How does the process of Business Valuation work?

by  Adv. Deepak Pandey  

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Navigating the Maze: A Guide to Business Valuation in India

Thinking about having an investor on board in your organisation and the investor wants you to evaluate the net worth of your organisation and you are not aware of the process but genuinely want to retain that investor then you don’t need to worry about it. We will help you understand how the process of business valuation works in India along with all the applicable methods suitable to your organisation. So, let’s quickly dig into understanding the true meaning of a business valuation.

Introduction

  • Business Valuation is a process in which the worth of an organisation in terms of finances is calculated. In a nutshell, business valuation provides the overall finances, liabilities, and assets of the organisation. 
  • A Business Valuation is a crucial piece of information that allows an incoming investor, business owner, and stakeholders to know the worth of the organisation. 
  • The Business Valuation of the Company is also essential for anyone who wants to closely monitor the financial activities of the orgainsation. 
  • Obtaining the Business Valuation of a listed entity is comparatively easier than an unlisted company whose shares are not listed on a stock exchange. 
  • Business Valuation is also important from the point of view of the different rules, regulations, and regulatory frameworks prevalent in the country. 

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Different types of Regulations governing Business Valuation in India 

Every regulation has a different set of motives that require the organisations to follow the procedure of Business Valuations. Let’s learn more about those motives and situations under which the below-mentioned regulatory bodies order an organisation to provide their Business Valuation. These regulatory bodies and their motives for ordering Business Valuation are as:

  • Reserve Bank of India: The Reserve Bank of India (“RBI”) is a governmental organisation that is responsible for maintaining the cash flow and inflation in the country. RBI orders a company to present its Business Valuation to check the loan-to-value ratio. 
  • Income Tax Act, 1961: The Income Tax is a Tribunal or regulatory body which is established to manage and act as a watchdog for the income generated from the various sources and to also curb the circulation of the black money. The Income Tax Act of 1961 makes it mandatory to provide the Business Valuation in order to account for the capital gains that have been incurred. Also, the valuation of the unlisted company’s shares will also be taken into consideration. 
  • Securities and Exchange Board of India: The Securities and Exchange Board of India (“SEBI”) is the watch-dog to look after the listing of entities on the stock exchanges and curb the practices that may prove to be detrimental and against the norms set by the SEBI. This is one of the reasons to check for the Business Valuation by the SEBI in order to look after the listing of the securities and the compliance requirement. 
  • Companies Act, 2013: The Companies Act, 2013 is an umbrella legislation to look after not only the formation process of an orgainsation in fact till the time an entity dissolves it is always judged on the parameters set by the Companies Act, 2013. The Business Valuation is required as per the Companies Act, 2013 in the case of the issuing of the sweat equity shares, mergers, demergers, or issuing of the ESOPs. 
  • Insolvency and Bankruptcy Code, 2016: As the name of the legislation suggests it is a legislation that has been established to swiftly complete the process of winding-up the companies. Though, there are also provisions in the Code to provide for the revival of an orgainsation. Therefore, it is very imperative to find the exact value of the Business in order to provide the resolution plan for the organisation. 
  • Indian Accounting Standard: The Indian Accounting Standard (“Ind AS ”) is a standard set up to account for an organisation’s financial annual accounts and this is what makes it obligatory on an organisation to check for their Business Valuation in order to file the annual accounts of the orgainsation.
  • Asset Reconstruction Company: As the name suggests these companies are established to help the organisations revive their assets therefore it becomes essential that the Asset Reconstruction Company is required to perform the Business Valuation of an organisation. 

These are the regulatory bodies that make it mandatory to value the assets and liabilities of an organiation in the form of Business Valuation. 

People also read: When Business Valuation is needed?

Factors to be taken into consideration for Business Valution 

There are certain factors that are required to be taken into consideration while arriving at the Business Valuation as eliminating them will prove to be a beneficial tool for getting the perfect set of Business Valuation. These are as:

  • Validated Information: For arriving at the proper Business Valuation the information is required to be updated and validated so that there will be no chances of error. 
  • Ignoring Market Conditions: Sometimes ignoring market conditions and reading the Property Valuation in isolation of the current market conditions may result in an error in the Property Valuation. 
  • Emotions: Selling the property in a hiffy jiffy results in an error in Property Valuation as there are different market conditions and different price conditions on which the property can be sold ultimately hampering the Property Valuation. 
  • Risk: The property that is less earning and possesses less risk results in a good investment option and thereby attracts a higher Property Valuation. 

Methods of Business Valuation in India

In order to perform the Business Valuation by an independent valuer as defined in the Insolvency and Bankruptcy Code various different methods have been provided to which an organisation is required to fulfill. These are as:

  • Comparable Company Analysis: As the name suggests  it is an approach used to perform the Business Valuation by comparing the financial accounts of the other company in the same industry. It is used to get an idea from the competing organisations as to what are the financial goals, assets, liabilities, what is room for growth, and the involved risks in the industry. After that, a thorough examination of the entity for whom the Business Valuation is being performed can be done easily. 
  • Asset-Based Approach: It is a method of Business Valuation whereby the individual assets of the organisation are valued and then summing them together to get the final Business Valuation. It is  essential that in computing the Business Valuation of the organisation it is very much essential that the tangible as well as intangible assets of the organisation are taken into consideration. 
  • Comparable Transactions Analysis: In this method of Business Valuation the Business Valuation of the organisation is compared with the entities from the same industry which has been recently sold to come to the true conclusion that what is the difference between their valuation and what is be done in order to improve the overall performance of the organisation. 
  • Discounted Cash Flow: It is the approach that uses the current value of the future cash projects of the organisation. The Weighted Average Cost of Capital is used as the discount rate to find the current value of the future cash flows. 
  • EBIDTA (Earnings Before Interest, Tax, Depreciation, and Amortisation): This is one of the most common approaches which takes into account the earnings of the organisation before deducting any interests, taxes, depreciation, and amortisation. 

