“Price is what we pay, value is what we get” – Warren Buffet
“Flipkart valuation slashed to $5.37 Bn by investor Fidelity” – Economic Times
“Reliance Industries Ltd. (RIL) became the most-valued Indian company to trade at a market value of INR 4.57 trillion” – Live Mint
“Everstone backed S Chand seeks $360 mn valuation” – VCCircle
Every day we come across various news articles with plethora of cases describing the mark up and mark down of business valuations. But what is valuation and why do we need it?
Well, valuation is a process of estimating the fair market value of an asset. An asset can be tangible like land & buildings, shares, securities, cars or intangibles like intellectual property, trademarks, patents, brands. Different people assign different meanings to valuation. For eg. You may have a different view of valuation when you are buying an asset and a contrasting view when you are selling the same.
The process of valuation is critical from both a commercial and a regulatory perspective. From a regulatory perspective, valuation is required under Income tax Act, Companies Act, FEMA etc. subject to conditions, to establish the fair market value of the asset involved in a proposed transaction. Also, adopting an appropriate valuation methodology backed by rational assumption is critical to avoid litigation across these regulations in India. Commercially, valuation is an integral part of our lives be it for immovable assets, such as real estate or movable assets being commodities including jewelry, securities, vehicles etc.
Valuation is considered as a science as well as an art. One being the concept of reason and other being the concept of creativity. Science lies in the complex mathematical calculations that the valuer carries out while performing valuation while the art lies in the subjective assumptions and the judgments made by the valuer.
One of the questions that arises is “what is the need of business valuation if I am not looking to sell my business?” which is indeed a reasonable question.
Well, Valuation is not done just when the company is about to be sold, the reasons that necessitate the need for valuing a business are varied and wide-ranging. As professional Chartered Accountants, we are constantly appointed by clients to derive the value of shares and securities which may be adopted by our clients for various commercial transactions and regulatory compliances to achieve their varying objectives including:-
- Raising of Equity Capital
- Raising of Debt
- Sale or acquisition of a business or a division thereof
- Reporting performance of a business to stakeholders
- For distribution of profits including through buyback of shares
- Reconstruction of business through mergers, demergers
As advisors to some of the largest corporates and Family Offices in and outside India, operating in diverse sectors across different scale of business, we are constantly challenged to identify the most appropriate method to adopt and assess a fair market value for shares and securities.
The approach to valuation is driven by certain globally accepted methodologies which are as follows:
1. INCOME BASED APPROACH
The income approach comprise of valuation methods that determine the value of business based on its ability to generate income streams/cash flows in future. Under this method, the value of a business is arrived at by discounting the future cash flows of the business at a particular discount rate
2. ASSET BASED APPROACH
The asset based approach determines the value of business by calculating its Net Asset Value i.e the difference between the fair market value of company’s total assets and total liabilities
3. MARKET APPROACH
Under this method, the value of business is calibrated by comparing the business to other similar businesses.
There are two types of methods under this approach:
– Transaction Multiple Method: Under this method, the value is derived using the pricing metrics of the transactions that have taken place in the comparable companies which are in similar line of business.
– Trading Multiple Method: Under this method, the value is derived by using pricing metrics of securities of similar companies which are being traded in the market
However, within these above mentioned approaches, one may be conservative or aggressive. Being conservative or aggressive sometimes depends upon the purpose of valuation. But the real value of the asset is at which the transaction take place. It is for this reason that many people use the transaction guideline and trading guideline method as the key indicator of the real value of the asset.
Since valuation is a highly subjective matter, no two valuers can value the asset in the same way or at the same price and this disparity may be due to the different assumptions.
Valuation is an interactive process between the valuer and the business owner. The quality of information provided pertaining to the asset plays a significant role in valuing the asset. As professionals, we possess a reasonable knowledge and understanding of various sectors and business dynamics both at a micro and macro level. However, each business has its own nuisances, competitive edge, risks and accordingly expectation of returns. The better you understand the business, the more reliable and rational will be your valuation. It is integral for both the client owning the asset and the service provider valuing the asset to interact and exchange information in a comprehensive manner to build a strong base for a reliable assessment of fair market value.
The whole idea of writing this blog was to enable the readers get a sense of the cosmos of valuation. In the upcoming blogs, we will discuss certain case studies that will give you a practical insights on how do we perform valuations.