In this irrational world of bias, let us Value the rationalization of our Time.
~ Dinesh.

Basics of Financial Statements

Business means the state of being Busy. Similarly, business also means a person’s regular occupation, profession, or trade. People who do Business are under active need of information about the position of their business, in the same way even the Governments have established certain statutory regulations for the business & service professionals to prepare Financial Statements and submit to them at regular intervals.
Business & Service Professionals can be categorized in to Individuals (including HUF’s AOP’s, BOI’s & Partnership Firms), Body Corporates (includes Private Entities, Public Entities & LLP’s).
These Financial Statements as follows:

a)    Balance Sheet (Statement of Financial Position),
b)    Statement of Profit and Loss (Income Statement),
c)    Cash Flow Statement,
d)    Explanatory Notes to above 3 documents.

The above documents are ideally prepared for one Financial Year (of 12 months) and many times due to regulatory requirements they are even prepared at quarterly intervals.

These documents form the basis for a Valuer (covered later) to analyze and understand about the business’s background and the industry in which they operate.

The need of Valuation (covered later) can arise under many circumstances ranging from starting a business (including expansion plans) to transferring a business (including liquidation plans) to continue sustaining in the market.

When does the need to Valuation, arise?

There are two ways to fund any business, using OWN Funds (shares-based funding) or LOAN Funds (loan-based funding).
There is no single safe way to raise funds and almost at all times, the fund raising is a combination of own and loan funds depending on the Corporate Life Cycle of the business.

This Corporate Life Cycle:

The stage from start-up to high-growth is where most business raise funds through share-based funding and during the maturity stage the funds are raised entirely loan based or a combination of share and loan based depending on the end-game.

From a Corporate Finance point-of-view, the need for Valuation is quite strong to know the true worth of a business.

From a Regulatory Compliance point-of-view, it must synchronize with the nature of transaction which the business is perceiving to enter.

Approaches to Valuation

There are many ways in which Valuation can be performed, most common and widely used are the following 3 approaches:

a)    Market Approach is adopted when there is an active market having recent & orderly transactions where the information is available and reliable to use
i.    Market Price,
ii.   Comparable Companies Multiple &
iii.  Comparable Transaction Multiple

b)    Income Approach is a widely adopted approach when the valuer is basing their outcome on income or cash flows
i.    Business Assets (Discounted Cash Flow) &
ii.   Valuation of Intangibles
A.  Relief from Royalty,
B.  Multi-Period Excess Earnings &
C.  With & Without

c)   Cost Approach is adopted when the businesses have heavily invested in Assets or they are facing headwinds or they are carrying distressed assets (not income generating assets)
i.    Replacement Cost &
ii.    Reproduction Cost
One or combination of the 3 approach has to be shortlisted by the Valuer,

Valuation in Indian Landscape for Unquoted Shares

Let us take an instance, where a Body Corporate in the form of a Private Company operating as ABC Private Limited in India which is in early growth stage, intending to raise funds by way of fresh issuance of equity shares to an interested investor who is investing from United Kingdom.

As this will be a scenario of fresh issue of shares by the Company, the issuer Company requires valuation to price their shares and the Investor requires valuation to make a sound financial decision.
There are 3 statues under which different categories of Valuers need to Value the Company for the same purpose, these statues are as follows:

a)    Companies Act, 2013
b)    Income-tax Act, 1961
c)    Foreign Exchange Management Act, 1999

Companies Act, 2013 (Section 247)

$ A Registered Valuer who is registered with Insolvency and Bankruptcy Board of India (IBBI), who can even be a CA, CS, CMA, MBA (Finance), PGDBM (Finance) or PG (Finance).
# Securities or Financial Assets covers raising funds by fresh issuance of equity shares.
@ At the time of allotment, i.e., filing of PAS-3.

Conclusion: Under the Companies Act, only a Registered Valuer, who is registered with IBBI can take-up the Valuation of ABC Private Limited for fresh issuance of equity shares.

Income-tax Act, 1961 (Explanation to Section 56 and Rule 11UA)

$ An Accountant means a Chartered Accountant as defined in Explanation to Section 288.
# A Merchant Banker means Category-I SEBI Registered Professional.
@ Unquoted Equity Shares mean which is not quoted on any Recognized Stock Exchange with regularity from time to time.
^ Assessee for internal documentation purpose and to be produced before Assessing Officer when called.

Conclusion: Under the Income-tax Act, a Merchant Banker (Discounted Cash Flow [DCF]) who is registered as a Category-I Merchant Banker with Securities and Exchange Board of India and Chartered Accountant (other than DCF) are eligible Professionals who can take-up the Valuation of ABC Private Limited for fresh issuance of equity shares.

Foreign Exchange Management Act, 1999 (Regulation 11 and Regulation 13)

$ As detailed under the Pricing Guidelines in Regulation 11 of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (“TISPRO Regulations”).
# The Valuation Report must be appended while updating Form FC-GPR in the Entity Master as per Reporting Requirements listed in Regulation 13 of TISPRO Regulations.

Conclusion: Under the Foreign Exchange Management Act, since the business will be attracting Foreign Direct Investment (FDI) the prescribed restrictions of RBI shall also have to be confirmed by the relevant professional and accordingly the Valuation Report is to be finalized.

Overall Conclusion

ABC Private Limited shall be sensitized with the statutory importance and requirements of the Valuation Report from the relevant Valuer before the fund raising activity, as the 3 regulators are presently not aligned with each other and prescribe different requirements for the transaction to conclude.

Hence, ABC Private Limited may end up approaching 3 different Valuers or at-least 2 Valuers once they have any intention to raise funds, as they have no other choice other than complying with the provisions of the relevant statutes.

Also, they will have to comply with relevant form filing under Companies Act, 2013 and the Foreign Exchange Management Act, 1999.