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FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

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Page 1: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Due Diligence, Legal andRegulatory Valuation aspects

“In the business world, the rearview mirror is

always clearer than the windshield”

Warren Buffett

FEMA – Valuation aspect (FDI & ODI)

and

Registered Valuer under Companies Act – 2013

To know how we can assist you with our Valuation services, please contact

Mr. Chander Sawhney

Vice President

M: +91 9810557353

E: [email protected]

Mr. Maneesh Srivastava

Senior Manager

M: +91 9871026040

E: [email protected]

Page 2: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Particulars Pg. No.

What and Why 3

How 10

When and Who 22

FEMA Valuation Guidelines 25

Registered Valuer 40

Tricky Issues 46

EOK Study Circle - ICAI22/11/2013

Page 3: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

WHAT & WHY

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Page 4: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Value & Valuation

Value is*

An Economic concept;

An Estimate of likely prices to be concluded by the buyer and seller of a good or

service that is available for purchase;

Not a fact.

Valuation is the process of determining the “Economic Worth” of an Asset or

Company under certain assumptions and limiting conditions and subject to the

data available on the valuation date.

* Source -International Valuation Standard Council

EOK Study Circle - ICAI22/11/2013

Page 5: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Key Facts

PRICE IS NOT THE SAME AS VALUE

TRANSACTION CONCLUDES AT NEGOTIATED PRICES

VALUATION IS HYBRID OF ART & SCIENCE

VALUE VARIES WITH PERSON, PURPOSE AND TIME

EOK Study Circle - ICAI22/11/2013

Page 6: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

S Standard of Valuation

T Thesis of Valuation

E Economics of Valuation

M Methodologies of Valuation

EOK Study Circle - ICAI22/11/2013

Page 7: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

FAIR MARKET VALUE

INTRINSIC VALUE FAIR VALUE

INVESTMENT VALUE

Standard of

Valuation

Thesis of Valuation Economics of

Valuation

Methodologies of

Valuation

Standard of Value is the hypothetical conditions under which a business is valued.

While selecting the Standard of Value following points is to be taken care of

Subject matter of Valuation;

Purpose of Valuation;

Statute;

Case Laws;

Circumstances.

Types of Standard of Value:

EOK Study Circle - ICAI22/11/2013

Page 8: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Standard of

Valuation

Thesis of Valuation Economics of

Valuation

Methodologies of

Valuation

Thesis of Value is Premise of value which relates to the assumptions upon which

the valuation is based.

Premise of Value

Going Concern – Value as an ongoing operating business enterprise.

Liquidation – Value when business is terminated . It could be „forced‟ or „orderly‟.

Value-in-use

Value-in-exchange

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Page 9: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Growing Cos.

Turnover/Profits: Increasing still Low

Proven Track Record: Limited

Valuation Methodology: Substantially on Business Model

Cost of Capital: Quite High

High Growth Cos.

Turnover/Profits : Good

Proven Track Record: Available

Valuation Methodology: Business Model with Asset Base

Cost of Capital: Reasonable

Mature Cos.

Turnover/Profits: Saturated

Proven Track Record: Widely Available

Method of Valuation: More from Existing Assets

Cost of Capital: May be High

Declining Cos.

`

Turnover/Profits: Drops

Proven Track Record: Substantial Operating History

Method of Valuation: Entirely from Existing Assets

Cost of Capital: N.A.

Turnover/Profits: Negligible

Proven Track Record: None

Valuation Methodology: Entirely on Business Model

Cost of Capital: Very High

Start Up Cos.

Turn

ove

r /

Pro

fits

Time

Valuation across business cycle follow the law of

economics

Standard of

Valuation

Thesis of Valuation Economics of

Valuation

Methodologies of

Valuation

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Page 10: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

HOW

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Page 11: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Enterprise / Business Value

En

terp

rise V

alu

e

Net Debt#

Equity#

Fixed

Assets#

Net Current

Assets#

Intangibles#

Stakeholders Assets

Va

lue

of

Bu

sin

ess

# Based on Market Values

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Page 12: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Standard of

Valuation

Thesis of Valuation Economics of

Valuation

Methodologies of

Valuation

Valuation Approaches

Income Based

Method

Asset Based

Method

Capitalization of Earning Method

(Historical)

