Demystifying Regulatory Rules of Business Valuation

“Demystifying Regulatory Rules
of Business Valuation”
32nd KSCAA Annual Conference
Bengaluru
6th March, 2020
Chander Sawhney
FCA, FCS, Registered Valuer (IBBI)

I. Overview of Valuation
II. Regulatory Valuations in India
III. Valuation Approaches
IV. Valuation under Specific Situations
V. Judicial Pronouncements
VI. Case Studies
Agenda

“
“
Price is what you Pay,
Value is what you get
Warren Buffett

Valuation across business cycle follow the
LAW of ECONOMICS
Growing
Cos.
 Turnover/Profits: Increasing still Low
 Proven Track Record: Limited
 Valuation Methodology: Substantially on Business Model
 Cost of Capital: Quite High
High Growth
Cos.
 Turnover/Profits : Good
 Proven Track Record: Available
 Valuation Methodology: Business Model with Asset Base
 Cost of Capital: Reasonable
Mature
Cos.
 Turnover/Profits: Saturated
 Proven Track Record: Widely Available
 Method of Valuation: More from Existing Assets
 Cost of Capital: May be High
Declining
Cos.
`
 Turnover/Profits: Drops
 Proven Track Record: Substantial Operating History
 Method of Valuation: Entirely from Existing Assets
 Cost of Capital: N.A.
 Turnover/Profits: Negligible
 Proven Track Record: None
 Valuation Methodology: Entirely on Business Model
 Cost of Capital: Very High
Start Up
Cos.
Turnover
/
Profits
Time

Skills Required for Performing Valuations
Revenue Ruling 59-60 (Internal Revenue Service of USA)
Revenue Ruling (RR) 59-60 is one of the oldest guidance available on Valuation in the world but still most
relevant for Tax Valuations specifically for valuing closely held equity shares. It is the most widely referenced
revenue ruling, also often referenced for Non Tax Valuations.
While valuing, it gives primary guidance on eight basic factors to consider-
• Nature of the Business and the History of the Enterprise from its inception
• Economic outlook in general and Outlook of the specific industry in particular
• Book Value of the stock and the Financial condition of the business
• Earning Capacity of the company
• Dividend-Paying Capacity of the company
• Goodwill or other Intangible value
• Sales of the stock and the Size of the block of stock to be valued
• Market prices of stock of company engaged in the same or a similar line of business

• Legal Recognition
• Regulated Profession
• Uniform Practice (Valuation Standards)
• Requires Skill set / Capacity Building
• Code of Conduct
New Era of Valuation in India – Registered Valuers

Companies (Registered Valuers and Valuation)Rules 2017
• Applicable w.e.f. 18th October, 2017
• Defines ‘Eligibility’, ‘Educational’ and ‘Exam’ requirements
• Made 3 Asset classes – Securities or Financial Assets, Land & Building and Plant & Machinery
• Brought in concept of RVO’s for education, training and monitoring of Valuers
• Need to comply with International Valuation Standards until Indian Valuation Standards come in force
• Prescribed Contents of Valuation Report
• Maintenance of Records for 3 years
• Professional competence, Due Care and Independence of valuer
• Model Code of Conduct for Registered Valuers and RVO’s

Contents of Valuation Report
The valuer shall in his report state the following:
• Background information of the asset being valued;
• Purpose of valuation and appointing authority
• Identity of valuer and any other experts involved in valuation;
• Disclosure of valuer interest/conflict, if any;
• Date of appointment, valuation date and date of report;
• Inspections and/or investigations undertaken;
• Nature and sources of the information used or relied upon;
• Procedures adopted in carrying out the valuation and the valuation standards followed;
• Restrictions on use of the report, if any;
• Major factors that were taken into account during the valuation;
• Conclusion; and
• Caveats, Limitations and Disclaimers to the extent they explain or elucidate the limitations faced by valuer, which
shall not be for the purpose of limiting his responsibility for the valuation report.
Companies (Registered Valuers and Valuation)Rules 2017

New Regulations – Financial Reporting
• Ind AS 113 - Dedicated Standard on “Fair Value” Measurement – in line with global equivalents – IFRS 13 and
ASC 820 (US GAAP). Covers Financial Reporting.
• Fair Value is a market-based measurement, NOT an entity-specific measurement
• Gives more preference to valuation methods relying on “Observable Inputs” than unobservable inputs.
• Specific Standards for specific issues
• Ind AS - 109, 107 and 32 : Financial Instruments
• Ind AS - 102 : Share based payment
• Ind AS - 103 : Business Combination
• Ind AS - 38 : Intangible Assets
• Ind AS - 16 : Property Plant & Equipment
• Ind AS - 36 : Impairment of Assets
IND AS

