Understand the Basis of Merchant Banker Valuation in Detail

There are various scenarios where a valuation report prepared by-a Merchant Banker is required, so if you are someone who is dealing with an issue or a transaction which involves obtaining of such a report then you are at the right place because we will provide you with the right guidance related to the basics of the Merchant Banker Valuation report. So, let’s delve into it!

Introduction 

If an organisation is looking to raise some capital and this is especially true for the start-up, then in order to attract the investors on board, a valuation report prepared by a Merchant Banker is required. In simple words, a Merchant Banker Valuation report is a document that is prepared by a licensed professional that gives the estimated fair market value of the shares or other securities of the company.

Majorly, this report depicts as to what a buyer is willing to pay to a willing seller in an arm’s length transaction. The report is based on a thorough analysis of the financial health of the company and its projected growth rate. A Merchant Banker Valuation report is usually prepared by the authorities which are holding the Merchant Banker Valuation license in India.

What are the Functions Performed by a Merchant Banker? 

• Valuations: The main job of a Merchant Banker is to prepare the Valuation Reports (which have been discussed in detail). As we have rightly mentioned that the Merchant Bankers are authorised by the SEBI to perform the valuations that are essential for raising the funds from the Venture Capitalists and the Private Equity, the valuation reports are not only useful for raising the funds but instead it also assists in understanding the company for having a better negotiations with their investors, mergers and acquisitions and other corporate restructuring purposes. 

• Underwriting: The next important function performed by a Merchant Banker is underwriting. During the IPO of a company, the Merchant Bankers guarantee to buy the unsold shares of the company, thereby giving the company an assurance of the success of the fundraising. 

• Consultation: The other important function performed by a Merchant Banker is providing Financial consultation to the companies. The Merchant Bankers act as the Trusted advisors who provide expert guidance to the companies on the process of how to raise the funds, the best methods and practice for raising these funds and the best strategies for the growth of the company. 

• Long-Term Funds: The Merchant Bankers also act as a tool to provide the companies the right amount of assistance for raising the long-term funds either through debt syndication or equity fundings. At the same time, they also assist the organisation to obtain the secured and unsecured loans for meeting the financial needs of the companies. The Merchant Bankers also provide a variety of options for raising funds, such as Venture Capitals, Private Equity, raising capital through Initial Public Offering and direct investments through family offices. 

• Intermediaries: The Merchant Bankers also act as the intermediaries for the companies and the investors. 

• Management of the IPO/FPO: The Merchant Bankers acts as the most important instrument for the management of the IPOs and FPOs thereby ensuring the compliance with the regulations provided by the SEBI and the looking of the process for the IPO and FPO from the stage of the prospects preparation to the final allotment of the shares. 

What is the Importance of the Merchant Bankers? 

• Growth of the Market: The Merchant Bankers promote the growth of the primary markets. 

• Provides Roadmap to the Companies: As we have discussed in the above section, the Merchant Bankers act as the Financial advisors for the companies, thereby providing them the necessary roadmap

• Assistance in the Purchase of the Securities: This point is the expansion of the above point where the Merchant Bankers assist the investors with the right amount of guidance for the purchase of the securities 

• Ensuring the Capital Flow: The Merchant Bankers also ensure that the company has the necessary flow of capital in their organization 

• Promoting the Financial Surplus of the organisation: A Merchant Banker is required and even ensures the financial surplus to the organisation.

• Coordinating the activities related to the Issue of the Shares: As we have rightly discussed in the above sections, a Merchant Banker always ensures that activities related to the issue of the shares are coordinated. Right from the IPO to the allotment of the shares.

• Ensuring Compliance with the Laws: The Merchant Banker always ensures that the rules and regulations are complied with by the relevant organisations.

• Assisting in raising of the Funds: The Merchant Banker also assists the small and large business corporations to raise the necessary funds.

What is the Scope of the Merchant Bankers?

• Changing the policies of the Financial Institutions: If the financial institutions are required to change their policies, then they are required to obtain the services of a Merchant Banker.

• Corporate restructuring: The Merchant Banker assists the companies to review their structures, operations and strategies

• Disinvestment: Sometimes in order to raise the funds, the organisations are required to reduce their assets and this is where the Merchant Bankers come into play.

• Assisting in the Growth of the New Issues Market: The Merchant Bankers always assist in the growth of the new issue of shares and both the markets are established, which leads to a surge in the private and public issues.

• Development of the Debt Market: Most of the capital by the organisation is raised with the help of the debt instrument, which leads to the development of the debt market.

What are the Categories of Merchant Bankers?

• Category I Merchant Banker: These Merchant Bankers are the biggest and top- tier Merchant Bankers certified by SEBI. These Merchant Bankers are placed in the top tier because they performed a wide variety of activities, including management issues, portfolio management and advisory services. Further, the Merchant Bankers are also involved in the IPOs / FPOs, equity financing and valuations.