Discounted Cash Flow Method

(Projected

Time Value)

Market Based

Method

Comparable Companies Market Multiples Method

(Listed Peers)

Comparable Transaction Multiples

Method

(Unlisted Peers)

Market Value Method (For Quoted Securities)

Book Value Method

Liquidation Value Method

Replacement Value Method

Contingent Claim Valuation

(Option Pricing)

Price of Recent Investment Method

Rule of Thumb

(Multiples: Customers, Rooms, Seats, No. of visitors

etc.) - Depends upon Industry

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Fundamental Method Relative Method

Other Method

Page 13: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

While concluding Value, all the methodologies must be considered and then weights applied

as per the facts of the case. In other words, Value conclusion should be based on the

Professional Judgement and Simple Average should best be avoided while concluding

Value.

Need of several valuation methods?

Each has strengths and weaknesses

Different methods useful in different situations

Each gives a different “take” on the value of the

company’s stock

Provides a range of valuations instead of point

estimates

Helps in Sanity Check

Page 14: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Sources of Information for Valuation

Sources of

Information

Historical financial results –

Income Statement, Balance

Sheets and Cash Flows

Data available in Public

Domain – Stock Exchange /

MCA/SEBI/Independent Report

Data on comparable

companies – SALES/EV-

EBITDA/ PAT/BV

Promoters and Management

background

Data on projects

planned/under

implementation

including future

projection

Discussion and

Representation with/by

the management of the

Company

Industry and Regulatory

trends

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Page 15: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

CASH FLOW

Investor assign value based on the cash flow they expect to receive in the

future

- Dividends / distributions

- Sale of liquidation proceeds

Value of a cash flow stream is a function of

- Timing of cash Receipt

- Risk associated with the cashflow

ASSETS

Operating Assets - Assets used in the operation of the business including working capital, Property, Plant &

Equipment & Intangible assets

- Valuing of operating assets is generally reflected in the cash flow generated by the

business

Non - Operating Assets- Assets not used in the operations including excess cash balances, and assets held for

investment purposes, such as vacant land & Securities

- Investors generally do not give much value to such assets and Structure modification

may be necessary

Key drivers of valuation

That’s why DCF is most

prominent valuation

method

Need for Restructuring

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Page 16: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

• Mergers

• IPO

• RBI

• Income Tax

• ESOP

• Companies Act

• SEBI

• Stock Exchange

Purpose Regulatory Accounting

• Purchase Price

Allocation

Dispute

Resolution

• Company Law

Board/ Courts

• Impairment /

Diminution

• Arbitration

• Mediation

• Acquisitions /

Investment

• Voluntary

Assessment

Value

Creation

• Equity Research

• Credit Rating

• Corporate

Planning

Valuation depends upon

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Page 17: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Choice of Valuation Approaches

“Value in Valuation is a question,

and

Your choice of Method is the first step

towards answer”

Applicability of a particular approach depends upon:

On whose behalf? – one buyer vs another buyer, buyer vs seller;

For what purpose? – independent strategic acquisition, group company consolidation, cross

border transaction;

When? – distress situation, industry downturn, boom etc;

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Page 18: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Choice of Valuation Approaches

• In General, Income Approach is preferred;

The dominance of profits for valuation of share was emphasised in “McCathies case” (Taxation,

69 CLR 1) where it was said that “the real value of shares in a company will depend more on the

profits which the company has been making and should be capable of making, having regard to

the nature of its business, than upon the amount which the shares would realise on liquidation”.

This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalan’s

case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.)

(122 ITR 38).