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The Process of Business Valuation

The process of Business Valuation is a very intriguing factor in knowing the net worth of an organisation. Even the forecast for the business can be realised after understanding the true valuation of the Business. The steps involved in the Business Valuation are as follows:

  • Underlining the Purpose of Valuation: The first step in the process of Business Valuation is to understand and underline clearly as to what is the purpose of Business Valuation whether it is being done in order to fulfil any forms of the above-mentioned regulatory body or achieve any internal growth prospectus or purpose.
  • Drawing the Property Valuation Agreement: The purpose of drawing up the Valuation Agreement is to list out all the essential elements required to complete the process of Business Valuation. These may include the date, its purpose, and the standard of value to be used for Business Valuation. 
  • Gathering the relevant documents: The next step in the process is to gather all the required documents for completing the Business Valuation. These are as balance sheets, operating agreements, income tax statements, leases, receipts of the payment of taxes, contract, etc. 
  • Financial Analysis: The next step in the process of Business Valuation is the financial analysis of the assets be they tangible, intangible, depreciating, or non-depreciating assets taken into consideration by the valuer so appointed. 
  • Gathering Industry Knowledge: It is very essential that Industry Knowledge should be obtained by comparing the same type of industries in which the valuing organisation is working in order to more elaboratively understand the prevailing trends and the situation of the industry. 
  • Application of the Valuation Methods: The next step in the process of Business Valuation is to apply the most appropriate Business Valuation method to the finances of the organisation gathered so far. 
  • Application of Discounts and Premiums: With the help of these Valuation methods some adjustments are required to be done to arrive at the final Business Valuation. These may range from discounts and premiums. 
  • Releasing the forecasts for the organisation: The next step in the process is after the Valuation of the Company has arrived it is important to release the business forecast for either the next quarter, six months, or a year.
  • Analysing the performance of the organisation: After applying the suitable valuation method and obtaining the Business Valuation the next step of the stakeholder, business owner, and investor is to analyse the performance of the organisation and the important steps that may be taken in order to curb any issues that have been highlighted in the performance sheet. 
  • Reporting and Documenting the Data: The last step in the process of Business Valuation is to prepare the reporting for the Business Valuation prepared so far and it is also essential that this data should be published to the regulatory bodies that wanted to get the Business Valuation revealed to them. 

People also read: FCFF & FCFE Valuation

Indian Case Laws Pertaining to Business Valuation

With the help of the below-mentioned landmark judgments validation has been provided to the various methods of the Business Valuation as discussed above. Some of the examples of these case laws are as:

  • CIT v Reliance Industries Ltd: In this case a comparable analysis of the market was done to arrive at the Business Valuation of the organisation and at the same time to know its worth and the Hon’ble Supreme Court of India concluded that it is a good approach to arrive at the Business Valuation with the Company Comparable method.
  • DLF v Securities and Exchange Board of India: With this decision the Securities and Exchange Board of India (“SAT”) has held that using the Net Value Asset method to arrive at the Business Valuation of the Company was correct and is genuinely required to know the market price of its shares.
  • ICICI Bank v Satyam Computers Ltd: In this case the Bombay High Court that the Discounted Cash Flow is the correct method to arrive at the true Business Valuation of the organisation. 

Therefore, it can be summed up after looking at the various examples of these case laws that Business Valuation is dependent upon the type of the organisation, the industry in which the organisation is working, and the future growth prospectus. 

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Conclusion

Business Valuation is the process by which the true value of an organisation can be derived. However, there is no straightjacket formula to using the method by which an organisation knows its worth. There are a good chunk of methods that are required to be implemented keeping in mind the various factors to arrive at the Business Valuation. It is always advised to seek legal guidance for Business Valuation. 

People also read: What is Marine Valuation and Why is it Required

FREQUENTLY ASKED QUESTIONS

Q1. How to Calculate the Valuation of a Business?

Ans1. Usually, it is done after adding the total revenue of the organisation prior to subtracting the operating expenses and then multiplying it by the industry multiple prevalent at the time of Business Valuation.

Q2. How is Business Valuation calculated in Shark Tank?

Ans2. The Business Valuation in Shark Tank is calculated by considering the last year’s sales and revenue and they also sometimes consider any revenue that is in the pipeline. 

Q3. How many times profit is a Business Worth?

Ans3. It is established that a small business may have 1-2 times the annual profit while a high-growth industry is expected to be more than 3-5 times. 

Q4. What is EV in Valuation?

Ans4. EV stands for Enterprise Valuation and it is a measure used to value the company’s total value. 

Q5. What is EBITDA Multiple?

Ans5. It is a ratio that takes into account the return on investment of the organisation in their Business Valuation. 

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Adv. Deepak Pandey

Adv. Deepak Pandey

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Deepak Pandey offers legal consultancy and advisory services with a keen emphasis on ethical and professional conduct to achieve favourable results. He has 5 years of experience in handling legal cases. As a result of his strong communication skills, Deepak is able to present his clients' cases with clarity and persuasion.

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