Valuation Requirements under Various Acts by Registered Valuer

Foreign Direct Investment (FDI) and Overseas Direct Investment (ODI) plays a significant roles in shaping the economic landscape of countries, particularly in a globalized world. In India, these investments are subject to stringent regulations and guidelines set forth by the Reserve Bank of India (RBI) and the Foreign Exchange Management Act (FEMA) 1999, article aims to provide a detailed understanding of the FDI Process, valuation services, and key aspects surrounding FDI and ODI transactions in India while Startup Funding process.

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 ODI etc. and the need for Valuation Reports under FEMA or companies Act 2013 or as per Income Tax.

Now through this article trying to delves into the areas where startups and newly registered companies often fall short in FEMA compliance, Company Law Compliances and valuation Requirements, and proposes strategies to address these shortcomings. Business or Company valuation plays a significant role in various aspects of corporate operations in India, ranging from fundraising and mergers & acquisitions to regulatory compliance and tax implications, While valuing listed companies with actively traded shares is relatively straightforward due to the availability of market prices, assessing the worth of unlisted companies poses significant challenges.

In India, regulations dictate who is eligible to perform valuations. As of February 1, 2019, only IBBI "Registered Valuers" are authorized to conduct valuations under the Companies Act, 2013. Similarly, valuers must be registered under section 247 of the Companies Act, 2013, to comply with the Insolvency and Bankruptcy Code and SEBI regulations. For tax purposes, only SEBI Registered Merchant Bankers are allowed to value unquoted equity shares using the Discounted Free Cash Flow Method under the Income Tax Act, 1961.

In many cases, a dual valuation by both an IBBI Registered Valuer and a SEBI Registered Merchant Banker may be necessary to meet the regulatory requirements of the Companies Act and the Income Tax Act, while the Companies Act focuses on minimum valuation requirements, the Income Tax Act emphasizes maximum valuation considerations.

Why FEMA regulations ?

In case of Foreign Direct investment or Overseas Investment comes Under the RBI Guidelines or FEMA regulations, FDI and ODI transactions are closely monitored to ensure transparency, fairness, and compliance with international standards, regulations cited that all FDI and ODI transactions must be conducted at fair prices, with FDI price serving as the minimum price and ODI price as the maximum price from an exchange control perspective.

What is FDI or ODI ?

Foreign Direct Investment (FDI) refers to direct investment equity flows into the reporting economy, encompassing equity capital, reinvestment of earnings, and other capital through India Entry Services, driving economic growth and development in India, serving as a major non-debt financial resource.

Overseas Direct Investment (ODI) involves investments made outside India in Joint Ventures (JV) or setting up Wholly Owned Subsidiaries (WOS), either under the Automatic Route or Approval Route. ODI contributes to the penetration of Indian capital overseas, diversification benefits, and industrial development.

Valuation Requirements:

Valuation is a key aspect of FDI and ODI transactions to ensure fair pricing and compliance with regulatory like RBI/SEBI/MCA etc. Valuations must be conducted by authorized professionals like Registered Valuer, Merchant Banker and some times by Chartered Accountant having 10 years of experiences in Practice and adhere to internationally accepted pricing methodologies like Discounted Cash Flow Analysis (DCF); Comparable transactions method; Comparable Market Multiples method; Market Valuation; Economic Value Added Approach; Free Cash Flow to Equity; Dividend Discount Model; Net Asset Valuation; Relative Valuation etc.

Trying to provides insights into the valuation requirements under different laws in India and the purposes they serve:

Several specific sections of the Companies Act, 2013, such as Section 62(1) C, 192(2), 230(2)(c)(v), 230(3), 232(2d), 232(3)(h), 236(2), and 281(1), likely pertain to the application or implications of valuation rules and standards in various corporate transactions or legal procedures governed by the Act, sections likely define the role and importance of valuation in processes such as capital restructuring, mergers and acquisitions, insolvency proceedings, and compliance requirements like-