• However, Asset Approach is preferred in case of Asset heavy companies

and on liquidation;

•Market Approach is preferred in case of listed entity and to evaluate the

value of unlisted company by comparing it with its listed peers;

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Page 19: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Company Specific Factors

• Management, Promoter Group

It is the alignment of

Company’s value via-a-

vis to its external

environment

• Operating, Capital and Corporate Finance Strategies

• Competitive advantages and cost position

• Product / Service offering / differentiation / pricing power

•Scale & Diversification

•Customer / Supplier concentration

•Corporate Governance

•Future prospects / Growth potential

•Industry peer group

•Regulatory environment

EOK Study Circle - ICAI22/11/2013

Page 20: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Industry Risk Analysis

• Good vs. Difficult industry

• Porter’s 5 forces

• Industry life cycle (growth)

• Industry cyclicality (earnings quality)

• Leading indicators

• Competition (ROIC)

• Pricing dynamics; Demand vs. Supply (ROIC)

• Changing business environments

• Regulation (ROIC)

• Product characteristics (earnings quality)

• Capital intensity and cost base (ROIC)

• Event risk

Following factors are required to

be considered:

EOK Study Circle - ICAI22/11/2013

Page 21: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Rule of Thumb

A rule of thumb or benchmark indicator is used as a

reasonableness check against the values determined by the

use of other valuation approaches.

Industry Valuation Parameters

Hospital EV/Room

Engineering Mcap/Order Book

Mutual Fund Asset under management

OIL EV/ Barrel of equivalent

Print Media EV/Subscriber

Power EV/MW, EBITDA/Per Unit

Entertainment & Media EV/Per screen

Metals EBITDA/Ton, EV/Metric ton

Textiles EBITDA depend upon capacity utilization Percentage & per spindle value

Pharma Bulk Drugs New Drug Approvals , Patents

Airlines EV/Plane or EV/passenger

Shipping EV/Order Book, Mcap/Order Book

Cement EV/Per ton & EBITDA/Per ton

Banks Non performing Assets , Current Account & Saving Account per Branch

However, Exclusive use of Rule of Thumb is not recommended

EOK Study Circle - ICAI22/11/2013

Page 22: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

WHEN & WHO

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Page 23: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Valuation in Indian Regulatory

Environment

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Page 24: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Inbound Investment DFCF

Gift of Unquoted Equity

Shares (Min)NAV

Outbound Investment Valuer Discretion

Gift of Unquoted Shares

other than Equity Shares

Price it would fetch if sold in

open market

Takeover Code/ Delisting -

Infrequently Traded

Only Parameters Prescribed

– Return on Net Worth, EPS,

NAV vis-a vis Industry

Average

Takeover Code/ Delisting -

Frequently TradedBased on Market Price

Reserve Bank of India

ESOP Tax Valuer Discretion

ESOP AccountingOption – Pricing Model

Income Tax

SEBI

CA / MB

>5Mn$ - MB, otherwise CA/MB

-

MB

MB

-

CA/MB

-

Stock ExchangesPreferential Allotment to

promoters / their relatives for consideration other than

cash

Valuer Discretion

Companies Act, 1956 Sweat Equity Valuer Discretion

CA / MB

-

Transactions Prescribed Methodologies Mandate to be done by

SNAPSHOT OF REGULATORY VALUATIONS IN INDIA

Gift of Unquoted Equity

Shares from Resident

(Max)

DCF (Valuation Based on

Assets, Business &

Intangibles is also

acceptable)

FCA / MB

Preferential Allotment to Others

Based on 26 weeks / 2 weeks

Market Price -

Companies Act, 2013

any property, stock, shares, debentures, securities or

goodwill or any other assets or the net worth of the

Company or its liabilities

To be prescribed REGISTERED VALUER

Page 25: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

FEMA Valuation Guidelines

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Page 26: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

FDI

VALUATION

• Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time deals

with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside

India) Regulations, 2000.

•In terms of Schedule 1 of the Notification, an Indian company may issue equity

shares/compulsorily convertible preference shares and compulsorily convertible debentures

(equity instruments) to a person resident outside India under the FDI policy, subject to inter alia,

compliance with the pricing guidelines.

•The price/ conversion formula of convertible capital instruments should be determined upfront

at the time of issue of the instruments.

Page 27: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Particulars Valuation before April 21, 2010 Valuation after April 21, 2010

Guidelines in Force CCI Guidelines In case of FDI Transactions:

Listed Company: Market Value

as per SEBI Preferential

Allotment Guidelines

Unlisted Company: DFCF

In case of ODI Transactions:

No method has been prescribed

Methods Prescribed Net Assets Value (NAV)

Profit Earning Capacity

Value(PECV)

Market Value (in case of Listed

Company)

Discount 15% Discount has been

prescribed on account of Lack of

Marketability

No such Discount has been

prescribed

Historical / Futuristic It is based on Historical Values It is based on Future Projections

Possibility of variation

in Value Conclusion

As valuation is more Formulae

based, final values came

standardized

As valuation is more dependent

on Assumptions and choice of

factors like Growth Rate, Cost

of Capital etc, value conclusion

may vary significantly.

