as profits (EBIT, EBITDA, and PAT), as well as capital expenditures and working capital.

It is the job of a company's management, as well as their responsibility, to make financial projections for the company's operations. REVIEWING THE ASSUMPTIONS MADE BY MANAGEMENT IN THEIR BUSINESS PLAN, INCLUDING THE BASIS OF PAT, PRESENT AND ESTIMATED REVENUES, PROFITS, CAPITAL EXPENDITURE, AND WORKING CAPITAL, ETC., IS THE ROLE OF A VALUER.

In accordance with the IVS, guidance on the appropriateness of Assumptions, as well as information obtained from Management

A valuer is required to evaluate the reasonableness of information received from management, representatives of management, or other experts in accordance with IVS 105 Valuation Approaches and Methods, paragraph 10.7. This evaluation is done in order to determine whether or not it is appropriate to rely on the information in question for the purpose of valuation.

Instructions for Conducting Investigations and Maintaining Compliance

In accordance with IVS 102, Paragraph 20.2, "Sufficient evidence must be assembled by means such as inspection, inquiry, computation, and analysis to ensure that the valuation is properly supported, adequate for the purpose of the valuation." In other words, the gathering of evidence must be done in such a way that it is sufficient for the purpose of the valuation.

6. CONSIDERING AND APPLYING APPROPRIATE VALUATION APPROACH

The purpose of the valuation (whether regulatory or transactional), the size of the transaction (whether minority or control), the stage the firm is in, and the business model all play a role in determining the valuation technique that should be utilised.

Valuation may be done in three different ways around the world. Approaches based on Income, Assets, and the Market

The Income and Asset techniques both end up with a fundamental valuation of the company, while the Market strategy ends up with a relative value for the company.

Approach Based on Income :

Methods of valuation that are based on expected future income begin with the premise that the current value of any company is a function of the future value that an investor can anticipate receiving as a result of purchasing all or part of the company. These methods of valuation are known as income-based methods.

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Technique of maximising the capitalization of earnings

The capitalization technique simply involves dividing the anticipated profits of a company by the pace at which capitalization is performed.

- The discounting of future cash flows method

The current worth of the company is expressed using the Discounted Cash Flow (DCF) model as a function of the company's potential to earn cash in the future. After accounting for all operational expenses, taxes, and the required investments in working capital and capital expenditures, the appraiser will then estimate the cash flows that will be generated by any given company using this procedure. The DCF technique can either arrive at an Enterprise value or an Equity value as a result, depending on the sort of cash flows that are taken into consideration, namely either free cash flow to firm (FCFF) or free cash flow to equity (FCFE). Both the FCFF and the FCFE are reduced based on their respective costs: the WACC for the FCFF and the Cost of Equity for the FCFE (Ke). The DCF technique is the approach that is used for the valuation of shares or businesses that receives the most widespread use.

- Approach Based on Assets

The asset-based valuation method is another sort of fundamental valuation technique. This method evaluates a firm on the basis of the resources or assets it owns that are vital to the company. The Net Asset Value (NAV) that is recorded in the books often does not contain intangible assets that are enjoyed by the company. These values are also influenced by accounting practises, which can, at times, be discretionary. In general, however, this is not the case. Hence, NAV is not considered to be an accurate reflection of the underlying worth of the company. Yet, it is used to analyse the entrance barrier that is present in a firm and is deemed feasible for businesses that have reached the mature or decreasing growth cycle as well as for property and investment organisations that have a solid asset base.

- Approach to the Market

The subject, firm, or assets in question are put through a series of comparisons with other assets or transactions that are either the same as or equivalent to them and for which pricing information is readily available. Similar assets are those that are typically found in the same sector, and ideally, those that are the same size and are located in the same location. The market approach to valuation is another name for this method.