• Category II Merchant Bankers: This category of the Merchant Bankers acts as the advisors, co-managers, consultants and underwriters. These category of the Merchant Bankers provides limited services as compared to the Category I of the Merchant Bankers because their job is to provide co-manging public issues and the limited advisory services

• Category III Merchant Bankers: This category of the Merchant Bankers performs lesser services as compared to the other categories of the Merchant Bankers as they cannot act as the lead managers for the management issue. The Merchant Bankers of this category act as the consultants to an issue and as the underwriter advisors.

• Category IV Merchant Banker: These categories of the Merchant Banker are limited to acting as the consultants or the advisors to an issue and they don’t engage in the process of the underwriting or the issue of the management activities.

What are the Advantages of a Merchant Banker?

• Provides the necessary advice pertaining to investment

• Aiding in the distribution of the profit to the investors

• Providing the necessary access related to the companies owned by the dealers, clients and the financial institutions.

• Assisting in the management of cash and other leading operations

What are the Disadvantages of a Merchant Banker?

• A Merchant Banker does not provide the necessary guarantee to the funding of the start-ups.

• A Merchant Banker has very limited access to the potential products of the organisation.

• Difficulty in meeting the size constraints

• A Merchant Banker does not provide the necessary funding to start-ups.

Introduction to Merchant Banker Valuation Report

A Merchant Banker Valuation report is a formal document prepared by the Merchant Banker to show case the estimates of the fair market value of the shares of the other securities of the company. The report is required to be based upon the growth prospectus and the financial health of the organisation.

This Merchant Banker Valuation report is always prepared by the authority who is holding the Merchant Banker Valuation Licence in India.

What are the circumstances under which a Merchant Banker Valuation report is required?

• Issuance of the Equity Shares or the Convertible Securities at the Premium: If in the case where a company plans to issue the equity shares or the convertible instruments at the price which is higher than the face value of such instruments a valuation prepared by a registered value with Insolvency and Bankruptcy Board of India is essential. This report helps in determining the fair market value of the securities.

• To raise the investments from the foreign shareholders: in the cases where certain companies seek investment from the foreign shareholder, then in such a circumstance, a valuation report for complying under the provisions of the income tax act is essential..

• Investors: The investors who are seeking to invest in a start-up rely upon a valuation report prepared by a Merchant Banker. These reports help them in assessing the potential return and risk on their investments. These valuation report provides valuable insight into the projected growth and the worth of the company to make better-informed decisions.

What are the circumstances under which a Merchant Banker Valuation report is not required?

• For the issuance of the Equity Shares at the Face Value: If a company issues their shares to the general public at their face value but not at a premium, then in such a circumstance, a Merchant Banker Valuation report is not required.

• Rights Issue: The companies who are raising the securities through rights issue are not required to obtain a Merchant Banker Valuation report.

• Valuation Report for Internal Use: The companies that are performing the internal valuations for assessing their strategies or drafting of their policies are not required to involve a registered values or Merchant Banker, though such reports are not valid for the regulatory compliance.

Section 11UA and the Need for Merchant Banker Valuation

Under section 11UA of the Income Tax Act, obtaining a Merchant Banker is not mandatory in order to avail the benefits under this section. Since this section offers tax benefits to the start-ups, the start-ups choose to get the valuation report for:

• Transparency: We have discussed the importance of having a Merchant Banker Valuation report for the investor. A valuation report prepared by an IBBI-registered valuer can enhance the credibility and transparency to potential investors.

• Tool for the Negotiation: These valuations report can serve as the assisting tool for the negotiations. These valuation report provides the benchmark for negotiating the investment amount and investment terms.

What are the Benefits of a Merchant Banker Valuation Report?

• Ensuring the Regulatory Compliances: The valuation reports prepared by the SEBI-registered Merchant Banker guide in the issuance of the equity shares at the premium under the specific conditions specified under the Income Tax Act, 1961. The valuation report prepared by the Merchant Banker ensures compliance with the provisions of the regulations such as the Income Tax Act, 1961.

• Accelerates Credibility: The valuation report prepared by the Merchant Banker enhances credibility amongst the stakeholders by providing an in-depth analysis of the startup organisation and its financial structure

• Provides Transparency: The valuation report prepared by a Merchant Banker ensures the companies in providing the right amount of transparency by providing an independent assessment of the value

• Assist in making the Investment Decisions: The valuation reports prepared by a Merchant Banker assist in taking investment-related decisions by assessing the risks associated with the company’s return on investment.

• Growth of the Company: The valuation reports prepared by the Merchant Bankers assist the companies that intend to be acquired, merged or enter into strategic partnerships, which ultimately assist them in the overall growth of the company.