FEMA Guidelines to Valuation

Note: Valuation guidelines do not apply to SEBI registered venture capital

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Page 28: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

22/11/2013

Page 29: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Discounted Free Cash Flow Method (DFCF)

Approaches to FDI Valuation

RBI has prescribed DFCF as the only valuation method in case of FDI (excluding for

initial subscription); but has not provided any guidance on its technical aspects.

Though DFCF is one of the most acceptable Valuation methods used by Business

valuers worldwide; however DFCF for all FDI transactions-excluding for initial

subscription (like minority stake/start up valuation etc) may not yield Fair Value in

line with the Commercial understanding. However Law being such, suitable Logical

adjustments may be necessary on a case to case basis.

DFCF expresses the present value of the business as a function of its

future cash earnings capacity. In this method, the appraiser estimates the

cash flows of any business after all operating expenses, taxes, and necessary

investments in working capital and capital expenditure is being met. Valuing

equity using the free cash flow to stockholders requires estimating only free

cash flow to equity holders, after debt holders have been paid off.

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Page 30: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Forward Looking and focuses on cash generation

Recognizes Time value of Money

Allows operating strategy to be built into a model

Incorporates value of Tangible and Intangible assets

Only as accurate as assumptions and projections used

Works best in producing a range of likely values

It Represents the Control Value

Major Characteristics of DFCF Valuation

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Page 31: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

DFCF Valuation Process

Understand Business Model

Identify Business Cycle

Analyze Historical Financial Performance

Review Industry and Regulatory Trends

Understand Future Growth Plans (including Capex needs)

Segregate Business and Other Cash Generating Assets

Identify Surplus Assets (assets not utilized for Business say

Land/Investments)

Create Business Projections (Profitability statement and Balance Sheets)

Discount Business Projections to Present (Explicit Period and Perpetuity)

Add Value of Surplus Assets and Subtract Value of Contingent Liabilities

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Page 32: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Free Cash Flows- Value Trend

Terminal Value is calculated for the Perpetuity period based on the

Adjusted last year cash flows of the Projected period.

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Page 33: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Free cash flows to firm (FCFF) is calculated as

EBITDA

Taxes

Change in Non Cash Working capital

Capital Expenditure

Free Cash

Flow to

Firm

Note that an alternate to above is following (FCFE) method in which the

value of Equity is directly valued in lieu of the value of Firm. Under this

approach, the Interest and Finance charges is also deducted to arrive at the

Free Cash Flows. Adjustment is also made for Debt (Inflows and Outflows)

over the definite period of Cash Flows and also in Perpetuity workings.

Theoretically, the value conclusion should remain same irrespective of the

method followed (FCFF or FCFE), (Provided, assumptions are consistent).

FREE CASH FLOWS

Free Cash Flow calculation

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Page 34: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL

Where:D = Debt part of capital structure

E = Equity part of capital structure

Kd = Cost of Debt (Post tax)

Ke = Cost of Equity

(Kd x D) + (Ke x E)

(D + E)

In case of following FCFE, Discount Rate is Ke and Not WACC

WACC

Cost of Capital calculation

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Page 35: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

DISCOUNT RATE - COST OF EQUITY

Where:Rf = Risk free rate of return (Generally taken as 10-year Government Bond

Yield)

B = Beta Value (Sensitivity of the stock returns to market returns)

Ke = Cost of Equity

Rm= Market Rate of Return (Generally taken as Long Term average return

of

Stock Market)

SCRP = Small Company Risk Premium

CSRP= Company specific Risk premium

Mod. CAPM Model

ke = Rf + B ( Rm-Rf) + SCRP + CSRP

The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing

Model (Mod. CAPM)

Cost of Equity calculation

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Page 36: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

PERPETUITY FORMULA

– Usually comprises a Large part of Total Value and is sensitive to small changes

– Capitalizes FCF after definite forecast period as a growing perpetuity;

– Estimate Terminal Value using Terminal Value Multiplier applied on last year cash flows

– Gordon Formula is often used to derive the Terminal Cash

Flows by applying the last year cash flows as a multiple of

the growth rate and discounting factor

– Estimated Terminal Value is then discounted to present day at company‟s cost of capital based on the discounting factor of last year projected cash flows

(1 + g)

(WACC – g)

IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation

Multiples to the Terminal Year Financials and also doing Scenario Analysis.

