What is Business Valuation?
Business valuation is required at the Growth stage of the company and generally before IPO or takeover Valuation is required.
Why is Business Valuation Important?
Valuation is an exercise to assess the worth of enterprise. In merger or amalgamation or demerger or acquisition, valuation is certainly needed. It is essential to fix the value of shares to be exchanged in merger or consideration payable for an acquisition.
When is Business Valuation required?
The following are some of the usual circumstances when the valuation of shares or enterprise becomes crucial:
- When issuing shares to the public either through an initial public offer or by an offer for sale of shares of promoters or for the further issue of shares to the public.
- When promoters want to invite the strategic investors or for pricing a first issue or a further issue, whether the preferential allotment or rights issue.
- In making an investment in the joint venture by subscription or acquisition of shares or other securities convertible into shares.
- For making an ‘open offer for acquisition of shares’.
- When the company intends to introduce a ‘buy back’ or ‘delisting of shares’.
- If the scheme of merger or demerger involves the issue of shares. In the schemes involving mergers or demergers, the share valuation has resorted in order to determine consideration for the purpose of issue of shares or any other consideration to shareholders of the transferor or demerged companies.
- On the directions of Tribunal or Authority or Arbitration Tribunals directs.
- For determining the fair price for effecting the sale or transfer of shares as per (AOA) Articles of Association of a company.
- As required by the agreements between two parties.
- To determine the purchase price of a ‘block of shares’, which may or may not give the holder thereof a controlling interest in the company.
- To value the interest of dissenting shareholders under a scheme of amalgamation merger or reconstruction.
- Conversion of debt instruments into shares.
- Advancing a loan against the security of shares of the company by the Bank/Financial Institution.
- As required by provisions of law such as the Companies Act, 2013 or Foreign Exchange Management Act, 1999 or Income Tax Act, 1961 or the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 [the Takeover Code] or SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 or SEBI (Buy Back of Securities) Regulations, 1998 or Delisting Guidelines.
Business Valuation/Acquisition Motives
The reasons could be
- Either a purely financial (taxation, asset-stripping, financial restructuring comprising an attempt to augment the resources base & portfolio-investment) or
- Business-related (expansion or diversification).
- Behavioral reasons have more to do with the personal ambitions or objectives (desire to grow big) of the top management. The expansion & diversification objectives are achievable either by building the capacities on one’s own or by buying the existing capacities.
- The decision criteria in such a situation would be a present value of differential cash flows. These differential cash flows would, thus, be limit on premium which the acquirer would be willing to pay
Factors influencing Business valuation
The salient factors include:
- The stock exchange price of the shares of the two companies before the commencement of negotiations or the announcement of the bid.
- Dividends paid on the shares.
- Relative growth prospects of the two companies.
- In case of equity shares, the relative gearing of the shares of the two companies. (‘gearing’ means the ratio of the amount of issued preference share capital and debenture stock to the amount of issued ordinary share capital.)
- Net assets of the two companies.
- Voting strength in the merged (amalgamated) enterprise of the shareholders of the two companies.
- Past history of the prices of shares of the two companies. Also, the following key principles should be kept in mind:
- There is no method of valuation which is absolutely correct. Hence the combination of all or some may be adopted.
- If possible, the seller should evaluate his company before contacting potential buyers. In fact, it would be wiser for the companies to evaluate their business on regular basis to keep themselves aware of its standing in the corresponding industry.
- Go for the third party valuation if desirable to avoid the over-valuation of the company which is the common tendency on seller’s part.
- Merger and amalgamation deals can take a number of months to complete during which time valuations can fluctuate substantially. Hence provisions must be made to protect against such swings.
General Principles of Business valuation
- Value is determined at a specific point in time.
- Value is perspective. It is equivalent to the present value, or economic worth, of all future benefits anticipated to accrue from ownership.
- The market determines the required rate of return.
- Value is influenced by liquidity.
- The higher the underlying net tangible asset value base, higher the going concern value.
Preliminary Steps in Valuation
A business/corporate valuation involves analytical and logical application/analysis of historical/future tangible and intangible attributes of the business. The preliminary study to valuation involves the following aspects:
- Analysis of business history
- Profit trends
- Goodwill/Brand name in the market
- Identifying economic factors directly affecting business
- Study of exchange risk involved
- Study of employee morale
- Study of market capitalization aspects
- Identification of hidden liabilities through analysis of material contracts.
Strategies Requiring Valuation – Examples
- Determining the consideration of Acquisition
- Determining the swap ratio for Merger/Demerger
- Sale/Purchase of Intangible assets including brands, patents, copyrights, trademarks, rights
- Determining the Fair value of shares for issuing ESOP
- Disinvestment of PSU stocks by the Government
- Liquidation /insolvency of company