1. Section 62(1)C: Valuation report is required for further issue of shares. This ensures that the valuation of shares issued by the company is conducted by a registered valuer.
2. Section 192(2): Valuation of assets involved in arrangements of noncash transactions involving directors. This ensures transparency and fairness in transactions involving assets and directors.
3. Section 230(2)(c)(v): Valuation of shares, property, and assets of the company under a scheme of corporate debt restructuring. This ensures that the valuation process is conducted impartially and accurately during restructuring processes.
4. Section 230(3): Valuation report, along with a notice of creditors/shareholders meeting, under a scheme of compromise/arrangement. This ensures that stakeholders are informed about the valuation of assets involved in such schemes.
5. Section 232(2)(d): Valuation report by an expert circulated for a meeting of creditors/members. This ensures that stakeholders have access to a professional valuation report for decision-making purposes.
6. Section 232(3)(h): Valuation report made by the tribunal for an exit opportunity to the shareholders of the transferor company under a scheme of compromise/arrangement, particularly when the transferor company is listed and the transferee company is unlisted. This ensures fairness in valuation during corporate restructuring.
7. Section 236(2): Valuation of equity shares held by minority shareholders. This ensures fair treatment of minority shareholders by valuing their equity shares accurately.
8. Section 281(1): Valuing assets for submission of a report by the liquidator. This ensures that the assets of the company are accurately valued for distribution purposes during liquidation.

Fresh Issues of Share Capital :

1. Reserve Bank of India (FDI): Valuation is mandated by the RBI for Foreign Direct Investment (FDI) transactions involving the issuance of shares to non-residents, ensures that the price at which shares are issued complies with FDI regulations but in case of subscription to MOA, no any Valuation shall be required which is normally issued at Face Value at the the time of Registration of the Company.

2. Reserve Bank of India (ODI): Similarly, for Overseas Direct Investment (ODI) transactions, the RBI requires valuation Report to determine the price of shares or capital instruments being transferred or issued outside India.

3. Income Tax Law: Valuation Report under income tax laws is necessary to determine the fair market value of shares issued for tax purposes, such as calculating capital gains tax or assessing tax liability.

4. Companies Act 2013: The Companies Act mandates valuation for fresh issues of share capital under section 42 to ensure compliance with capital maintenance requirements and to protect the interests of shareholders by Registered Valuer only as per 247 of the companies Act 2013.

5. SEBI Law: Valuation may also be required under SEBI regulations, especially for companies planning to list on stock exchanges, where adherence to pricing norms and disclosure requirements is essential.

Transfer of Shares:

1. Reserve Bank of India (FDI and ODI): Similar to fresh issues, valuation is required for the transfer of shares in FDI and ODI transactions to determine the fair price of the shares being transferred and mandatory to file with FCTRS Applications.

2. Income Tax Law: Valuation of shares is mandatory for tax purposes, particularly in cases of transfer of shares between parties, to ascertain capital gains or losses and fulfill tax obligations.

Merger or Acquisitions / Scheme of Arrangement:

Mergers and acquisitions have become ubiquitous in the business world, spanning across various sectors, complex process heavily relies on valuation. Valuing the target company involves several important processes, and the chosen valuation approach depends on factors such as the scale of operations and the nature of the business.

1. Company Law: Valuation plays a pivotal role in business combinations, mergers, and schemes of arrangement under section Companies Act 2013, to ensures fairness and transparency in determining the exchange ratio of shares and the consideration to be provided to shareholders.

2. SEBI Laws: SEBI regulations may also govern valuation aspects of business combinations, especially in the context of listed companies, where compliance with takeover regulations and disclosure norms is imperative.

3. Financial Reporting: Valuation is essential for financial reporting purposes, providing stakeholders with an accurate assessment of the value of assets, liabilities, and equity interests involved in the business combination.

For Example:-

In February 2000, the Tata Group, an Indian conglomerate, purchased The Tetley Group, the world's second-largest producer and distributor of tea, for British ￡271 million.

In 2004, Tata Motors acquired Daewoo's truck manufacturing unit in South Korea.

In 2005, Tata Motors acquired a 21% stake in Aragonese Hispano Carrocera, giving it controlling rights over the company.

In January 2007, Tata Steel purchased a 100% stake in the Corus Group at 608 pence per share in an all-cash deal, valued at US $12.04 billion. This acquisition made Tata Steel the world's fifth-largest steel group.

In June 2008, Tata Motors acquired British Jaguar Land Rover (JLR), including the Daimler and Lanchester brand names, from Ford for US $2.3 billion.

