What are Valuation Services and its importance
A question always arises as to why there is a need for valuation services and what is its importance and who requires these valuation services?
There has been a phenomenal increase in India’s economic and business environment in the last few decades. The progress of this change can also be noticed in the number of start-up registrations, entrepreneurs growing in numbers, Eco system developing around and funds raised by the Indian business is leading to new global leadership. These new entrants and investor groups and other stakeholders are curious and interested in valuation of their investees or target companies. Increased corporate governance, growing regulatory and shareholder activism has led to increased growth in valuing business as a whole.
Warren Buffet rightly said ‘’Price is what you pay, Value is what you get’’. Hence one should have focus on what is the value they obtain by the price they are ready to pay.
Concepts of Value and Valuation Services:
Before we further understand the purpose and requirements of valuation, understanding what does value and valuation mean is important.
- Value is said to be the worth of a thing whereas valuation is the process to arrive at such worth. Value means different to different people. The value derived is differed if context, assumptions, limiting conditions or date changes.
- In financial terminology, valuation is the process of determining the ‘Economic Worth’ of the property with suitable assumptions and limiting conditions for particular purpose and also arriving at a value for a particular valuation date.
- Valuer has to make suitable assumptions regarding expected growth in turnover, profitability etc and also forecasts on expenses on introduction or discontinuation of a line of product or service or increase in capacity. Estimates on blockage of working capital if any and also on the current economic and industry trends.
What is the Importance of Valuation?
- Valuation can be used as a powerful driver to measure the company’s performance and growth since its start and helps company reach its target position. Valuation services can also be used to know the worth of enterprise’s assets and liabilities which helps management know the actual worth of business.
- Valuation services are rapidly gaining their importance in fund raising. As investors are keen to know the rate of return, they would earn on the investment made, valuation of the enterprise provides investor with the knowledge of the company’s worth and leverage of the investor.
- Valuation services have also become necessary in financial reporting. Valuation is used to decide on the impairment of asset and also to derive fair valuations for reporting or tax purposes.
- Sometimes there are portfolio investments made by the enterprise. Such portfolio consists of equity and debt. Valuation of these portfolio investments are also conducted by the enterprise to review such investments on timely basis.
- Sometimes there are portfolio investments made by the enterprise. Such portfolio consists of equity and debt. Valuation of these portfolio investments are also conducted by the enterprise to review such investments on timely basis.
- In case of introduction or divestment of any product or service in the enterprise, valuation is necessary to review such decision that is, whether the enterprise is gaining out of such product line or no.
What are the Types of Valuation Service Engagements?
Valuation service engagements are categorized in to three broad categories which are as under:
Valuation Engagement – To arrive at a value and form an opinion by following all the valuation procedures, approaches and methods.
Valuation Engagement – To arrive at a value and form an opinion by following all the valuation procedures, approaches and methods.
Fairness Opinion or Valuation Review Engagements – A valuer provides an opinion on the work done by another valuer. As part of such review, certain procedures may be carried on by such valuer to an extent to form an opinion.
When is Valuation Required?
Certain transactions carried on in a company may require to be assessed on certain basis. The following can be few of the primary areas where valuation services may be required:
Enterprise/Business Valuation: One of the complex forms of valuation is business valuation as it involves knowledge of economy, industry, accounting, taxation and legal regimes apart from following valuation principles and methodologies. A lot of other factors like corporate governance, management, transparency too come into play during value assessment. Enterprise valuation service helps to know the value of the company as a whole hence it is crucial at the time of selling of the business. It helps the prospective buyers know the value of the business they are going to take-over.
Tangible Assets: Infrastructure Assets, Industrial Assets, plant and machinery etc come under tangible assets. In general, company may not value these assets on a regular basis. But off-late there has been a rapid development in the infrastructure such as road, railways, power and urban sectors of the country since infrastructure is an important factor for country’s economic growth. There are a wide variety of opportunities awaiting for the enterprises to generate income. To know their potential and avail such opportunities, valuation service is necessary. Through valuation, enterprises will know their current status and how to seek further growth in the business.
Intangible Assets or Intellectual Property Rights (IPRs) : Intangible assets of a company include goodwill, trademark, brands, copyrights, technology know how etc. Though these assets do not have any physical substance, a monetary value is derived to them as a certain amount of time and money is spent on the business to build these assets. Valuation of these assets is essential since these can be self-generated assets. Value added to the company through these assets can be determined only through valuation service.
Real Estate: Generally, the price of properties or real estate keeps fluctuating based on the market conditions. Hence before making any investment in the real estate, any person would like to know, value of the property that he is paying for. Valuation service plays a key role since, investing in property is a long-term plan and a person wants to gain out of such investment. Value of the property changes based on the location of the property and any appraisals in value would be made if there are any improvements made to such property.