• Acts as a Serving Tool: The valuation report prepared by a Merchant Banker acts as the negotiation tool for the terms and the investment amount

• Mitigation of the Risks: The valuation report prepared by the Merchant Bankers assists in the mitigation of the risk of any issue related to the value of the asset.

What are the Contents of a Report Merchant Banker?

• Executive Summary: The executive summary of the valuation report incorporates the purpose of the valuation. The executive summary of the report consists of the scope of the report, the purpose of preparing the report, the date of valuation, the date of the report and the key findings of the report.

• Background of the Organisation: A brief description and the background of the organization and the assets that are being valued. The background information that an ideal valuation report must include are the description of the business, the area of the operation of the business, the description of the services of the organisation, the historical background of the company, the list of the shareholders and the board of the directors of the company and the schedule of the governance and the management of the company.

• Analysis of the Industry: An industrial landscape must be provided in the Merchant Banker Valuation report. These analyses are usually related to economic conditions, technology, consumer trends and market conditions. The important information required for the issuance of A Merchant Banker are:

• Projected and Current Challenges in the Target Market

• Historical Market Price

• A Detailed Analysis of the Overview of the Industry

• The market size of the competition

• Growth trends over the course of years in the regulatory environment

• The pattern of challenges in the Target Market

• Financial Analysis of the Company: The valuation must contain a detailed analysis of the financial position of the company. The information must be related to the financial ratios, details of the financial transaction, details of the issued shares, the past performance of the company, projected financial analysis of the company and the financial information of the company, such as the cash flow statement or the balance sheet. 

• Valuation Methodology: The next important piece of information that must be encapsulated in the Merchant Banker Valuation Report is the methodology used for the purpose of valuation and the procedure used for calculating the worth of the company. The approaches that can be used for calculating the Valuation are the Market Approach, Cost of Asset Approach, Discounted Cash Flow, Comparable Company Analysis or the Precedent Transaction Approach. 

• Summary of the Valuation: Lastly, the valuation report must consist of the summary and the final outcome of the issuance of the report. Followed by the official stamp and signature of the Merchant Banker. 

• Appendices: The supporting documents of the valuation report which are required to act as the restriction, caveat or disclaimer, are to be attached along with the Merchant Banker Valuation Report. These appendices can be:

• The Calculated Woksheet
• Report of the conducted market research
• Index of the Terms and the Abbreviations used in the preparation.  
• A Financial Statement of the company 

What can be the consequences of an Inaccurate  Valuation Report prepared by a Merchant Banker?

Merchant Bankers are considered as the agents working for the government and it is always considered that an accurate informed valuation report is being prepared by them, so a Merchant Banker has to face legal consequences for the preparation of a wrong valuation report and these can include:

• For non-compliance with the provisions of the Income Tax Act, Stricter Penalties can be imposed
• Loss of reputation of the company and the Credibility of the Merchant Banker
• Withholding approval of the issuance of the shares 
• Any sort of the Financial Implications 

Conclusion 

A Merchant Banker Valuation Report holds great significance in terms of the corporate laws and the working of the corporation swiftly. Therefore, a Merchant Banker Valuation Report should be sought in every case and by every organisation at any level as a lot of tax benefits are also associated with the valuation report prepared by a Merchant Banker. 

Frequently Asked Questions

Q1. What is Merchant Banker Valuation?

Ans 1. A Merchant Banker Valuation is the process of determining the price of an asset of the company. An accurate valuation is important for numerous purposes.

Q 2. What is the minimum net worth requirement for Merchant Banker?

Ans 2. The minimum requirement for a Merchant Banker is not less than Rs five crores.

Q 3. What is MB valuation?

Ans 3. A Merchant Banker is a valuation document prepared by a Merchant Banker that provides the assessment of the particular asset value

Q 4. What are the four categories of Merchant Bankers?

Ans 4. There are your categories of Merchant Bankers specified by SEBI, which acts as manager, advisor, underwriter or consultant.

Q 5. Can a CA become a Merchant Bankers?

Ans 5. Yes, a CA can become a Merchant Banker.

Q 6. Who are the top 5 Merchant Bankers in India?

Ans 6. The top 5 Merchant Bankers in India are Axis Capital, Kotak Mahindra Capital, SBI Capital Markets, ICICI Securities and Global Investment Bank.

Q 7. What is GMV in valuation?

Ans 7. GMV stands for the gross merchandise value, which is the total amount of the sales in a company over a specified period of time measured either yearly or quarterly.

Q 8. What is MB in banks?

Ans 8. MB stands for merchant bank, which is a financial establishment that provides the necessary money for the debt and equity financings.

Q 9. What is the valuation formula?

Ans 9. The formula for valuation is Current Value = (Asset Value) / (1- Debt Ratio)

Q 10. What is a Merchant Banking Model?

Ans 10. A Merchant Banking Model is where a bank specialises in providing of services for private corporations.