Terminal value calculation

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Page 37: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Pre Money or Post Money: If the effect of the money coming in Company is

taken in Projections, the Expanded capital base should be considered or else the

Equity Value should be reduced by the inflow amount to reconcile with the existing

capital base.

Terminal growth rate: Since it is tough to estimate the perpetual growth rate of a

company, it is preferred to take the perpetuity growth rate factoring in long term

estimated GDP of the Country and Historical/Projection Inflation of the Country.

Projection Validation via-a-vis Industry: Need to have Sanity check of the

projections with the trend of the industry.

Beta of Unlisted Company: It is calculated on relative basis by adjusting the

average beta of its comparable companies for differences in Capital Structure of the

unlisted company with the listed peers.

Risk Free Rate: Yield of a Zero Coupon Bond or Long Term government Bond yield

should be taken as the risk free rate since it does not have any reinvestment risk .

Tricky issues in DFCF

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Page 38: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Adjustment of Company Specific Risk Premium or Small Company Risk

Premium: Small Companies are generally more risky than big companies. CAPM

model does not take into consideration the size risk and specific company risk as

Beta measures only systematic risk and Market Risk Premium (generally

pertaining to Sensex Companies). These risks should also be taken into account

while computing the cost of equity.

Length of Projections: The Projected Cash Flows should factor in the entire

Business Cycle of a Company.

Notional/Actual Tax: Actual Tax Liability may be worked out and replaced for the

Notional Tax Liability

Investments: Investments should be valued separately based on their

Independent Cash Flows

Surplus Assets: The Value of Surplus Assets (not being utilized for Business

purposes) should be added separately and their cash flows should be ignored

while computing the Free Cash Flows.

Tricky issues in DFCF (Cont.)

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Page 39: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

22/11/2013

Page 40: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Registered ValuerCompanies Act, 2013

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Page 41: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Registered Valuers

Registered Valuers

Financial Valuer Technical Valuer

• A Chartered Accountant,

Company Secretary or Cost

Accountant in whole time

practice or retired member

of Indian Corporate law

Service or any other person

as prescribed.

• A Merchant Banker

registered with SEBI and

which has in employment

under it CA/CS/CWA for

carrying out (signing)

Valuation by such qualified

persons.

• Member of the Institute

of Engineers or Member

of the Institute of

Architects in whole time

practice.

• A person or firm or LLP or

Merchant Banker

possessing both

qualifications may act in

dual capacity.

Shall have 5 Years

of Continuous

Experience, Post

Qualification

Shall have 5

Years of

Continues

Experience,

Post

Qualification

Stock, Shares,

Debentures,

Securities,

Goodwill

Property

Persons eligible to apply for being Registered as Valuer

RegisteredValuer to beappointed byAudit Committeeor in its absenceby the Board ofDirectors.22/11/2013

Page 42: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Registered Valuers

Registered Valuer

Further Issue of Shares

Compromise and

Arrangements

Winding up / Liquidation

Non Cash Transactions

with Directors

Exit to Minority

Shareholders

Corporate Debt

Restructuring

Registered Valuers

(Financial

Valuation)Value

Responsibilities

• Valuer to make impartial, true and fair

valuation

• Not undertake valuation if directly or

indirectly interested

• Exercise due diligence

• Valuation to be done as per rules

Upon contravention

• Fine – 25,000 to 100,000

With intention to defraud

• Imprisonment upto 1 year and

• Fine- 1,00,000 to 5,00,000

Additionally upon contravention, to

refund remuneration received and also

liable for damages.

