21 July 2014 | Volume 6 Issue 6
RBI acknowledges internationally accepted pricing methodology for valuation of shares

Background
In April 2010, the Reserve Bank of India (RBI) had mandated that the valuation of shares issued by an Indian company to a foreign company should be done based on the Discounted Cash Flow (DCF) method only.  The Discounted Cash Flow (DCF) method is a prominent method based on the Income Approach of valuation, which is entirely based on the ‘future cash earning capacity’ of any business and thus, often leads to an optimum value scenario.

With an aim to simplify the foreign direct investment (FDI) process, the RBI in its First Bi-monthly Monetary Policy Statement, 2014-15 announced the withdrawal of all existing guidelines relating to valuation in case of an acquisition/sale of shares of an Indian company and it was proposed that the valuation would be based on internationally acceptable market practices.


The RBI has notified that valuation needs to be performed according to any internationally accepted pricing methodology on an arm’s length basis. [1] Additionally, partly paid equity shares and warrants issued by an Indian company in accordance with the provision of the Companies Act, 2013 and the Securities and Exchange Board of India’s (SEBI) guidelines, as applicable, shall be eligible instruments for the purpose of FDI and foreign portfolio investment (FPI) by Foreign Institutional Investors (FIIs)/Registered Foreign Portfolio Investors (RFPIs) subject to compliance with FDI and FPI schemes.[2]  
 
Impact of the amendment
With the change in pricing guidelines, the valuer needs to apply professional judgement and the applicable valuation methodologies on a case-by-case basis. This implies that other valuation methodologies such as the Market Multiple method, Comparable Transactions method, Net Asset Value method, etc. also will need to be considered while valuing FDI-permissible instruments, including warrants and partly paid shares.

As the new guidelines emphasise on applying the revised pricing guidelines on an arm’s length basis, this will help Indian companies to comply with not only the RBI but also with transfer pricing regulations. 
 


Conclusion
  • Equity Shares, Convertible Preference Shares or Convertible Debentures (Equity Instruments) of an unlisted company shall be issued at a price not lower than the value arrived at as per any internationally accepted pricing methodology for valuation of shares on an arm’s length basis.
  •  A non-resident investor shall be eligible to exit from the investment in equity instruments of an Indian company with or without the optionality clauses, at a price not more than that arrived at as per any internationally accepted pricing methodology on an arm’s length basis, subject to the applicable lock-in period. The guiding principle would be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment/agreement and shall exit at a fair price computed as above at the time of exit.
  • The non-resident investor shall be eligible to acquire equity instruments from the resident shareholders at a price not less than the value arrived at as per any internationally accepted pricing methodology on an arm’s length basis. 
  • Share warrants and partly paid shares shall be eligible instruments subject to certain conditions as mentioned above. The pricing of the partly paid equity shares shall be determined upfront. In case of warrants, the price/conversion formula should be determined upfront and the price at the time of conversion should not be lower than the fair value worked out at the time of issuing such warrants.
     

[1] Circular No. 306/ 2014 dated 23 May 2014 read with RBI/2014-15/129 A.P. (DIR Series) Circular No. 4 dated 15 July 2014
[2] RBI/2014-15/123 A.P. (DIR Series) Circular No. 3 dated 14 July 2014
To discuss how this change could affect your business, please feel free to get in touch with us. You can contact:

Deepti Ahuja, Partner
deepti.ahuja@skpgroup.com
+91 22 6730 9000

Anshuman Bhar, Senior Consultant
anshuman.bhar@skpgroup.com
+91 22 6555 9959

SKP
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+91 22 6730 9000 |
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