Understanding Purpose
of Valuation
Information requisition
from the Company
Financial Analysis and
Normalisation
Adjustments
Understanding Industry
Characteristics and
Trends
Forecasting and
reviewing Company
Performance
Considering and
Applying appropriate
Valuation
Methodologies
Performing Value
adjustments, Value
Conclusion,
Documentation and
Reporting
Valuation Process

Time horizon: Short
term versus long term
Transaction,
regulatory or
financial reporting
purposes
Time horizon:
Short term versus
long term
Type of
shareholders:
Minority versus
control
Enterprise Value
vs. Equity Value
Understanding Purpose of Valuation

II. Regulatory Valuation requirements
in India

Requirement of
business/share
valuation in India
under different
laws

Valuation for
Fresh Issue and/or
Transfer of Shares
Governing Provisions/ Regulations Section 62(1)(c) read with rule 13 of the
Companies (Share Capital and
Debentures) Rules, 2014
Valuation Methodology for issue
of shares
Not prescribed
Valuation shall be done in accordance
with the Companies (Registered Valuers
and Valuation) Rules, 2017
However, for preferential allotment of
shares of listed companies, SEBI
Regulations need to be followed.
Who can do Valuation? Registered Valuer
A. Companies Act, 2013
Applicability - Issue of Shares and Convertible Instruments
Note- There are various other sections under the Companies Act, 2013 which
require the Valuation by a Registered Valuer.

Valuation for
Fresh Issue of
Shares
B. Income Tax Act, 1961
Applicability – Issue and Transfer of Shares and other Securities
Governing Provisions/ Regulations
Section 56(2)(viib) read with rule 11UA(2) and 11UA(1)(c)(c)
of the Income Tax Rules, 1962
Valuation Methodology for - Issue of
unquoted Equity shares - Rule 11UA(2)
- Issue of Unquoted Shares (other than
equity shares) - Rule 11UA(1)(c)(c)
Discounted Cash Flow (DCF) or Net Asset Value (NAV) method
or value as may be substantiated by the company to the
satisfaction of the AO based on the value of its assets
including intangible assets
- Price it would fetch if sold in the open market
Who can do Valuation?
For unquoted equity shares, SEBI-registered category I
merchant banker (where DCF method is used)
For unquoted shares (other than equity shares): Chartered
accountant or SEBI-registered category I Merchant Banker.
Case 1 - Issue of Shares and Other Securities

Valuation for
Transfer of Shares
Governing Provisions/
Regulations
Section 56(2)(x) read with rule 11UA(1)(c) of the Income Tax Rules, 1962
Valuation methodology for issue
of shares
Quoted Shares: Market price on recognised stock exchange on the valuation date
or on a date immediately preceding the valuation date where on the valuation
date there is no trading in such shares and securities on any recognised stock
exchange - rule 11UA(1)(c)(a)
Unquoted Equity Shares: Adjusted net asset value (NAV) - rule 11UA(1)(c)(b)
Unquoted Shares (other than equity shares): Price it would fetch if sold in the
open market - rule 11UA(1)(c)(c)
For shares other than equity shares: Chartered accountant or SEBI-registered
category I merchant banker
For quoted shares and unquoted equity shares: Not prescribed
Case 2 - Transfer of Shares and Other Securities

Valuation for
Transfer of Shares
Valuation for Capital
Gain purposes
Section 50CA provides for a special provision for determination of minimum
consideration in case of transfer of unquoted shares, being a capital asset.
Further section 50D of the Income Tax Act, 1961 states that where consideration for
transfer of a capital asset is not ascertainable, its fair market value shall be deemed to be
its consideration.
Transfer Pricing
Section 92C provides that any international transaction between associated entities
needs to be done at arm’s length price. Now, even in case of domestic related party
transactions above Rs 20 crore, applicability of transfer pricing provisions get triggered.
In case where issue or transfer of shares, business or certain rights (intangibles) is
involved in such a case, it requires valuation.
Indirect Transfer of
Assets
As per section 9 of the Income Tax Act, 1961, any capital gains arising to a non-resident
on transfer of shares of a foreign company if such shares derive its value substantially
from the assets located in India (indirect transfer of shares of Indian company) is deemed
to accrue or arise in India.
In order to cover only large transactions that derive their value from underlying Indian
business, two additional criteria need to be met:
• the fair market value (FMV) of assets located in India exceeds Rs 10 crore; and
• FMV of assets located in India represents at least 50% of FMV of total assets of the
foreign company or entity.
Other areas where tax valuation is required for transfer of shares/assets under the
Income Tax Act, 1961