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Page 43: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Section wise Requirement of Registered Valuers

Section 62(1)(c) – For Valuing further Issue of Shares

Section 192(2) – For Valuing Assets involved in Arrangement of Non Cash transactions involving Directors

Section 230(2)(c)(v) – For Valuing Shares, Property and Assets of the company under a Scheme of

Corporate Debt Restructuring

Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio under a Scheme of

Compromise/Arrangement, a copy of Valuation Report by Expert, if any shall be accompanied

Section 232(3)(h) - Where under a Scheme of Compromise/Arrangement the transferor company is a listed

company and the transferee company is an unlisted company, for exit opportunity to the shareholders of

transferor company, valuation may be required to be made by the Tribunal

Section 236(2) – For Valuing Equity Shares held by Minority Shareholders

Section 260(2)(c) – For preparing Valuation report in respect of Shares and Assets to arrive at the Reserve

Price or Lease rent or Share Exchange Ratio for Company Administrator

Section 281(1)(a) – For Valuing Assets for submission of report by Company Liquidator

Section 305(2)(d) – For report on the Assets of the company for preparation of declaration of solvency

under voluntary winding up

Section 319(3)(b) – For Valuing the interest of any dissenting member of the transferor company who did

not vote in favour of the special resolution, as may be required by the Company Liquidator

Section 325(1)(b) – For valuation of annuities and future and contingent liabilities in winding up of

insolvent companyEOK Study Circle - ICAI22/11/2013

Page 44: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Registered Valuers (Draft Rules) – Methods of Valuation

I. Before adopting methods, decide Valuation Approach-

• Asset Approach

• Income Approach

• Market Approach

II. Valuer to consider following points while undertaking Valuation-

• Nature of the Business and the History of the Enterprise from its inception

• Economic outlook in general and outlook of the specific industry in particular

• Book Value of the stock and the Financial condition of the business

• Earning Capacity of the company

• Dividend-Paying Capacity of the company.

• Goodwill or other Intangible value

• Sales of the stock and the Size of the block of stock to be valued

• Market prices of stock of corporations engaged in the same or a similar line of business

• Contingent Liabilities or substantial legal issues, within India and Abroad, impacting business

• Nature of Instrument proposed to be issued, and nature of transaction contemplated by parties

Relates to IRS Revenue Ruling (1959-60),USA

Page 45: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Registered Valuers (Draft Rules) – Methods of Valuation

III. Registered Valuer shall make valuation of any asset in accordance with any one or more of the

following methods-

a. Net Asset Value Method (NAV)

b. Market Price Method

c. Yield Method / PECV Method

d. Discounted Cash Flow Method (DCF)

e. Comparable Companies Multiples Method (CCM)

f. Comparable Transaction Multiples Method (CTM)

g. Price of Recent Investment Method (PORI)

h. Sum of the parts Valuation Method (SOTP)

i. Liquidation Value

j. Weighted Average Method

k. Any other method accepted or notified by RBI, SEBI or Income Tax Authorities

l. Any other method that valuer may deem fit provided adequate justification for use of suh method (and not

any of the above methods) is provided

IV. Registered Valuer shall make valuation of any asset as on the Valuation date and in accordance

with applicable standards, if any stipulated for this purpose.

V. Contents of Valuation report shall contain information as contained in Form 17.3

Page 46: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Registered Valuers (Forms) – Contents of Valuation report

1) Description of valuation engagement

(a) Name of the client:

(b) Other intended users:

(c) Purpose for valuation:

(2) Description of business/ asset / liability being valued

(a) Nature of business or asset / liability

(b) Legal background

(c) Financial aspects

(d) Tax matters

(3) Description of the information underlying the valuation

(a) Analysis of past results

(b) Budgets, with underlying assumptions

(c) Availability and quality of underlying data

(d) Review of budgets for plausibility

(e) Statement of responsibility for information received

Page 47: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Registered Valuers (Forms) – Contents of Valuation report

(4) Description of specific valuation of assets used in the business:

(a)Basis or bases of value

(b) Valuation Date

(c) Description of the procedures carried out

(d) Principles used in the valuation

(e) The valuation method used and reasoning

(f) Nature, scope and quality of underlying data and

(g) The extent of estimates and assumptions together with considerations underlying them

(5) Confirmation that the valuation has been undertaken in accordance with these Rules

(6) Further it is certified that valuation has been undertaken after taking into account relevant

conditions/regulations/rules/notifications, if any, issued by the Central/State Government(s) from time to time.

