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Regulatory Aspects of Valuation Introduction & Principles Adopted

Understanding Corporate valuation is not only a pre-requisite during different types of restructuring phase of the company. It is required at frequent intervals to identify economic value creation & any destruction if any occurred. It is also important to note that the value is different from a price.

The process of valuation consists of the detailed & comprehensive analysis taking into account the past, present & future earnings prospects & analysis of physical plus intangible assets & general economic & the industry conditions.

Determining the realistic value of the firm is indeed a difficult process. Sometimes the market price of the share of the company may be the approximate indication of a firm. Market price again depends on the current earnings & future growth. The market price of shares might not be feasible for the unlisted company for which the asset-based approach to Valuation Consulting might be the feasible option.

The Ministry of Corporate Affairs^[1] (the then Department of Company Affairs) have constituted an Expert Group under Chairmanship of Mr. Shardul S. Shroff to suggest the guidelines on the valuation of shares with regard to amalgamation, merger, de-merger, acquisition, & buy-back, etc.,

The Expert Group is of the view that there are 2 circumstances under which prescribed valuation guidelines may apply to all the companies. They are as follows:

• Circumstances under which the valuation from a Registered Valuer(s) is compulsory &
• Circumstances under which a valuation from a Registered Valuer(s) is recommended but not obligatory.

The Expert Group has adopted 2 basic principles for identifying the situations under which the obligatory valuation is vital. The circumstances include the following:

• Each and every time when a shareholder’s resolution, ordinary or the special, is requisite to authorize a transaction or where shareholders are required to take the decision on the values which may have the bearing on or help in making the decision.
• All the Related Party transactions described herein.

Read our article:Brief on business valuation methods in India

Without limiting the broad view of the above, some of the specific circumstances under which Expert Group opines that company or the Board of Directors should seek a mandatory valuation from a Registered Valuer(s) are:

• All Schemes of Compromise and Arrangement
• Sale of a business, including investment business and disposal of a controlling interest in an undertaking or a company, through disposal of shares, an undertaking or a substantial part thereof including a slump sale or itemized sale
• All equity & equity-linked investments where shareholders’ approval are required
• Purchases, Sales, combinations & restructuring entailing acquisition or the disposal of business, an undertaking or the part of the undertaking, securities, equity & preference capital, & outstanding debt & liabilities, where the Related Parties are the counterparties.

However, valuation should not be obligatory for the transactions, which aren’t material in nature. The Expert Group is of a view that it can’t straightjacket the test of materiality either on a monetary test or on the pro-rata principle without reference to a context & purpose, e.g. the transfer of a small percentage may result in the change of control & would be considered material. Materiality may be in the context of the liabilities, contingent liabilities or the value transferred rights.

While the test of materiality must, therefore, be applied in each case, proper consideration should be given to asset or liability value, turnover & profit contribution in making this determination;

• All preferential allotments made to the Related Parties & persons controlling the company
• Specified recapitalization situations – whether effected through the buyback of shares under the SEBI^[2] (Buy-back of Securities) Regulations, 1998 or the Open offers by persons in management or the promoters, or the capital reduction under Section 100 or in any other manner, which have an effect of ‘squeezing out’ minority shareholders, for improving the control of promoters or persons in management beyond 90% or more of the issued share capital.

Compulsory valuations are recommended where persons in management or the promoters become shareholders of 90% or more of the issued share capital of the company & seek to negotiate the exit of the minority shareholders, provided there is significant minority interest in such a situation. The Expert Group is of a view that under the following circumstances, the valuation opinion may not be described as the Company Registration activity requiring disclosure to the shareholders. These circumstances include:

• Capital reduction;
• Issue of shares to the public through the public offering;
• Rights issue under Companies Act;
• Disinvestment of the Central & State Public Sector Undertaking;
• Family settlements.

Read our article:Regulatory Aspects of Valuation Introduction & Principles Adopted