Valuation for
Fresh Issue and/or
Transfer of Shares
Governing
Provisions/
Regulations
FDI-
Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside
India) Regulations
ODI –
Direct investments by residents in Joint Venture (JV) and Wholly Owned Subsidiary (WOS)
abroad -
Valuation
Methodology for
issue of shares
FDI–
Unlisted company - Internationally accepted pricing methodology
Listed company - SEBI preferential allotment guidelines.
ODI-
No mention for basis of valuation of shares of a foreign company.
Who can do
Valuation?
Under ODI guidelines, where investment amount exceeds USD 5 million, - SEBI-registered
merchant banker or investment banker/merchant banker outside India registered with the
appropriate regulatory authority in the host country and in all other cases, a chartered
accountant or a certified public accountant.
In case investment is by way of swap of shares - Category I Merchant Banker registered with
SEBI or an Investment Banker outside India registered with the appropriate regulatory
authority in the host country.
Under FDI transactions, in case of an unlisted Indian Company - Chartered Accountant or SEBI
registered Merchant Banker or Cost Accountant.
C. Reserve Bank of India
Applicability – Issue and Transfer of Shares

Valuation for
Buyback
• No specific Valuation requirement under Companies Act, 2013 other than disclosure
• Tax Liability in the hands of the Company under section 115QA of Income Tax Act
@20% plus surcharge and cess on any amount of distributed income by the company
on buy-back of shares (unlisted shares) from a shareholder. The distributed income is
defined as the difference between the buyback consideration and the amount received
by the company for issue of such shares.
• While the company would pay Tax on Buyback, the shareholder would be exempt from
tax u/s 10(34A).
--------------------------------------------------------------------------------------------------
Regarding applicability of Section 56 (2)(viia)* on Buyback, it was recently held in the
matter of Vora Financial Services Pvt. Ltd. by Mumbai ITAT (I.T.A. No. 532/Mum/2018) that
Buyback is not a Transfer and hence Valuation is not required.
Note – While Section 56 (2) (viib) pertains to determination of maximum value for issue of
shares, section 56(2)(x) determines minimum value for transfer of shares.
*now replaced with 56(2)(x)

Valuation for
Fresh Issue of
Shares
D. SEBI Regulations
Applicability – Issue of Shares
Regulations
SEBI (ICDR) Regulations, 2009 [Preferential Issue]
Valuation Methodology for
issue of shares
Frequently Traded - As per Market Price (refer Regulation 76)
Infrequently Traded - Based on the price of its comparable companies, book
value and other valuation parameters (refer Regulation 76A)
Infrequently Traded
Independent merchant banker or an independent chartered accountant in
practice having a minimum experience of 10 years

Valuation for
Transfer of Shares
D. SEBI Regulations
Applicability – Transfer of Shares
Regulations
SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
Valuation Methodology
for issue of shares
Regulation 8(2)
In case of Direct Acquisition:
(d) Frequently Traded Shares: The volume-weighted average market price of such shares
for a period of 60 trading days immediately preceding the date of the public
announcement as traded on the stock exchange where the maximum volume of trading
in the shares of the target company are recorded during such period
(e) Infrequently Traded Shares: The price determined by the acquirer and the manager to
the open offer taking into account valuation parameters including, book value,
comparable trading multiples, and such other parameters as are customary for valuation
of shares of such companies
Who can do Valuation? Infrequently Traded Shares:
For cl 8(2)(e), the Board may, at the expense of the acquirer, require valuation of the
shares by an independent merchant banker other than the manager to the open offer or
an independent chartered accountant in practice having a minimum experience of 10
years

Valuation for
Mergers
In case of a merger valuation, the emphasis is on arriving at the “relative” values of the shares of the merging companies to
facilitate determination of the “swap ratio”
Under SEBI Circular no CFD/DIL3/CIR/2017/21 dated 10 March 2017, Valuation by independent chartered account mandatory
other than those specifically exempted. ''Valuation Report from an Independent Chartered Accountant'' is not required in
cases where there is no change in the shareholding pattern of the listed company / resultant company.
Computation of Fair Share Exchange Ratio
As per SEBI circular No. CFD/DIL3/CIR/2017/26 dated 23 March 2017, fair value of listed companies needs to be undertaken as
per preferential allotment guidelines prescribed under the SEBI (ICDR) Regulations, 2009. The relevant date for this purpose is
defined as the date of Board Meeting in which the scheme of merger is approved.
Further as per NSE circular No. NSE/CML/2017/12 dated 1 June 2017 and BSE circular number LIST/COMP/02/2017-18 dated 29
May 2017, as advised by SEBI, w.r.t. the valuation reports on Scheme of Arrangement, the valuation reports shall display the
workings, relative fair value per share and fair exchange ratio in the following format:
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
Note- The reasons for not adopting certain approaches also needs to be given here.

