Demystifying Valuation under the Companies Act, 2013

The Companies Act, 2013 (the Act) ushered in a new era of corporate governance in India. One of the significant changes it introduced was the emphasis on accurate and reliable asset valuation. This blog post delves deep into the intricacies of valuation requirements and their implications under the Act.

Why Valuation Matters?

Accurate asset valuation plays a critical role in ensuring transparency and fairness in a company’s financial reporting. This transparency benefits various stakeholders, including:

• Investors: Reliable valuations enable investors to make informed decisions about investing in a company. They gain confidence in the company’s financial health when valuations are conducted by qualified professionals.
• Creditors: Proper valuation helps creditors assess the company’s ability to repay debts.
• Regulators: Valuation reports by Registered Valuers (RVs) ensure compliance with the Act’s requirements for specific transactions.
• Company Management: Fair valuation facilitates informed decision-making by company management in various situations like mergers and acquisitions.

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Registered Valuers: The Guardians of Valuation

The Act introduces the concept of Registered Valuers (RVs) who are entrusted with the responsibility of conducting valuations. Here’s a closer look at the framework governing RVs:

• Appointment: The company’s Audit Committee, if established, or the Board of Directors appoints RVs.
• Qualifications: To become an RV, a person must possess relevant qualifications and experience in specific asset classes, such as Chartered Accountancy, Company Secretaryship, Cost Accountancy, membership in professional engineering or architectural bodies, or hold equivalent qualifications recognised by the Ministry of Corporate Affairs.
• Responsibilities: RVs are duty-bound to:
  • Exercise due diligence and care throughout the valuation process.
  • Conduct impartial and fair valuations, free from bias or conflicts of interest.
  • Comply with the valuation rules and methodologies prescribed under the Act.
• Accountability: RVs face penalties or even removal from the register of valuers for violating these provisions.

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The Valuation Report: A Window into the Valuation Process

The RV’s report serves as a crucial document that captures the details and rationale behind the valuation. Here’s a breakdown of the key information a comprehensive valuation report should include:

• Valuer’s Credentials: The report should clearly state the RV’s qualifications, registration number, and contact information, allowing for verification of their expertise.
• Asset Description: A clear and detailed description of the assets being valued is essential for understanding the valuation context.
• Valuation Approach and Methodology: The report should explain the valuation approach used (e.g., market approach, income approach, cost approach) and the specific valuation methodologies employed within that approach.
• Assumptions and Considerations: Key assumptions made during the valuation process, along with their justifications, need to be clearly outlined. These assumptions can significantly impact the valuation outcome.
• Valuation Conclusion: The report should clearly state the estimated fair value of the asset(s) based on the chosen methodology.
• Disclosures and Limitations: Any limitations inherent to the valuation process, such as data limitations or uncertainties, should be disclosed to provide transparency about the valuation’s reliability.
• Additional Information: The report might also include:
  • Significant assumptions upon which the value is based, potentially summarised for confidentiality purposes.
  • Past valuation reports (if applicable) and justification for any changes in valuation methodology compared to past reports.

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Salient features of a Registered Valuer

The Companies Act, 2013 (the Act) ushered in a new era of transparency and accountability in corporate governance. A key pillar of this reform is the concept of Registered Valuers (RVs). Let’s delve into the legalities surrounding RVs and their significance.

Appointment of RVs (Section 247):

The Act mandates that all valuations be conducted by qualified RVs. The responsibility for appointing an RV falls on the company’s Audit Committee, if established (Section 247(1)). In its absence, the Board of Directors takes on this task (Section 247(1)).

Eligibility for Becoming an RV (Section 247(1), Companies (Registered Valuers and Valuation) Rules, 2017):

The Act, along with the Companies (Registered Valuers and Valuation) Rules, 2017 (the Rules), defines the qualifications required to become an RV. Here are some of the key eligibility criteria:

• Professional Qualifications (Section 247(1), Rule 4): Individuals with recognized professional qualifications like Chartered Accountant, Company Secretary, or Cost Accountant can apply, provided they are in full-time practice (Rule 4(1)(a)). Retired members of the Indian Corporate Law Service or those holding equivalent Indian or foreign qualifications recognized by the Ministry of Corporate Affairs can also qualify (Rule 4(1)(b)).
• Industry Expertise (Rule 4(1)(c, d)): Membership in professional bodies like the Institute of Engineers or Architects, with a focus on full-time practice, allows individuals to become RVs within their respective domains (Rule 4(1)(c, d)).
• Emerging Qualifications (Rule 4(2)): The Act empowers the Central Government to expand the pool of eligible RVs by notifying additional qualifications or competencies as needed (Rule 4(2)).

Responsibilities and Accountability of RVs (Section 247(3)):

RVs undertake significant responsibilities during a valuation engagement. Here are some core expectations outlined in Section 247(3) of the Act:

• Due Diligence: RVs are expected to exercise thoroughness and care throughout the valuation process.
• Impartiality and Fair Valuation: Maintaining objectivity and conducting a fair and accurate valuation of the assets is paramount.
• Compliance with Regulations: RVs must adhere to the prescribed valuation rules and methodologies outlined by the Act and Draft Rules.
• Conflict of Interest: RVs are prohibited from undertaking valuations where they have any direct or indirect interest in the assets being valued (Section 247(3)).

