In today’s dynamic business environment, the need for accurate and transparent valuation is paramount. A valuation report is a document prepared by a qualified professional, often referred to as a registered valuer, that provides an estimate of the fair market value of a specific asset. This asset can be a property, a business, or a financial instrument. Whether for mergers and acquisitions, fundraising, or compliance with regulatory requirements, a robust valuation report plays a crucial role. The principles and rules for valuing companies lie at the intersection of law and accounting.
The Company Law aims to protect existing shareholders by preventing companies from issuing securities at prices below their fair market value[1]. The Securities and Exchange Board of India (“SEBI”) works to ensure that investors, particularly retail investors, are not offered securities at prices exceeding their fair market value. Additionally, income tax authorities are focused on ensuring fair valuation of securities in transactions to combat tax evasion.
This blog aims to delve into the nuances of valuation reports produced by registered valuers and merchant bankers, helping you understand which is suitable for your specific needs under the existing regulatory framework.
Valuation by a Registered Valuer:
The Companies Act, 2013 (“Act”), establishes a comprehensive legal framework for corporate governance and compliance in India. Valuation under the Companies Act, 2013 is conducted by a registered valuer. A registered valuer refers to a person registered with the Insolvency and Bankruptcy Board of India (IBBI) in accordance with the Companies (Registered Valuers and Valuation) Rules, 2017 (the Rules). Valuation by a registered valuer is particularly relevant in several contexts under this Act, as enumerated below:
- Securities Issued for Consideration Other Than Cash:
According to Rule 12(5) of the Companies (Prospectus and Allotment of Securities) Rules, 2014, in case of allotment of securities other than bonus shares for consideration other than cash, a report of a registered valuer in respect of valuation of the consideration shall be attached to Form PAS -3 along with a copy of the contract, duly stamped, pursuant to which the securities have been allotted together with any contract of sale if relating to a property or an asset, or a contract for services or other consideration.
- Preferential Issue of Shares:
For the preferential issue of shares[2] under Section 62(1)(c) of the Companies Act read with Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014, the price of the shares or other securities to be issued for cash or consideration other than cash, shall be determined on the basis of valuation report of a registered valuer. It is however pertinent to note that the explanation to Rule 13 specifies that until a registered valuer is appointed in accordance with the provisions of the Act, the valuation report shall be provided by an independent merchant banker registered with SEBI or an independent Chartered Accountant in practice having a minimum experience of ten years.
Further, Rule 13(3) provides that the price of shares or other securities to be issued on preferential basis shall not be less than the price determined on the basis of valuation report of a registered valuer. This provision highlights the significance of a valuation report in the process of issuance of shares.
- Issue of Sweat Equity Shares
To issue sweat equity shares[3] to directors or employees at a discount or for non-cash consideration, as stipulated in Section 52 of the Companies Act and Rule 8 of the Share Capital and Debentures Rules, a valuation report is necessary for the intellectual property rights, know-how, or value additions related to the issuance of those shares. Further, Rule 8(6) specifies that the sweat equity shares to be issued shall be valued at a price determined by a registered valuer as the fair price giving justification for such valuation.
- Corporate Restructuring
Under Section 230 of the Companies Act, 2013, a valuation report is required for corporate debt restructuring when a registered valuer assesses the value of a company’s assets and shares. According to section 230(2)(c), in case of a scheme of corporate debt restructuring consented to by not less than seventy-five per cent. of the secured creditors in value, a valuation report in respect of the shares and the property and all assets, tangible and intangible, movable and immovable, of the company valued by a registered valuer shall be provided to the Tribunal. Further, according to section 230(3), a copy of the valuation report is required to be sent to the creditors or class of creditors or members of the company along with the notice of the meeting to be convened for approval of the restructuring pursuant to an order passed by the Tribunal.
- Purchase of Minority Shareholding
As per section 236(1), shareholders becoming holders of ninety percent or more of the issued capital of the company on account of an amalgamation, share exchange, conversion of securities or for any other reason, can purchase the remaining shares of the company from the minority shareholders. For this purpose, the price to be offered to the minority shareholders for the purchase of their shares (“offer price”) shall be determined on the basis of a valuation by a registered valuer. According to Rule 27 of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, the offer price shall be determined in the following manner:
- In case of listed companies – In the manner as may be prescribed by SEBI.