- Comparable (or guideline) businesses multiples (CCM) approach

A multiple-based valuation is arrived at by computing the market multiples of comparable listed firms and then applying those market multiples to the company that is being evaluated. Identifying similar is a large work in and of itself, and it should only be done after doing an in-depth scan of the market. The end outcome is a value of the minority. The exercise of judgement, taking into account both qualitative and quantitative aspects, is required for the selection of the right multiple within the range.

- Comparable (or guideline) transaction multiples (CTM) technique

The valuation of a firm for the purposes of mergers and acquisitions or investments is the primary use of this method. In order to arrive at a transaction-based valuation of a firm, valuation multiples are created from investment transactions that have taken place in the same industry (with private companies). These multiples are then applied to the company that is being evaluated. The fact that the majority of investments are made in privately held businesses, as well as the fact that only a small amount of information regarding the transactions (such as year-to-date financials and valuation multiples) is available in the public domain, presents the method with its greatest obstacle, which is the generation of a control valuation.

- Market value technique

In the case of frequently traded shares of companies that are listed on stock exchanges that have nationwide trading, the market value method is typically the most preferred method. This is due to the perception that the market value method takes into account the inherent potential of the company in question.

Other methods for the estimation of value

While choosing a model, data availability as well as the quality and accuracy of the data might be limiting variables that call for appropriate changes taking into consideration trends in the sector and the valuer's expertise.

It is recommended to use the Income Method when valuing a business on the assumption that it is a going concern in general;

The Indian Supreme Court stated in the cases of Commissioner of Wealth Tax v. Mahadeo Jalan's case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.) (122 ITR 38) that "the real value of shares in a company will depend more on the profits which the company has been making and should be capable of making, having regard to the nature of its business, than upon the amount which the shareholders In line with the "Fair Value" standard for financial reporting, also known as the "Indian Accounting Standard" 113, the valuation methodologies that rely on observable inputs should be given precedence. So, the information on an asset's price that is readily available in a market that is active is typically considered to be the most convincing proof of the asset's value.

IVS 105, Valuation Approaches and Methodologies provides guidance on how to select appropriate valuation approaches and methods.

Paragraph 10.3, when picking valuation approaches and procedures for an asset, the objective is to choose the approach that is most appropriate given the specific set of circumstances. There is no one approach that is appropriate for use in each and every scenario.

Paragraph 10.4, Valuers are not required to use more than one method for the valuation of an asset, particularly when the valuer has a high degree of confidence in the accuracy and reliability of a single method, given the facts and circumstances of the valuation engagement. In other words, valuers are not required to use more than one method for the valuation of an asset.

However, valuers should consider the use of multiple approaches and methods, and more than one valuation approach or method should be considered and may be used to arrive at an indication of value. This is particularly important in situations in which there are insufficient factual or observable inputs for a single method to produce a reliable conclusion. In situations in which more than one approach and method are used, or even multiple methods within a single approach, the conclusion of value based on those multiple approaches and/or methods should be reasonable, and the process of analysing and reconciling the different values into a single conclusion, without averaging them, should be described by the valuer in the report. This is because averaging the values would result in a value that is not representative of the market.

Para 10.5, It is the obligation of the valuer to select the method(s) that are suitable for each individual valuation engagement.

Paragraph 10.7 states that valuers should make the most of the relevant observable market information when applying any of the three methodologies.

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7. PERFORMING SCENARIO ANALYSIS, VALUE ADJUSTMENTS, DOCUMENTATION AND REPORTING

-Scenario Analysis

It is in your best interest to perform valuation using a variety of different scenarios. This is due to the fact that different methods of valuation lead to different value conclusions, and the achievement of forecast cannot be guaranteed because it is dependent on future industry trends and government policies, both of which cannot be fully predicted.

-Value Adjustments

There may be a need to account for discrepancies between the base value produced through a specific valuation technique and the value of the subject interest if the purpose of the engagement, the relevant standard of value, or other circumstances of the engagement suggest the need to do so. If this is the case, discounts or premiums should be calculated accordingly. A discount for lack of marketability (DLOM) and a discount for lack of control are two different forms of valuation adjustments that may be used in the event that a company or its shares are being valued (DLOC).

