What is a Valuation? How are Share Valuation / Business Valuation carried out?

Varun Hariharan

14 Mar, 2023

Valuation is when the company shares/ debentures are measured on the basis of the fair and actual value received from them. Under the Foreign Exchange Management Act, 1999 (FEMA) valuation can be done by a SEBI registered merchant banker or a chartered accountant. The international method of valuation is called the Discounted Cash Flow Model (DCF). Through the process of share valuation/business valuation, a person who is resident outside India who has acquired a capital instrument of an Indian company or a person resident in India transfers the instrument or vice versa. The valuation is done according to the prescribed guidelines of pricing.

Valuation is the process of accessing the actual/ fair market price of the shares/ debentures or the capital instrument. Valuation is carried out as the prices of shares/ debentures keep fluctuating. Therefore to access the value of the instrument, valuation is carried out. This is required to find out the price of the instrument when it is transferred. Valuation of the instrument is carried out for the following:

• To understand how the valuation price is calculated.
• Procedure-related to the valuation of an instrument.
• To understand the international accepted method of valuation.
• To comply with the laws related to Foreign Exchange. 

The requirement of Business Valuation/ Share Valuation 

Business valuation/ Share Valuation is required when a capital instrument is transferred. The transfer of capital instrument is regulated by the laws related to FEMA. The FEMA (Transfer or Issue of Security by a person resident outside India) regulations 2017 govern the law related to valuation. The transfer by way of sale shall be done through the principle that is adopted as arm’s length price. This would be accepted according to an international methodology.

Who Regulates Business Valuation / Share Valuation under FEMA

The following authority and laws regulate the valuation process:

• Reserve Bank of India
• Foreign Exchange Management Act, 1999
• Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (FEMA 20)
• Companies Act 2013

Eligibility criteria for Business Valuation/ Share Valuation

• There has to be an accepted instrument regarding valuation.
• The instrument must be a capital instrument which is defined as a capital instrument such as a share or a debenture.
• The method of valuation must be according to a process and procedure which is acceptable according to international standards of valuation.
• Use of the Discounted Cash Flow Methodology for Valuation.
• The Transfer price of the instrument must be according to the principles of international valuation.

Process for Business Valuation / Share Valuation

• Through the process of share valuation/business valuation, a person who is resident outside India who has acquired a capital instrument of an Indian company transfers the instrument to a person resident in India or vice versa.
• Valuation of shares is done through the acclaimed method as recognized by the Reserve Bank of India.
  Indian Company can issue equity shares/ preference shares and debentures to a person resident outside India under the Foreign Direct Investment Policy, subject to compliance with the pricing guidelines.
• The price of convertible capital instruments would also be required to be determined at the time of issue of instruments
• The method that is primarily used for valuation under this is the Discounted Cash Flow Method (DCF), which is acceptable according to international standards.
• RBI through its consolidated FDI policy has considered that in case there is a Transfer or Issue of Security by a person resident outside India then the valuation method is through internationally accepted pricing methodology on arm’s length basis as per a duly registered Chartered Accountant or SEBI Registered Merchant Banker

Documents required for Business Valuation/ Share Valuation

• Consent letters signed by the transferor and the transferee.
• Share purchase agreement
• The shareholding pattern of the investee company before and after the transfer of shares must show equity participation of residents and non-residents category-wise.
• In case the transferor is an NRI (Non-Resident Indian) all the copies of RBI approvals which proves the shares held by them on repatriation/non-repatriation basis must be provided. The amount of sale shall be credited to non-resident rupee account.
• A Certificate from a Chartered Accountant (Merchant Banker only, CA only authorised under the companies act 2013 provided Valuation exam cleared) must be provided, which indicates the fair value of shares.
• Undertaking from the transferee that all the pricing guidelines have been strictly adhered to.
• No objection/ tax clearance certificate from the Income Tax Authority/ Chartered Accountant.

Under the Companies Act 2013 the following documents are required:

• The relevant Form is SH-4 which needs to be executed by transferor and transferee.
• Apart from this, the FC- TRS form is also the relevant form.

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