- In case of unlisted companies – The offer price shall be determined by taking into account the i) the highest price paid by the acquirer, person or group of persons for acquisition during last twelve months; or ii) the fair price of shares of the company is to be determined after taking into account valuation parameters including return on net worth, book value of shares, earning per share, price earning multiple vis-à-vis the industry average, and such other parameters as are customary for valuation of shares of such companies.
It is important to note that in the case of both listed and unlisted companies, the registered valuer is required to provide a valuation report addressed to the board of directors of the company giving adequate justification for the valuation undertaken.
- Winding up of a Company:
According to section 281, the company liquidator is required to submit a report to the Tribunal within 60 days of passing an order for winding up of a company. The report is required to include the nature and details of the assets of the company including their location and value, stating separately the cash balance in hand and in the bank, if any, and the negotiable securities, if any, held by the company for which the valuation shall be obtained from a registered valuer.
Valuation by a Merchant Banker:
According to SEBI (Merchant Bankers) Regulations, 1992, a merchant banker refers to any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management. A merchant banker can issue a valuation report under the Income Tax Act, 1961 and FEMA Regulations.
Under the Income Tax Act ,1961, a merchant banker’s valuation report is required only when a company issues new shares, transfers existing shares, secondary transactions of unquoted shares etc. at a premium. For example, when a company intends to issue 1,00,000 shares having face value of Rs. 10 per share for Rs. 12 per share through preferential issue, this warrants obtaining of a valuation report under the Companies Act, 2013 from a registered valuer and under the Income Tax Act, 1961 from a merchant banker. Additionally, if the valuation is undertaken using the Discounted Cash Flow (DCF) method[4], then the report must be issued only by a merchant banker.
The rules and details of valuation are prescribed in Rule 11UA of the Income Tax Rules which specifies that the valuation is required to be obtained from SEBI registered Category I merchant bankers who are eligible to act as issue managers, advisors, consultants, underwriters and portfolio managers.
For ease of understanding, the following table summarizes the requirement of obtaining a valuation report from a registered valuer and/or a merchant banker depending on the type of issue:
| Type of Issue | Valuation report from Registered Valuer under the Companies Act 2013 | Valuation report from Merchant Banker |
| Issue of equity/preference shares through private placement | Yes, according to the Companies Act, 2013 it is necessary. | Yes, according to the Income Tax Act, 1961 this is necessary. |
| Preferential issue of shares | Required. | Required under Income Tax Act, 1961 if issued at a premium. |
| Raising of funds by issuing equity shares through a rights issue | Not required. | Yes, it is required. If valuation is undertaken using Net Asset Value (NAV) method[5], then valuation report is not required. |
| Raising of funds through CCD, i.e. convertible debentures | Required if the minimum price of conversion (conversion ratio) is predetermined at the time of issue. | Required at the time of conversion of the CCDs to shares. |
| Issue of CCPS, i.e., compulsorily convertible preference shares | Required. | Required at the time of conversion of the CCPS to shares. |
| Issue of Convertible Notes[6] | Required only when the notes are converted to shares. | Required only when the notes are converted to shares. |
Further, under FEMA (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, the transfer of securities between persons resident outside India and a person residing in India shall be done at an arm’s length price which should be valued by a SEBI registered merchant banker or a chartered accountant as per any internationally accepted pricing methodology.
In conclusion, choosing between a registered valuer and a merchant banker depends on type of issue and the regulatory framework. For companies in India, aligning valuation practices with regulatory requirements is not just a matter of compliance but a strategic necessity. Engaging appropriate qualified professionals and adhering to best practices as per the legal framework can significantly enhance the credibility of valuation reports, ultimately contributing to informed decision-making and successful business outcomes.
[1] Fair Market Value refers to the current value of one share of a company also considered as the price at which the share can be sold in the open market.
[2] Preferential Issue refers to the issue of shares or convertible securities to a select group of persons which is neither a rights issue nor a public issue.
[3] Sweat Equity Shares refers to equity shares as are issued by a company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions.
[4] Discounted Cash Flow Method is a valuation technique that uses expected future cash flows, in conjunction with a discount rate, to estimate the present fair value of an investment.
[5] The NAV method refers to calculation of the value of a business by subtracting its total liabilities from its total assets.
[6] A convertible note refers to a short-term debt instrument (security) that can be converted into equity.