Penalties for Non-Compliance (Section 247(3)):

Failing to comply with these provisions can lead to penalties for RVs as outlined in Section 247(3) of the Act:

• Fine: A fine of not less than ₹25,000 but which may extend to ₹1 lakh can be imposed.
• Imprisonment: In cases involving an intention to defraud the company or its members, imprisonment for a term of up to one year can be imposed, along with the fine.
• Removal from Register: The Act empowers authorities to remove an RV from the register of valuers for violating these provisions.

Dispute Resolution and Appeals (Rule 23):

The Rules establish a mechanism for handling situations where an RV disagrees with a decision made by the Central Government. In such cases, the RV can file an appeal with the designated Tribunal (Rule 23).

By ensuring that only qualified and ethical professionals conduct valuations, the Companies Act and its associated regulations aim to promote transparency and reliability in corporate financial reporting within India. This system fosters trust among investors, creditors, and other stakeholders, ultimately contributing to a healthier corporate environment.

When is Income Tax Valuation Required in India (Companies Act 2013)?

Scenario	Purpose	Relevant Section
Issuing additional shares	Determine fair value for new shares	Section 62
Non-cash transactions with directors	Value assets involved in the deal	Section 192
Compromise/arrangement or debt restructuring	Value assets and liabilities for fair settlements	Sections 230/232
Purchasing minority shareholder holdings	Arrive at a fair purchase price	Section 236
Company administration	Establish reserve price for company assets	Section 260
Company liquidation	Value assets for liquidator’s report	Section 281
Voluntary winding up	Assess solvency through asset valuation	Section 305
Dissenting member buyout	Value member’s interest for fair compensation	Section 319

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Valuation Methods

The Draft Rules associated with the Act provide RVs with the flexibility to employ various valuation methods as deemed appropriate for the specific asset class and valuation purpose. Some of the commonly used valuation methods include:

• Net Asset Value Method: This method calculates the net asset value of a company by subtracting its liabilities from its total assets.
• Market Price Method: This method uses the prices of similar assets recently sold in the market to estimate the value of the subject asset.
• Yield Method / Profit Earning Capacity Value (PECV): This method estimates the value of an asset based on the income it is expected to generate in the future.
• Discounted Cash Flow Method (DCF): This method discounts the future cash flows an asset is expected to generate to its present value to arrive at a fair value.
• Comparable Companies Multiples Methodology (CCM): This method compares the subject company’s financial ratios (e.g., price-to-earnings ratio) with publicly traded companies in the same industry to estimate its value.
• Comparable Transaction Multiples Method (CTM): This method uses the multiples paid for similar assets in recent transactions to estimate the value of the subject asset.

• Price of Recent Investment Method (PORI): This method estimates the fair value of an asset by referencing the price paid by a recent investor for a similar asset or a stake in the company.
  
• Sum of the Parts Valuation (SOTP): This method values a company with distinct business segments or subsidiaries by:
  
  • Identifying each segment or subsidiary as a separate entity.
  • Valuing each segment/subsidiary individually using appropriate methods.
  • Adding the fair values of all segments/subsidiaries to arrive at the company’s overall fair value.
• Liquidation Value: This method estimates the value of an asset based on the cash that could be realised from selling it in a forced sale scenario.
  
• Weighted Average Method: This method estimates the fair value of a portfolio of assets by:
  
  • Valuing each asset in the portfolio individually.
  • Assigning a weight to each asset based on its importance within the portfolio.
  • Multiplying each asset’s value by its weight and summing the products to get the overall portfolio value.

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What Valuation Report should Contain

1. Valuer Information:

• Who: Name and Registration Number of the Valuer
• Contact: Address and Email Address

2. Valuation Engagement Details:

• Client: Name of the Company or Individual Hiring the Valuer
• Intended Users: Who will be relying on this valuation report (e.g., investors, creditors)
• Purpose: Why is this valuation being conducted?

3. Description of the Subject of Valuation:

• What: Clearly identify the business, asset, or liability being valued.
• Legal Background: Relevant legal considerations related to the subject.
• Financials: Summary of the subject’s financial health.
• Tax Implications: Any tax considerations related to the valuation.

4. Information Used in the Valuation:

• Historical Performance: Analysis of past results (e.g., revenue, expenses).
• Financial Forecasts: Review of budgets and assumptions used.
• Data Quality: Assessment of the availability and reliability of underlying data.
• Review of Forecasts: Confirmation that budgets are reasonable.
• Information Source Disclaimer: Clarification on who is responsible for providing the information used.

5. Valuation Methodology:

• Valuation Basis: The primary approach used for valuation (e.g., market value, fair value).
• Valuation Date: Specific date the valuation represents.
• Valuation Procedures: A clear explanation of the steps taken during the valuation.
• Valuation Principles: The guiding principles used (e.g., fair market standards).
• Valuation Method Explanation: Detailed explanation of the specific valuation method chosen and the rationale behind it.
• Data Quality and Assumptions: Assessment of the nature, scope, and reliability of data, along with the justification for any estimates or assumptions made.