(i) The valuation report must clearly state the significant assumptions upon which the value is based.

When reporting there may be instances, where there are confidential figures, these must be

summarized in a separate exhibit

(ii) In his valuation report, the registered valuer must set out a clear value or range of values along with

the reasoning

(ii) In case the valuer has been involved in valuing any part of the subject matter of valuation in the

past, the past valuation report(s) should be attached and referred to herein. In case a different

basis has been adopted for valuation (than adopted in the past), the valuer should justify the

reason for such differences

Page 48: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Some Specific Tricky Issues

EOK Study Circle - ICAI22/11/2013

Page 49: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Discounts

• Discount for Entity Level

Discounts & Premiums come into picture when there exist difference between the

subject being valued and the Methodologies applied. As this can translate control value

to non-control and vise versa , so these should be judiciously applied.

– Impact on entity as a whole

Key Person Discount

Discount for Contingent Liability

Discount for diversified company

Discount for Holding Company

• Discount for Shareholders Level – Impact on specific ownership interest

Discount Lack of Control (DLOC)

Discount Lack of Marketability (DLOM)

• Size of distribution or dividends

• Dispute

• Revenue / Earning – Growth / Stability

• Private Company

Tax Payout

• % stake & special rights

• Shareholders Agreement caveats

Global Studies over the years on diversified

companies and holding companies has shown

that companies trade at a discount in the range

of 20%. to 40% each.

DLOM: As per CCI Guidelines, 15%

discount has been prescribed; however

practically DLOM and DLOC depends upon

following factors:

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Page 50: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Premium

•Control Premium - An investor seeking to acquire control of a company is typically

willing to pay more than the current market price of the

company. Control premium is an amount that a buyer is usually

willing to pay over the fair market value of a publicly traded

company to acquire controlling stake in a company

Research has shown that the control premium in

India has ranged from 20% to 37% in the past few

years.

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Page 51: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Excess Cash and Non Operating Assets

Excess cash is defined as „total cash (in balance

sheet) – operating cash (i.e. minimum required cash)

to sustain operations (working capital) and manage

contingencies

Key Issue: Estimation of Excess Cash ?

Non operating Assets are the Surplus assets which are not used in operations of the business and does not

reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should be

separately added to the value derived through valuation methodologies to arrive at the value of the company.

One of the solutions is to estimate average

cash/sales or total balance sheet size of the

company’s relevant Industry and then estimate if

the company being valued has cash in excess of the

industry’s average.

What is an asset is not yielding adequate returns ?

EOK Study Circle - ICAI22/11/2013

Page 52: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Cross Holding and Investments

Holdings in other firms can be categorized into:

Types of Cross Holding Meaning

Minority, Passive Investments If the securities or assets owned in another firm represent less

than 20% of the overall ownership of that firm

Minority, Active Investments If the securities or assets owned in another firm represent

between 20% and 50% of the overall ownership of that firm

Majority, Active Investments If the securities or assets owned in another firm represent more

than 50% of the overall ownership of that firm

Investment Value

Ways to value Cross Holding and Investments:

Dividend Yield Capitalization or DCF based on expected dividends

Seperate Valuation (Preferred)

By way of Shareholders

Agreement even less %

holding may command

control value

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Page 53: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Accounting Practices and Tax issues

Most of the information that is used in

valuation comes from financial statements.

which in turn are made on certain

Accounting practices considered

appropriate.