Employee Stock Option Plan (ESOPs) or Sweat Equity Shares: Any company would like to retain its high skilled employees by providing the necessary benefits to them. Few such benefits include ESOPs and Sweat Equity shares. These are issued to employees as a token of appreciation for their renowned services to the company. Valuation services come into play when such ESOPs and Sweat Equity shares are granted by the employer and exercised by the employee. Valuation of these benefits is considered for accounting and taxation purposes. Employers book compensation expense over the vesting period based on the valuation done.
Mergers and Acquisitions: Acquisition implies an enterprise buying a portion or a particular segment of another enterprise where merger means a complete takeover of one enterprise by the other. The former enterprise ceases to exist in case of merger. Valuation service in case of merger and acquisition is necessary to determine the price paid by one company to the other for such take over. Such price is determined by adding certain percentage over and above the assets of the company. The value fixed in case of mergers and acquisitions is always negotiable as the seller always want a highest price possible and buyer will bargain to buy at lowest price possible.
Fund Raising: Fund is the fuel for any enterprise to work. Hence raising of such funds is an important event that a company requires for its functioning. Investors would be willing to invest on seeing their leverage in the company. Such information is provided to the investor only through valuing the company. Enterprise valuation is to be performed at the time of raising funds. Though a specific value is arrived, such price is always negotiable by the investors based on their expectation of returns from such investment.
Initial public offering (IPO) is a mode of fund raising. Valuation services for IPO are done by Merchant Bankers after assessing the market valuation of comparable companies and adjusting such value with the desired company’s growth expectations.
Financial Instruments: Financial instruments include investment in equity instruments, derivatives, debt instruments etc. Securities valuation mainly is done to determine the market value. Such valuation attracts factors like increase in demand and supply of the security, stock market rate of similar securities and present value of future cash flows. Another important factor for valuation of financial instruments is for financial reporting purposes in case of mergers and acquisitions, dispute resolution, liquidation etc.
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Are There any Regulatory Requirements for Valuation Services?
Apart from the above stated instances of where valuation services are required, there are a few regulatory requirements as well where valuation service has to be performed by appointing a Registered Valuer. Such instances can be summed up as follows:
Under Companies Act, 2013 – It has mandated the practice of valuation service in certain cases to make valuation in line with international standards which increases transparency leading to a better corporate governance. The following are instances where Registered Valuer is mandated by the Companies Act, 2013
- Issue of equity shares and convertible instruments
- In case of Employee Benefits issued
- Valuing assets involved in arrangement of non-cash transactions to directors
- Valuing shares, property and assets of the company under scheme of corporate debt restructuring
- Valuation including share swap ratio under a scheme of compromise accompanied by valuation report
- Under a scheme of compromise, transferor being listed company and transferee being unlisted company, tribunal may order valuation for exit opportunity to the shareholders of transferor company.
- Valuing equity shares held by minority shareholders
- Determination of value of assets in case of liquidation .
Under Insolvency and bankruptcy, 2016 – A registered valuer is appointed by the resolution in case of liquidation of the company. Such valuer values all the assets that is tangible and intangible assets and also liabilities of the company and presents a valuation report to the enterprise.
Under SEBI Regulations, 2016 – Valuation is required in case there are any transactions relating to transfers between residents and non-residents, issue or reduction of share capital, swap-ratio and restructuring of business. A registered valuer is required to be appointed as per SEBI regulations and value the underlying asset under the above instances.
Under RBI Regulation – In case of allotment or transfer of equity shares or convertible instruments of Indian company to or from non-residents must carry fair valuation as per RBI regulations. Such valuation may be certified either by a chartered accountant or SEBI registered Merchant Banker where such shares are not listed on any stock exchange in India. RBI vide its consolidated FDI policy notified, fair valuation od shares has to be done on arm’s length price in case of transfer or issue of security by a non-resident as regard to FDI.
Under Income Tax Act – As per Rule 11UA, of Income Tax Rules states the manner in which fair market value of a property other than immovable property has to be determined for the purpose of section 56 of Income tax Act. The following are the instances where fair valuation is to be determined:
- Jewellery
- Archaeological collections, drawings, paintings, sculptures or any work of art
- Shares and securities
There has been a rapid growth in Indian economy and the Corporate work environment has also been evolving in the past few years. With increase in these factors’ valuation has also found its place in the growing environment. As every investor and investee wishes to know the worth of their business and desires to know the further ways to improve their performance, valuation is used as a performance driver to measure the growth of the company.
With the latest amendments in Companies Act and Insolvency and Bankruptcy Code, valuation has become a mandatory regulation under few instances for financial reporting and tax purposes.