Valuation for
Mergers
Fairness Opinion
In case of M&A, focus is on comparative valuation of companies and thus apart from adhering to
the general valuation principles, the valuation needs to be fair from the point of view of
shareholders of the transferor and transferee companies.
In accordance with SEBI Circular no CFD/DIL3/CIR/2017/21 dated 10 March 2017 and SEBI (Listing
Obligations and Disclosure Requirements) Regulations, 2015, the listed as well as the unlisted
company getting merged shall each be required to obtain a ‘fairness opinion’ on the valuation of
assets/equity shares done by the valuers from an independent merchant banker.
Purchase Price Allocation (PPA)
Under Ind AS 103, now all business combinations (except group consolidation) are considered in
the nature of purchase and 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. Ind AS 38 and IVS 210 deals with Intangible Assets.
As per para 18 (measurement principle) of Ind AS 103, the acquirer shall measure the identifiable
assets acquired and the liabilities assumed at their acquisition-date fair values.
The difference amount, if any, between the consideration paid and assets acquired goes to
goodwill.

Valuation for
Mergers
Purchase Price Allocation (PPA) Template

Valuation for
Sweat Equity
E. Valuation for Sweat Equity
Regulations
Section 2 (88) of the Act defines ‘sweat equity shares’
Section 54 of the Act: Issue of Sweat Equity Shares
Rule 8 of the Companies (Share Capital and Debentures) Rules, 2014
SEBI (Issue of Sweat Equity) Regulations, 2002
Section 17(2)(vi) of the Indian Income Tax Act, 1961 read with Notification no. 94/2009
dated 18 December 2009 issued by CBDT
issue of shares
Not prescribed
Valuation of IPR / Know How (For Listed Companies)
By a Merchant Banker.
Valuation of IPR / Know How (For Unlisted Companies)
By Registered Valuer
Valuation of sweat equity shares: By Registered Valuer

Valuation for
ESOP
F. Valuation for ESOP
Regulations
Sec 62 of Companies Act, 2013 read with Rule 12 of Share Capital Rules, 2014
SEBI (Share Based Employee Benefits) Regulations, 2014
ICAI Guidance Note on , 2005 Edition
Ind AS 102 : Share based payments
Section 17(2)(vi) of the Indian Income Tax Act, 1961 read with Notification no. 94/2009
dated 18 December 2009 issued by CBDT
issue of shares
If a Company listed on recognized stock exchange in India and issued shares under an
ESOS / ESPS, the fair value of stock option shall be estimated using an option pricing
model (Black-Scholes or a binomial model) which shall be treated as employee
compensation cost for the Company.
Under SEBI Regulations, Market Price is defined as the Closing Market Price
immediately before the Relevant Date which is further defined as date of meeting of
Compensation committee on which grant is made or date on which notice of exercise is
given to the company.
If company is unlisted, Intrinsic value method is allowed with disclosure of Fair Value
Who can do Valuation? Not Prescribed

Valuation for
Financial
Reporting
G. Valuation for Financial Reporting
Regulations
Indian Accounting Standards (Ind AS)
Fair Value is required for Financial Instruments, Derivatives, Options, Purchase Price
Allocation, Impairment etc.
Valuation methodology
Fair value hierarchy is prescribed under Ind AS 113. Preference is given to valuation
method relying on observable inputs, i.e. market price. However, if market price is
not available, other valuation techniques may be applied in level wise hierarchy giving
more preference to Observable Inputs.
Who can do Valuation? Not prescribed

Valuation for IBC
H. Valuation for IBC
Regulations
Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for
Corporate Persons) Regulations, 2016.
Regulation 27. Appointment of registered valuers (2 Registered Valuers are to be
appointed)
Regulation 35. Fair value and Liquidation value.
Regulation 2(1)(hb) defines “fair value” as the estimated realizable value of the
assets of the corporate debtor, if they were to be exchanged on the insolvency
commencement date between a willing buyer and a willing seller in an arm’s length
transaction, after proper marketing and where the parties had acted knowledgeably,
prudently and without compulsion;”
Regulation 2(1)(k) “liquidation value” means the estimated realizable value of the
assets of the corporate debtor, if the corporate debtor were to be liquidated on the
insolvency commencement date.”
Valuation shall be done in accordance with internationally accepted valuation
standards, after physical verification of the inventory and fixed assets of the
corporate debtor.
Average of two closest estimates of value shall be considered as fair value or
Liquidation value.

Valuation for IBC
Valuation for IBC
Regulations
Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016.
Regulation 32. Manner of Sale
-Sale of Assets can take place on Standalone basis or as a business of Corporate
Debtor
Regulation 35. Valuation of Assets/Business
The Liquidator shall appoint two Registered Valuers to value the Assets or Business
where it is intended to be sold as such.
Valuation shall be done in accordance with internationally accepted valuation
standards, after physical verification of the inventory and fixed assets of the
corporate debtor.
Average of two estimates of value shall be considered as the value of Assets.