In April 2011, Tata Chemicals acquired a 25.1% stake in an ammonia-urea fertilizer complex in Gabon for US $290 million. The company was also considering investing an additional US $170 million in the second phase of expansion of the fertilizer complex.

ESOP/Sweat Equity:

1. Income Tax Law: Valuation Report is required for Employee Stock Option Plans (ESOPs) and Sweat Equity schemes at the time of exercising the option to determine the fair value of shares allotted to employees for taxation purposes.

2. Companies Act 2013: necessary for issuing ESOPs and Sweat Equity, ensuring that the valuation methodology adopted is fair and transparent under Companies Act 2013

3. Financial Reporting: Valuation of ESOPs and Sweat Equity impacts financial statements, requiring accurate disclosure of the value of equity instruments issued to employees.

Validity of Valuation Report: For FDI purposes, valuation is required for issuing equity or convertible instruments to non-residents or transferring such instruments between residents and non-residents. Valuations are valid for 90 days from the date of valuation.

Hence, valuation requirements under different laws in India serve diverse purposes, ranging from regulatory compliance to taxation and financial reporting. Understanding and adhering to these valuation requirements are essential for businesses to navigate legal complexities, ensure compliance, and maintain transparency in their transactions.

Who Can Perform Valuation ?

For FDI valuations, Registered Valuer under IBBI, SEBI registered Merchant Bankers or Chartered Accountants (CAs) are authorized to conduct valuation Services, depending on the scenario. For ODI valuations, the Authorized Dealer (AD) bank may recommend Merchant Bankers, Registered Valuers, or other professionals to calculate arm's length pricing.

The Ministry of Corporate Affairs (MCA) introduced Section 247 into the Companies Act, 2013, through a notification dated October 18, 2017, section did not exist in the previous legislation, the Companies Act, 1956. Alongside the introduction of Section 247, the MCA also enacted "The Companies (Registered Valuers and Valuation) Rules, 2017" on the same date, established by the MCA consist of six chapters, which cover various aspects related to valuation, including eligibility criteria, qualifications, registration of valuers, recognition of valuation professional organizations, procedures for cancellation or suspension of registration or recognition, valuation standards, penal provisions, etc.

Furthermore, the Insolvency and Bankruptcy Board of India (IBBI) was designated as the authority responsible for overseeing the implementation and enforcement of these Rules, authority's responsibilities include ensuring compliance with the rules and regulations outlined in the Companies Act, 2013, and its associated regulations concerning valuation.

Assumptions & Valuation Methodologies:

Valuations for listed companies are guided by SEBI guidelines, while for unlisted companies, fair value must be determined using internationally accepted pricing methodologies such as the Discounted Cash Flow (DCF) method, Net Assets Value Method etc.

Assumptions and limiting conditions play a key role in the valuation services for the company :-

1. Business Plan Assumptions: Valuation of a company heavily relies on its business plan, which is based on various assumptions regarding expected growth, market conditions, industry trends, etc, Registered valuer must critically evaluate and validate these assumptions to ensure the accuracy and reliability of the valuation.

2. Financial Forecasts: The management prepares financial forecasts, including projections of revenues, profits, capital expenditure, and working capital, Registered valuer needs to scrutinize these forecasts to assess their reasonableness and consistency with prevailing economic and industry trends.

3. Validation of Assumptions: It is the responsibility of the valuer to validate the assumptions made by the management in its business plan, involves assessing the reliability of data inputs, methodologies used, and the soundness of underlying assumptions.

4. Choice of Valuation Methodology: The valuer must decide on the most appropriate valuation methodology based on the specific circumstances of the company and the transaction, decision involves making assumptions regarding factors such as future cash flows, growth rates, and risk factors.

5. Cost of Capital: Assumptions regarding the cost of capital, including discount rates and appropriate risk premiums, are essential in determining the present value of future cash flows, Registered valuer must carefully consider these assumptions to ensure the accuracy of the valuation.

6. Value Adjustments: The valuer may need to make adjustments for factors such as discounts for lack of marketability or control, premiums for synergies, or other value-enhancing factors. These adjustments require assumptions about the magnitude and applicability of such adjustments in the given context.