6. Compliance with Rules:

• Confirmation that the valuation adheres to all relevant regulations and guidelines.

7. Consideration of Regulations:

• A statement confirming the valuation considered any relevant regulations, rules, or notifications issued by the government.

8. Valuation Statement:

• Date of the valuation report.
• Signature and location of the Valuer.

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Considerations and Potential Issues

While the Act and Draft Rules establish a framework for valuation, there are still aspects that require further clarification or raise potential issues:

• Appointment Process: The requirement for the Audit Committee or Board to appoint RVs might lead to delays, especially for routine valuations. Empowering management to appoint RVs for specific situations like internal valuations could streamline the process.
• Defining “Due Diligence”: The Act mandates that RVs exercise due diligence during valuation. However, a more specific definition of “due diligence” outlining the expected steps would be beneficial. Due diligence can encompass various areas like financial, tax, or commercial, and RVs may not possess expertise in all these areas.
• Expanding the Valuation Professional Pool: Including other qualified professionals, such as those holding post-graduate degrees in business management or finance, or possessing Chartered Financial Analyst (CFA) designations, could broaden the pool of potential RVs.

The Road Ahead: Embracing Transparency and Improved Governance

The Companies Act, 2013, with its emphasis on Registered Valuers and standardised valuation procedures, represents a significant step towards enhancing transparency and reliability in corporate financial reporting. This, in turn, fosters better corporate governance and facilitates informed decision-making by various stakeholders.

Here are some additional points to consider:

• Professional Opportunities: The increased demand for valuation services due to the Act creates professional opportunities for qualified individuals to become RVs.
• Enhanced Investor Confidence: A robust valuation system with qualified RVs instils greater confidence in investors regarding the accuracy of a company’s financial health.
• Balancing Efficiency with Compliance: Finding the right balance between ensuring adherence to valuation requirements and streamlining the appointment process for routine valuations remains an ongoing challenge.

Conclusion

By understanding the intricacies of valuation under the Companies Act, 2013, companies can ensure they comply with legal requirements while leveraging accurate valuations for informed decision-making and enhanced stakeholder confidence. As the framework continues to evolve, staying updated on clarifications and potential amendments will be crucial for both companies and RVs navigating this vital aspect of corporate governance.

FAQs on Valuation Methods under the Companies Act, 2013

Q1. What is the purpose of using different valuation methods?

Ans1. The Companies Act, 2013 allows for various valuation methods to cater to different asset types and valuation scenarios. No single method is universally applicable. Choosing the right method ensures a more accurate reflection of the asset’s fair value.

Q2. Briefly explain the Price of the Recent Investment Method (PORI).

Ans2. PORI estimates an asset’s value based on the price paid by a recent investor for a similar asset or a stake in the company. This method is suitable for valuing startups or companies with limited financial history or market data. However, it requires ensuring the investment is truly comparable and there haven’t been significant changes since the investment.

Q3. What is the benefit of using the Sum of the Parts Valuation (SOTP) method?

Ans3. SOTP is particularly useful for valuing companies with distinct business segments. It breaks down the company’s value by individually valuing each segment and then aggregating them. This provides a more accurate picture compared to a single valuation method, especially for companies with diverse operations.

Q4. When is the Liquidation Value method used?

Ans4. The Liquidation Value method estimates the value of an asset based on the cash achievable from a forced sale. This method is typically used when a company is considering liquidation or when the asset’s future use is uncertain.

Q5. What are the limitations of the Weighted Average Method?

Ans5. While simple to implement, the Weighted Average Method’s accuracy relies heavily on the accuracy of individual asset valuations within the portfolio. Additionally, it might not be suitable for portfolios with significant variations in asset types or characteristics.

Q6. Who appoints Registered Valuers (RVs) under the Companies Act?

Ans6. The company’s Audit Committee, if established, appoints RVs. In its absence, the Board of Directors takes on this responsibility.

Q7. What are some of the qualifications required to become a Registered Valuer?

Ans7. To become an RV, a person must possess relevant qualifications and experience in specific asset classes. This can include Chartered Accountancy, Company Secretaryship, Cost Accountancy, membership in professional engineering or architectural bodies, or hold equivalent qualifications recognized by the Ministry of Corporate Affairs.

Q8. What are the key things an RV’s valuation report should include?

Ans8. A comprehensive valuation report should include details like the RV’s credentials, a clear description of the assets, the valuation approach and methodology used, key assumptions and considerations, the valuation conclusion, and any limitations associated with the valuation.

Q9. How does the Companies Act, 2013 promote transparency in corporate financial reporting?

Ans9. By emphasizing the use of Registered Valuers and standardized valuation procedures, the Act aims to ensure that asset valuations are conducted by qualified professionals and follow prescribed methodologies. This enhances the reliability and transparency of financial statements.

Q10. How does accurate asset valuation benefit stakeholders?

Ans10. Accurate valuation benefits various stakeholders, including investors who gain confidence in a company’s financial health, creditors who can better assess the company’s ability to repay debts and company management who can make informed decisions based on reliable valuation data.