Valuation
Approaches &
Methodologies

 Factors considered in Valuation using Comparable Companies Multiples Methodology:
o Basis of selection of comparable companies (Market size / ROCE / Earning margins)
o Multiple used for valuation (Considering the type of business / Industry)
o Adjustment of fair value of surplus assets
o Application of Market / Company specific Discounts / Premium (if any)
 Factors considered in Comparable Transaction Multiples Methodology:
o Source / Age / Parties among which transaction has taken place
o Multiple used for valuation (Considering the type of business / Industry)
 Factors considered in Discounted Cash Flow Methodology:
o Source of financial projections (In case of listed companies management information related to financial
projections is price sensitive, however, in many cases valuers rely on the financial projections prepared by
market analysts)
o Specific adjustments w.rt. FCFF vs FCFE
o Factors considered for calculation of WACC in case of FCFF / Ke in case of FCFE
o Reasons for consideration of Company Specific additional Risk Premium (if any)
Factors considered in Valuation application

Free Cash Flow to
Firm (FCFF)
calculation

Cost of Capital
calculation
DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL
Where:
D = Debt part of capital structure
E = Equity part of capital structure
Kd = Cost of Debt (Post tax)
Ke = Cost of Equity
WACC
(Kd x D) + (Ke x E)
(D + E)

Cost of Equity
calculation
DISCOUNT RATE - COST OF EQUITY
Where:
Rf = Risk free rate of return (Generally taken as 10-year Government Bond Yield)
B = Beta Value (Sensitivity of the stock returns to market returns)
Ke = Cost of Equity
Rm= Market Rate of Return (Generally taken as Long Term average return of
Stock Market)
SCRP = Small Company Risk Premium
CSRP= Company specific Risk premium
Mod. CAPM Model
ke = Rf + B ( Rm-Rf) + SCRP + CSRP
The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing
Model (Mod. CAPM)

Terminal calculation
PERPETUITY FORMULA
– Usually comprises a Large part of Total Value and is sensitive to small
changes
– Capitalizes FCF after definite forecast period as a growing perpetuity;
– Estimate Terminal Value using Terminal Value Multiplier applied on last year
cash flows
– Gordon Formula is often used to derive the Terminal Cash
Flows by applying the last year cash flows as a multiple of
the growth rate and discounting factor
– Estimated Terminal Value is then discounted to present day at company’s
cost of capital based on the discounting factor of last year projected cash
flows
(1 + g)
(WACC – g)

CCM VALUATION
Market BASED Multiples
can be misleading
To use a multiple you must:
• Know what are the fundamentals that determine the multiple and how changes in
these fundamentals change the multiple
• Know what the distribution of the multiple looks like (Mean/Median/Outliers)
• Ensure that both the denominator and numerator represent same group
 PE, Book Value, Mcap/Sales Multiples result in Equity Value
 EBIT, EBITDA, EV / Sales Multiple result in Enterprise Value
• Ensure that firms are comparable (Business Model, Product Profile, Geography,
Stage & Size of Business, Profitability margins, Borrowings etc. play a crucial role in
finding “Comps”

Rule of
Thumb
Industry Valuation Parameters
Hospital EV/Room
Engineering Mcap/Order Book
Mutual Fund Asset under management
OIL EV/ Barrel of equivalent
Print Media EV/Subscriber
Power EV/MW, EBITDA/Per Unit
Entertainment & Media EV/Per screen
Metals EBITDA/Ton, EV/Metric ton
Textiles EBITDA depend upon capacity utilization Percentage & per spindle value
Pharma Bulk Drugs New Drug Approvals , Patents
Airlines EV/Plane or EV/passenger
Shipping EV/Order Book, Mcap/Order Book
Cement EV/Per ton & EBITDA/Per ton
Banks Non performing Assets , Current Account & Saving Account per Branch
A rule of thumb or benchmark indicator is used as a reasonableness check against the
values determined by the use of other valuation approaches.
However, Exclusive
use of Rule of
Thumb is not
recommended

Choice of Valuation
approaches
In General, for Business Valuation on going concern basis, Income Approach is
preferred;
The dominance of profits for valuation of share was emphasised in “McCathies
case” (Taxation, 69 CLR 1) where it was said 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 shares would realise on liquidation”.
This was also re-iterated by the Indian Courts in 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).
 However, Asset Approach is preferred in case of Asset heavy companies and on
liquidation; The liquidated value of the Net Assets is also considered the minimum
value of the whole company and will prevail even if Earning capacity is low or
negative subject to any discounting in appropriate circumstances (like Reluctance
to wind up, Ability to control, Tax adjustments etc.)
 Market Approach is preferred in case of listed entity and also to evaluate the value
of unlisted company by comparing it with its peers;
In selecting a model, data availability and
quality/accuracy of data can be limiting
factors and require suitable adjustments
considering industry trends and valuer’s
experience.