7. Weighting of Valuation Methodologies: In cases where multiple valuation methodologies are used, the valuer must decide on the appropriate weighting to assign to each methodology, decision involves making assumptions based on the relative reliability and relevance of each methodology in the specific circumstances of the valuation.

The valuation services requires careful consideration of various assumptions and limiting conditions to ensure the accuracy, reliability, and fairness of the valuation conclusion. Transparent disclosure of these assumptions and limitations is essential to provide stakeholders with a clear understanding of the basis of the valuation.

Pricing/Valuation Guidelines:

Pricing/Valuation guidelines are governed by FEMA, Foreign Exchange Management (Non-Debt Instruments) Regulations, 2019, and RBI notifications. These guidelines ensure that transactions involving listed and unlisted companies adhere to specific rules to maintain fairness and transparency.

DCF is widely used in practice for valuing shares or businesses because it accounts for the time value of money and provides a comprehensive assessment of a company's future earning potential.

DCF calculates the present value of expected future cash flows generated by a business. It's based on the principle that the value of an investment is determined by its ability to generate cash flows over time. The valuer estimates the future cash flows of the business, typically over a projected period, taking into account all operating expenses, taxes, and necessary investments in working capital and capital expenditure. These cash flows represent the money the business is expected to generate after meeting its operational and investment needs.

Trends of FDI:

Valuation has emerged as a focal point of political and economic discussions, particularly in the context of privatization of state-owned enterprises, Owners, Investors and entrepreneurs often inquire about the value of their businesses and compare it to others. With the evolving sophistication of business practices and the dynamic economic and social landscape, professional valuers encounter questions such as:

1. What is the value of our business?

2. What is the value of their business?

3. What is the appropriate price for that company?

4. What is the appropriate price for our company?

Given questions underscore the importance of accurate and reliable business valuations in decision-making processes, especially in scenarios involving privatization and market transactions.

According to the Department for Promotion of Industry and Internal Trade (DPIIT), FDI equity inflow in India has been substantial, indicating positive outcomes from government initiatives aimed at improving the ease of doing business and relaxing FDI norms.

Valuation of Assets in India

Valuation of Tangibles

Tangible assets are fundamental to business operations, playing a key role in the production and trading of goods and services, delves into the various aspects of tangible assets, including their cost, value, and methods of valuation. Special attention is given to important tangible assets such as Real Estate, Plant & Machinery, Vehicles, and Ships & Barges.

Valuation of Intangibles

Valuation extends beyond tangible assets to include intangible assets, which are integral to a company's success, like trademarks, Patent, certification marks, and designs significantly contribute to enhancing business sales. Brands, technologies, formulas, and software are essential components of a company's success, emphasizes the importance of intangible assets and covers a wide range of them to provide a comprehensive understanding of their valuation.

You know Some common hindrances facing business valuation professionals ?

• Developing realistic assumptions for projections and documenting them.
• Tracking and reviewing necessary documents.
• Analyzing tax returns and financial statements.
• Finding reliable industry data for private companies.
• Collecting suitable market comparables and documenting their selection.
• Calculating an appropriate discount rate and justifying the methodology.
• Creating a comprehensive valuation report.
• Ensuring compliance with professional standards and guidelines.

Cited challenges highlight the detailed and meticulous nature of business valuation work. Therefore, FDI and ODI transactions are subject to rigorous regulations with filing of FC-GPR, Filing of FLA Reporting, Filing of FC-TRS, Filing of ODI etc. and guidelines in India before making any FDI or ODI, aimed at fostering transparency, fairness, and compliance with international standards.

If you're running a Subsidiary company or company with foreign investment, in India, ensuring compliance is mandatory for startup founders to avoid substantial penalties under FEMA (Foreign Exchange Management Act), the Companies Act, or Income Tax Rules. Understanding regulatory compliances, formulating a compliance strategy, allocating resources, monitoring compliance, and staying abreast of regulatory updates are crucial steps. Particularly, when engaging in Foreign Direct Investment (FDI) and issuing share capital at prices exceeding the face value, adherence to a Compliance Calendar Valuation Services is imperative, approach ensures compliance and necessitates the acquisition of a comprehensive Valuation Report, thus facilitating smooth operations within the regulatory framework.