• Cash Accounting v/s Accrual Accounting

• Operating Lease v/s Financial Lease

• Capitalization of Expenses

• Notional Tax vs. Actual Tax

• Treatment of Intangible Assets

• Companies Paying MAT

• Treatment of Tax benefits and Losses

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Page 54: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Valuation Methodologies and Value Impact

Major Valuation Methodologies Ideal for Result

Net Asset Value

Net Asset Value (Book Value) Minority ValueEquity Value

Net Asset Value (Fair Value) Control Value

Comparable Companies Multiples (CCM) Method

Price to Earning , Book Value MultipleMinority Value

Equity Value

EBIT , EBITDA Multiple Enterprise Value

Comparable Transaction Multiples (CTM) Method

Price to Earning , Book Value MultipleControl Value

Equity Value

EBIT , EBITDA Multiple Enterprise Value

Discounted Cash Flow (DCF)

Equity Control Value Equity Value

Firm Enterprise Value

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Page 55: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

About

Corporate Professionals

Offering varied legal & financial services, 'Corporate Professionals' has emerged as an innovative leader in

delivering corporate advisory & solutions. Aiming to become a one-stop-shop offering integrated legal and

financial solutions, the Group has successfully completed a high number of corporate transactions in the last

couple of years. We have successfully engaged in and executed over 3000 assignments of more than 1200

corporate houses, domestic as well as international, across several Industries.

The Group has distinctively positioned itself as Merchant Banker (SEBI Cat-I license) with Boutique

Investment Banking & Transaction Advisory services and as Legal Advisors with high quality comprehensive

Corporate Laws, Tax & Regulatory services. With an endeavor to satisfy our clients' stated as well as

unstated needs, we adopt the most feasible and legally viable approach to execute assignments in a

seamless, cost effective and time bound manner. High Integrity and Confidentiality in dealing with clients

and assignments undertaken is deeply inculcated in our team.

The Group prestigiously owns a strong skill set that comes from its research oriented, multi-disciplinary,

young and dynamic team. With right blend of legal and financial skills, continuous focus on research and

effective use of Information Technology, Corporate Professionals is creating customized products, for

different class of clients. Innovative flair of executing assignments with problem solving zeal and use of

Technology has enabled us to offer path breaking solutions. Not just for executing Clients' Assignments but

also in internal management, the Group adheres to a system driven approach.

The Group dedicates around 30% working time of its professional team on continuous research in the

dynamic legal and financial fields, with an object of creating a knowledge hub, extensive knowledge

dissemination and to develop skills of its team to deliver high quality services.

“Corporate Professionals” refers to one or more of group companies and its network of firms and other

entities, each of which is a separate legal, independent entity. For more details, please visit

www.corporateprofessionals.com.

Page 56: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

Mr. Chander Sawhney

Vice President

M: +91 9810557353

D: +91 11 40622252

E: [email protected]

Mr. Maneesh Srivastava

Senior Manager

M: +91 9871026040

D: +91 11 40622255

E: [email protected]

Mr. Gaurav Kumar Barick

Assistant Manager

M: +91 8130141874

D: +91 11 40622241

E: [email protected]

Mr. Sameer Verma

Assistant Manager

M: +91 9911945607

D: +91 11 40622216

E: [email protected]

Our Valuation Team

Page 57: FEMA Valuation Aspects(FDI & ODI) and Registered Valuation

As Close As You Need

As Far As You Go……

Delhi Office

D-28, South Ex., Part-I, New Delhi-110049,

D-38, South Ex., Part-I, New Delhi-110049,

T: +91 11 40622255

M:+ 91 9871026040,

E: [email protected]

Mumbai Office

520, Mastermind- I, Royal Palms Estate, Aarey

Colony,

Goregaon East, Mumbai -400065

T: +91 2267109044

M:+ 91 9820079664

E: [email protected]

Indian Offices

Overseas Offices

Our Associates

India

Ahmedabad, Allahabad, Bangalore, Bhopal, Bhubaneshwar, Chandigarh, Chennai, Coimbatore, Goa, Guwahati, Gwalior,

Hyderabad, Indore, Jaipur, Jammu, Kanpur, Kochi, Kolkata, Lucknow, Ludhiana, Patna, Pune.

Overseas

Bulgaria, Belgium, British Virgin Islands, Canada, China, Costa Rica, Cyprus, European Union, Germany, Hongkong, Ireland,

Japan, Kenya, Malaysia, Mauritius, Singapore, Sri Lanka, Switzerland, The Netherlands, Turkey, United Arab Emirates, United

Kingdom, United States.

Bedford Office (United Kingdom)

2-4 Mill Street, MK40 3HD, Bedford

Switchboard: +44 (0) 2030063240,

E: [email protected]