Choice of Valuation
approaches -
Guidance under IVS
of IVSC
As per IVS 105, Valuation Approaches and Methods
Para 10.3, the goal in selecting valuation approaches and methods for an asset is to find the most
appropriate method under the particular circumstances. No one method is suitable in every possible
situation.
Para 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.
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,
particularly when there are insufficient factual or observable inputs for a single method to produce a
reliable conclusion. Where more than one approach and method is 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 differing values into a single conclusion,
without averaging, should be described by the valuer in the report.
Para 10.5, It is the valuer’s responsibility to choose the appropriate method(s) for each valuation
engagement.
Para 10.7, Valuers should maximise the use of relevant observable market information in all three
approaches.

Valuation
methodologies &
Value impact
Major Valuation Methodologies Ideal for Result
Net Asset Value
Net Asset Value (Book Value) Minority Value
Equity Value
Net Asset Value (Fair Value) Control Value
Comparable Companies Multiples (CCM) Method
Price to Earning , Book Value
Multiple Minority Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Comparable Transaction Multiples (CTM) Method
Price to Earning , Book Value
Multiple Control Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Discounted Cash Flow (DCF)
Equity Control Value Equity Value
Firm Enterprise Value

Discounts and Premiums come into picture when there exists difference between the subject being valued and the methodologies applied. As this can
translate control value to non-control and vice-versa, so these should be judiciously applied.
Discount at Company Level
The company level discounts affect the equity value of the company and are applied before any apportionment is made to the shareholders. Major types
of company level discounts include the following:
• Key Person Discount
• Discount for Contingent Liabilities
• Diversified Company Discount
• Holding Company Discount
• Liquidation Discount (Tax Payout on Appreciation of Assets)
Discounts and Premium at Shareholder Level
The shareholder level discounts affect the value of specific shareholders and are applied after distribution of the equity value to the respective
shareholders. Major types of shareholder level discounts include the following:
• Discount for Lack of Control (DLOC)
• Discount for Lack of Marketability (DLOM)
• Control Premium
Performing Value Adjustments

Non Operating Assets
Operating Assets
• Assets used in the operation of the business including working capital, Property, Plant & Equipment & Intangible assets
• Valuing of operating assets is generally reflected in the cash flow generated by the business
Non - Operating Assets
• Assets not used in the operations including excess cash balances, and assets held for investment purposes, such as vacant land & Securities (which
are not generating any operational income) are the non-operating assets.
• Investors generally do not give much value to such assets and Structure modification may be necessary
Treatment of Non-operating Assets
The value of such non-operating asset should be added separately to arrive at the enterprise value.
Performing Value Adjustments

IV. Valuation under
Specific Situations

Startup
Valuations
Key characteristics of start-up companies
• No past history, operations not reached commercial
production
• Negligible revenues with high operational
losses/negative cash flows
• Limited promoters capital infused and high dependence
on external sources of funds
• Illiquid investments
• Speculative/aggressive financial projections
• High risk companies
• Complex capital structure

Startup
Valuations
India taking a center stage in global markets because of high growth & reform
expectations, demographic dividend and large market, many Indian startups have
come out, especially in the last decade, building scalable businesses (substantially
Tech-enabled) to solve a multitude of problems we face in our daily life.
Till 2015, Indian digital retail and e-Commerce companies and their valuations
were being closely linked to the soaring valuation of US tech start-ups and
investors are under the fear of missing out. The online retail companies were
relying on a different metric of valuations – "GMV" gross merchandise value which
is defined to indicate total sales value for merchandise sold through a marketplace
over a period. However, it must be noted that GMV is not reflected on their
financial statements and their actual revenues are just a fraction of GMV. The GMV
or sales (as per financial statement) was then multiplied by a multiple (x times) to
get the Valuation of the entity.
Interestingly the trend of Investments has remained difficult and different from
2016. Many e-tailers reported decline in number of orders significantly as they cut
discounts leading to drop in their GMV raising eyebrows on their fresh funding
rounds and valuations.
“Topline is vanity, Bottomline is Sanity,
Cashflow is reality”

Valuation
Methodologies
for Start-up’s
While valuing early stage start-up companies, the
valuer and the investor takes a call on the promoter
and his track record along with the assessment of
groundwork and readiness of the start-up.
Qualitative attributes play a significant role in its
assessment as most of the plans are future driven
in an early stage start-up. That is why early stage
start-up is called the valley of death where only few
survive and majority perish.
Probability based models are mostly applied in
practice to take into account different scenarios of
business.