-Assets That Are Not Used In Business

Non-operating assets are assets that are not used in the operations of a business and include excess cash balances and assets held for investment purposes. The valuation of operating assets is typically reflected in the cash flow that is generated by the company. However, there are also non-operating assets.

As a rule, investors do not place a high value on such assets; hence, demerger or hive off may be necessary in order to maximise the generation of value. Yet, when evaluating a firm, the value of such non-operating assets should be added separately to arrive at the enterprise value. This is done so that the worth of the company can be determined.

-Documentation

The documentation is the primary record of the information that was acquired and analysed, the procedures that were conducted, the valuation techniques and methodologies that were examined and employed, as well as the valuation result. It is up to the professional opinion of the valuer to decide the quantity of documentation, as well as its kind and substance. While conducting an evaluation, it is important to have enough documentation of the material that will be relied upon. The fact that such information is included in the report meets the requirements of this standard.

According to the Companies (Registered Valuers and Valuation) Regulations, 2017, the paperwork is to be kept by the valuer for a duration of three years. On the other hand, if there is a case that is currently being considered by the Tribunal or the Appellate Tribunal, the record will be kept until the conclusion of the case.

-Reporting

The transmission of the results of the valuation to the customer or any other person who will be using the report is one of the last phases of the process of valuing anything. The nature of the project, its aim, its results, and the requirements of the decision-makers who will receive and rely on the report will all play a role in determining the format of the particular report in question.

In accordance with the Companies (Registered Valuers and Valuation) Regulations that were implemented in 2017, the valuer is required to provide the following information in his valuation report:

information on the history of the asset that is being appraised;
The reason for the evaluation, as well as the appointment of authority;
Identification of the valuer as well as any additional specialists who are participating in the appraisal;
Declaration of any conflicts of interest or interests held by the valuer;
The date of the appointment, the date of the valuation, and the date of the report;
investigations and/or inspections that have been carried out;
The nature of the information used or relied upon, as well as the sources of that knowledge;
standards of valuation that were adhered to and the procedures that were used while carrying out the appraisal;
If there are any restrictions on how the report can be used;
The following are some of the primary considerations that went into the valuation:
Conclusion;
Caveats, limits, and disclaimers, to the degree that they explain or illustrate the constraints faced by the valuer; nonetheless, these should not be included for the purpose of diminishing the valuer's liability for the valuation report.

The valuation of securities or financial assets is done most accurately when the entire process is followed, beginning with an understanding of the purpose of valuation, followed by the requisitioning of information from the company while keeping the purpose of valuation in mind, the performance of financial analysis and the application of normalisation adjustments, the comprehension of industry characteristics and trends, the forecasting and validating of company performance, the consideration and application of an appropriate valuation approach, and the execution of scenario analysis. If we were to be sensible, we would state that the valuation of securities or financial assets goes beyond the figures, and that the key to being a successful valuer is to adhere to the entirety of the valuation process in good faith. It goes without saying that simply following the process in its entirety and asking the appropriate questions of the company or client being valued would provide the valuer with useful information that would guide them in presenting an accurate and objective view of the valuation of the asset or company.

Notwithstanding the fact that the International Valuation Standards (IVS), which were published by the International Valuation Standards Council (IVSC), provide a significant amount of direction with regard to several components of the valuation process, Nevertheless, the experience of the valuer is extremely important when applying these principles since it determines whether or not the company's business model is acceptable, which procedures are used to arrive at a value conclusion, and how much that value is.

It is time for professionals who are interested in working in this industry to step forward and acquire academic and practical understanding of the principles and ideas of company valuation, as well as valuation techniques and processes, as well as worldwide valuation standards. Nevertheless, one must keep in mind that valuation is a very laborious task that also includes a great deal of responsibilities in its current state, where it is regulated by the government. Furthermore, the experience of the valuer is still going to be the most important factor in determining valuations.

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