Our previous post deals with the various constituents of a term sheet and one such constituent being the price is always hinged on valuation of the entity. This post deals with the various methods of valuation generally accepted in the Indian context.
Valuation matters to entrepreneurs because it determines the portion of their company they have to give away to an investor in exchange for money. Ascertaining the most appropriate method of valuation of the securities of a company is in the event of receipt of an investment or sale of existing securities is an essential part of any transaction. This is also a statutory requirement.
Methods of Valuation: The issue/transfer price of unlisted equity instrument may be determined as per internationally accepted pricing methodology duly certified by a Chartered Accountant or a Registered Merchant Banker. The most commonly used methods of valuation are the DCF (Discounted cash flow) and Return on Equity method (ROE).
Internationally accepted methods of valuation which are also accepted by the Reserve Bank of India
Asset approach
Net asset value method: An asset-based approach is a type of business valuation that focuses on a company's net asset value (NAV).
Liquidation Value: Liquidation value is the total worth of a company's physical assets when it goes out of business or if it were to go out of business.
Income approach
Discounted Cash Flow: DCF is a valuation method used to estimate the attractiveness of an investment opportunity. DCF analysis uses future free cash flow projections and discounts them to arrive at a present value estimate, which is used to evaluate the potential for investment.
Yield method: It is always expressed in terms of percentage. Since the valuation of securities is made based on yield, it is called Yield-Basis Method.
Market approach
Market Price: The market price method reflects an individual's willingness to pay for the costs and benefits of shares that are bought and sold in markets.
Comparable transactions: Comparable transactions consider the past sales of similar companies as well as the market value of publicly traded firms that have an equivalent business model to the company being valued.
Not all of the above methodologies would yield the same result. The choice of the method of valuation is usually dependent on the age of the company and the industry in which it operates. This is also a subjective process though is largely based on the historic financial records of the Company.
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.