Valuation of
Preferred Stock v.
Equity Shares
Example, presume an Investor Invests 10$ for 10% Preferred Stock stake (say CCPS with
Dividend and Liquidation preferences) in a company. In this case it cannot be said that
the Equity Value of Company is 100$ (10$/10%). Actual Company Value will actually be
much lower as rest 90% Equity does not carry any preferred rights. The same can be
computed using complex Option Pricing (BackSolve method). As a ballpark number, the
difference can be 30-40% signifying the value of preferences / control depending on a
no. of factors.
The first step in valuing a company with complex capital structure is to value the
company itself using a combination of the Income, Market and Asset approaches
depending on its Nature and Stage of Business, Business Model, Purpose of Valuation
etc.
The second step is to allocate the value of the company among different classes of
securities like Equity Shares, CCPS, OCPS etc. (including their different series). It is
important to understand terms of each of the series of securities including the
conversion option, liquidation preference, participation in profits etc.
The BACKSOLVE OPM is a form of market approach which derives the implied equity
value for one type of equity security (Common Stock) from derived value of another
form of equity security (Preferred stock).
In this method, each share class only has value if the funds available for distribution to
shareholders exceed the value of the liquidation preferences at the time of a liquidity
event for each of the prior share classes in a company's cap table.

The corporate debt instruments are not valued as
equity because they may or may not have an
element of conversion attached. In case there is no
conversion option, debt or bond valuation is done by
treating it as fixed income security on which cash
flows (principle and interest) are pre-determined
and occur on specific scheduled date.
The same is valued on present value basis by
discounting the applicable coupon interest payments
and redemption amount at end of defined period, as
agreed between the parties at an appropriate rate
considering the credit rating of bonds.
Valuation of Corporate
Debt Instruments and
Corporate Guarantee

Valuation of
Investment
entities
Holdings in other firms can be categorized into:
Types of Cross Holding Meaning
Minority, Passive Investments If the securities or assets owned in another firm represent less
than 20% of the overall ownership of that firm
Minority, Active Investments If the securities or assets owned in another firm represent
between 20% and 50% of the overall ownership of that firm
Majority, Active Investments If the securities or assets owned in another firm represent more
than 50% of the overall ownership of that firm
Investment Value
Ways to value Cross Holding and Investments:
Dividend Yield Capitalization or DCF based on expected dividends
Separate Valuation (Preferred)
By way of Shareholders
Agreement even less % holding
may command control value

Excess Cash
and Non
Operating
Assets
Excess cash is defined as ‘total cash (in balance sheet) – operating cash (i.e. minimum required cash) to
sustain operations (working capital) and manage contingencies
Key Issue: Estimation of Excess Cash ?
Non operating Assets are the Surplus assets which are not used in operations of the business and does not
reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should
be separately added to the value derived through valuation methodologies to arrive at the value of the
company.
One of the solutions is to estimate average cash/sales or total balance sheet size of the company’s relevant
Industry and then estimate if the company being valued has cash in excess of the industry’s average.
However when valuing a non controlling ownership interest under the income approach, the
value of any non operating assets, non operating liabilities, or excess or deficient operating
assets may or may not be used to adjust the value of the operating entity depending on the
Valuer’s assessment of the influence exercisable by the non controlling interest (ICAI
Business Valuation Standard)

Accounting
Practices &
Tax Issues
Most of the information that is used in valuation comes from financial statements.
which in turn are made on certain Accounting practices considered appropriate.
• Ind AS v. Ind GAAP
• Operating Lease v/s Financial Lease
• Notional Tax vs. Actual Tax
• Treatment of Intangible Assets
• Companies Paying MAT
• Treatment of Tax benefits and Losses
• Auditors Qualification
• Management Discussion and Analysis (MDA)
• ESOP’s
• Contingent Liabilities
• Cash v. Accrual System

Qualitative
Factors
Macro
• Economy Trends
• Industry Assessment
Micro
• Management Competence and Experience
• Competitors and Entry Barriers
• Proprietary Assets (Tangible and Intangibles)
• Strategic relationships
• Financial Condition
• Risk Factors

V. Judicial Pronouncements
in India

Judicial
Pronouncements
(Valuation Case Laws)
Over the years, the courts in India have decided on various issues of
valuation but more so on the macro and logical aspects. So far, India
has not seen much of technical deliberations at court level and the
courts generally do not intervene in the valuation process if it is
done by experts and specifically when a well-defined process has
been followed.
Nonetheless, there have been cases wherein courts have accepted
the preference given to one approach compared to others. Like for
valuing a company undergoing concern assumption, in general
income and market approaches are preferred over the asset
approach. However, for valuing a holding company or a company
under liquidation, asset approach is preferred.
Recently, the Income Tax officers have started questioning the
achievement of projections, choice of a particular valuation
methodology for shares and basis for selection of comparable
based on the functions, assets and risks involved.

