India: An Insight Into Business Valuation

Last Updated: 29 October 2012
Article by Chander Sawhney

Knowing what business is worth and what determines its value is prerequisite for intelligent decision making. It is the process of determining the "Economic Wealth" of company under certain assumptions and limiting condition and subject to data available on the valuation date. It is pertinent to mention that the valuation of a business is not an exact science and ultimately depends upon a number of factors like the purpose of valuation, stage of business, past financials, expected financial results, industry scenario, market recognition etc.

What Is Business Valuation?

The Business Valuation is a process to estimate the economic worth of stakeholder's interest in a business.

To determine the value of any business, the reasons for and circumstances surrounding the business valuation must be pre ascertained.

These are formally known as the "Standard of Value" and "Premise of Value".

To be precise, the "Standard of Value" is the hypothetical conditions under which the business is valued and the "Premise of Value" relates to the assumptions upon which the valuation is based.

Key Facts of Business Valuation:

- Price is not the same as Value
The Value of a business, by whatever business valuation method it is obtained, is not the selling price of the business. As Warren Buffett said, "Price is what you pay; Value is what you get." They are not the same.

- Value varies with Person, Purpose and Time
The Value is a subjective term and can have different connotations meaning different things to different people and the result will not be the same, should the context or time changes.

- Transaction concludes at Negotiated Prices
Though the value of a business can be objectively determined employing valuation approaches, this value is still subjective, dependent on buyer and seller expectations and subsequent negotiations and the Transaction happens at negotiated price only.

- Valuation is hybrid of Art & Science
Valuation is more of an art and not an exact science. The Art is Professional Judgment and Science is Statistics. Mathematical certainty is neither determined nor indeed is it possible as use of professional judgment is an essential component of estimating value.

Some Basic Reasons to get Business Valuation

How of Business Valuation - India's Perspective

At present there are no prescribed standards and codes for valuation in India, in many cases the valuation lacks the uniformity and generally accepted global valuation practices. A number of business valuation models can be constructed that utilize various methods under the broad business valuation approaches.

In determining which of these approaches to use the valuation professional must exercise discretion. Each technique has advantages and drawbacks, which must be considered when applying those techniques to a particular business. Most treatises and court decisions encourage the valuer to consider more than one method, which must be reconciled with each other to arrive at a Value conclusion. Understanding of the internal resources and intellectual capital of the business being valued is as important as the economic, industrial and social environment.

Generally Acceptable Methodologies of Valuation

There are broadly three approaches to valuation which need to be considered in any Business Valuation exercise as each approach has its own significance and being helpful in making a sanity check.

  1. Asset Approach
  2. Income Approach
  3. Market Approach

- Asset Approach (NAV) - Generally the Net Asset Value reflected in books do not usually include intangible assets enjoyed by the business and are also impacted by accounting policies which may be discretionary at times. NAV is not perceived as a true indicator of the fair business value. However, it is used to evaluate the entry barrier that exists in a business and is considered viable for companies having reached the mature or declining growth cycle and also for property and investment companies having strong asset base.

  • Book Value Method - It is based on the balance sheet review of assets and liabilities;
  • Replacement Cost Method - It is based on current set up cost of plant of a similar age, size and capacity;
  • Liquidation Value Method - It is based on estimated realizable value of various assets.

- Income Approach - The Income based method of valuations are based on the premise that the current value of any business is a function of the future value that an investor can expect to receive from purchasing all or part of the business.

  • Discounted Cash Flow Method (DCF) - DCF 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.This approach catches the future business potential of a company and is very prevalent in the service industry.
  • Capitalization of Earning Method - The capitalization method basically divides the business expected earnings by the so-called capitalization rate. The idea is that the business value is defined by the business earnings and the capitalization rate is used to relate the two.

- Market Based Approach - In this method, value is determined by comparing the subject, company or assets with its peers or Transactions happening in the same industry and preferably of the same size and region. This is also known as Relative Valuation Method.

  • Comparable Companies Multiples Approach- Market Multiples of Comparable Listed Companies are computed and applied to the Company being valued to arrive at a multiple based valuation.
  • Comparable Transaction Multiples Method - This technique is mostly used for valuing a company for M&A, the transaction that  have taken place in the Industry which are similar to the transaction under consideration are taken into account.
  • Market Value Approach - The Market Value method is generally the most preferred method in case of frequently traded Shares of Companies listed on Stock Exchanges having nationwide trading as it is perceived that the market value takes into account the inherent potential of the Company.

- Other Valuations Approaches

  • Contingent Claim Approach - Under this valuation approach, Option Pricing Model is applied to estimate the Value. Generally ESOP Valuation for Accounting purpose is done using the Black Scholes Method. Now even Patent Valuation is also done using Black Scholes Method.
  • Price of Recent Investment Approach - Under this valuation approach, the recent investment in the business by an Independent party may be taken as the base value for the current appraisal, if no substantial changes have taken place since the date of such last investment. Generally the last Investment is seen over a period of last 1 year and suitable adjustments are made to arrive at current value.
  • Rule of Thumb Approach - Although technically not a valuation method, a rule of thumb or benchmark indicator is used as a reasonableness check against the values determined by the use of other valuation approaches.

Recent Regulatory Changes

- For so long, Valuation has been debated in India as an Art or Science and substantial part of the litigation in Mergers & Acquisitions (M&A) takes place on the issue of Valuation as it involves an element of subjectivity that often gets challenged. More so, as in India, there are no standards for business valuation specifically for unlisted and private companies so in many cases the Valuation lacks the uniformity and generally accepted global Valuation practices. Even limited judicial guidance is available over the subject in India. Further, absence of any stringent course of action and Non Regulation under any Statute is also leading to loose ends.

-  Institute of Chartered Accountants of India (ICAI) has recently developed and recommended Business Valuation Practice Standards (BVPS) aiming to establish uniform principles, practices and procedures for valuers performing valuation services in India.

- The introduction of concept of Registered Valuer in the Companies Bill, 2011 has also provided a framework to enable fair valuation in companies and thus, charts a need for professional valuers for standardizing the use of valuation practices in India, leading to transparency and better governance.

- It has been observed that different regulators in India (RBI, Income Tax, SEBI, etc) have prescribed different and in some cases conflicting valuation methodologies creating practical difficulties. A diagrammatic view is provided below:

Conclusion

Valuation is more of an art and not an exact science, though the value of a business can be objectively determined employing valuation approaches, this value is still subjective, dependent on buyer and seller expectations and subsequent negotiations and use of professional judgment is an essential component of estimating value.

In the absence of standards of business valuation the valuation is more on an art based on the professional experience of the valuer rather than a science based on empirical studies and logics. Though Internationally Business Valuations are governed by broadly various standards like: Valuation Standards of American Institute of CPAs (AICPA), American Society of Appraisers (ASA), Institute of Business Appraisers (IBA), National Association of Certified Valuation Analysts (NACVA), The Canadian Institute of Chartered Business Valuators (CICBV), Revenue Ruling 59- 60 (USA), ICAI Valuation Standard (Recommendatory)however keeping in view the growing relevance and importance of valuation in business and investment decisions as well as in regulatory compliance processes the development of practice of valuation as a discipline and profession in the present context has become a necessity because of imperatives of financial markets, emerging global economy, and changing framework of accounting and financial reporting.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Chander Sawhney
 
In association with
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.