Valuation Case Laws
WHETHER ANY VALUATION METHODOLDY IS PRESCRIBED FOR MERGER?
Though there are no specific methodology prescribed for valuation under Merger, however in Hindustan
Lever Employees' Union v Hindustan Lever Limited and Others AIR 1995 SC 470 -
The Valuer applied all three valuation approaches and gave suitable weights of 2:2:1 to Income, Market
and Asset Approach for a scheme of merger”
The Court held that the Jurisdiction of the Court in sanctioning a claim of merger is not to ascertain with
mathematical accuracy if the determination satisfied the arithmetical test. A company court does not
exercise an appellate jurisdiction. It exercises a jurisdiction founded on fairness.
The Court's obligation is to be satisfied that valuation was in accordance with law and it was carried out by
an independent body.

Valuation Case Laws
CHOICE OF VALUATION METHODOLDIES ?
Dr. Mrs. Renuka Datla v Solvay Pharmaceutical B.V. and Ors. AIR 2004 SC 321
It was held that if the valuer adopts the method of valuation prescribed or, in the
absence of any prescribed method, adopts any recognised method of valuation,
his valuation cannot be assailed unless it is shown that the valuation was made on
a fundamentally erroneous basis, or that a patent mistake had been committed, or
the valuer adopted a demonstrably wrong approach or a fundamental error going
to the root of the matter. Where a method of valuation is prescribed, the valuation
must be made by adopting scrupulously the method prescribed, taking into
account all relevant factors which may be enumerated as relevant for arriving at
the valuation.
(Discussion on Discounted Cash Flow Method was made in this case even though
not applied by Valuer due to -
(1) no independent (third party) projections have been provided; and
(2) both parties provided projections that differ substantially.)

Valuation Case Laws
ROLE OF COURT
Miheer H. Mafatlal v Mafatlal Industries Ltd. AIR 1997 SC 506 : (1997) 1 SCC 579
In this case, it was held that if exchange ratio has been calculated by a recognised
firm of chartered accountants who are expert in field of valuation and the same
has not been objected by majority shareholders, it is not for the court to
substitute its exchange ratio. Thus, the appeal by minority shareholders for
unreasonable exchange ratio failed and was dismissed.
Brooke Bond Lipton India Ltd v Unknown (1999) 98 CompCas 496 (Cal)
In this case, it was held that if the ratio of exchange has been fixed by an
experienced and reputed firm of chartered accountants, then in the absence of
any charge of fraud against them the court will accept such valuation and ratio of
exchange. A mere allegation of fraud is not enough; it must be a proper charge of
fraud with full particulars. In the instant case, there is no charge made or
established.
Dinesh Vrajlal Lakhani v Parke Davis (India) Ltd. 2003 (4) ALL MR 496
It was held that while considering a Scheme of Amalgamation, the Court does not
exercise an appellate jurisdiction, but a jurisdiction founded on fairness. The Court
would not interfere with the swap ratio adopted on the advice of an expert unless
it was contrary to law. The Learned Judge held that it was not the case before him
that the swap ratio was contrary to law or that the experts who submitted the
valuation report were not independent. The objections were overruled.

Income Tax
Case Laws
Comparison of projected cash flows with actual cash flows by TPO
Hyderabad ITAT in the matter of “DQ Entertainment (International) Ltd.” emphasised that
the value at the time of making the business decision is important, opines,” when the values
are replaced subsequently, it is not valuation but evaluation i.e. moving the post of result
determined out of projections”; further held “for valuation of intangibles, only the future
projections can be adopted and such valuation cannot be reviewed with actuals after 3 or 4
years down the line”; relies on coordinate bench ruling in Social Media India Ltd and Bangalore
ITAT ruling in Tally Solutions (P) Ltd.
Rejection of Valuation Report
Delhi ITAT rejected a valuation report in the matter of “Agro Portfolio Pvt. Ltd.” obtained by
the taxpayer to defend the share premium amount on issue of shares. The grounds of rejection
was that no independent enquiry, even on test check basis, was made by the valuer to verify
the reasonableness of the figures furnished by the management.
Similar observation made by Bangalore ITAT in TUV Rheinland NIFE Academy and
Innoviti Payment Solutions
Taxability of Issue of Share Capital
Bombay High Court in the matter of “Vodafone India Services Pvt. Ltd.”(VISPL) wherein the
Bombay HC categorically held that issue of shares at a premium by the VISPL in favour of its
Associated Enterprise did not give rise to any “income” from an International Transaction, and
therefore, there was no need to invoke Transfer Pricing provisions. This judgement clearly
segregated issue of capital as a capital account transaction.

Chander Sawhney
Chartered Accountant & Registered Valuer (IBBI)
FCA, FCS, B.Com (H)
M: +91 9810557353
E: chandersawhney@gmail.com

Demystifying Regulatory Rules of Business Valuation

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