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Valuation of Shares - New Pricing Guidelines

In order to make the pricing methodologies more compatible with the current valuation practice, the
Reserve Bank of India has issued the Notification Number FEMA 205/2010 (“the New Notification”) on April
5, 2010 which shall come into force with effect from April 21, 2010.

The New Notification aims at providing more clarity on the pricing of shares issued by an Indian
company to Non Residents and also brings with it an array of questions which would need clarification to
make the guidelines fully effective.

The salient features of the New Notification are enumerated below. I have tried to capture the difference
between the regulations as they exist now vis-à-vis after the issue of the New Notification.

I. PRICING GUIDELINES AS APPLICABLE TO ISSUE OF SHARES TO NON RESIDENTS

Current position

The current provisions state that an Indian company must issue shares to non resident investors at a
minimum price which should not be lower than:

Valuation Criteria Valuation Method

For Companies whose shares are listed on a Price worked out in accordance with
recognized stock exchange the applicable Securities and
Exchange Board of India (‘SEBI’)
guidelines

For Companies whose shares are not listed on a Fair valuation of shares, which is
recognized stock exchange required to be undertaken by a
Chartered Accountant to determine
the price in accordance with the
erstwhile Controller of Capital Issues
(‘CCI’) Guidelines

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Provisions specified under the New Notification

The New Notification now mandates that the price on issue of shares by an Indian company to a non
resident should not be lower than:

Valuation Criteria Valuation Method Change from existing


provisions
For Companies whose Price worked out in accordance with No Change
shares listed on a the applicable Securities and
recognized stock Exchange Board of India (‘SEBI’)
exchange guidelines

For Companies whose Fair valuation of shares required to • SEBI


shares not listed on a be undertaken by a SEBI registered category merchant
recognized stock exchange Categoryâ€I Merchant Banker or a bankers can also carry
Chartered Accountant, in accordance out the valuation in
with Discounted Free Cash Flow addition to Chartered
(‘DFCF’) method Accountants

• DFCF method of
valuation replaces the
CCI guidelines

Preferential Allotments Price as computed under transfer of RBI has not prescribed
shares from resident to non resident any new guidelines in
in accordance with the RBI guidelines this relation. As per the
issued from time to time. current regulatory
framework, the CCI
guidelines are to be
applied for transfer of
shares of Indian unlisted
companies from Indian
residents to

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nonâ€residents.

Author’s Insights

The CCI guidelines for the valuation of shares of unlisted companies use conservative method of
valuation by considering an average of the Net Asset Value (‘NAV’) of the company and the
company’s Profit Earning Capacity Value (‘PECV’), which was arrived at based on its past financial
performance. Whereas the notification instead specifies DFCF method which is based on future free
cash flows. Since the valuation of shares is a future oriented practice, DFCF method is more
appropriate as compared to CCI Guidelines. Also price to be computed using the DFCF method
would normally be higher than that computed under the erstwhile CCI guidelines.

II. PRICING GUIDELINES APPLICABLE TO RIGHTS ISSUE

Current Position

The FEMA regulations required that if an Indian company issues shares by way of right issue to a
non resident then the price of such shares should not be less than the price at which such offer of
right issue is made to an Indian resident investor.

Provisions specified under the New Notification

The New Notification now mandates that in case of right issue of shares by an Indian company to a
non resident the price should not be lower than:

Valuation Criteria Valuation Method

For Companies whose shares listed on a Price as determined by the company


recognized stock exchange

For Companies whose shares not listed on a Price at which such offer of right issue

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recognized stock exchange is made to Indian resident investors

Author’s Insights

The New Notification gives more realistic approach to the pricing of right issue. Now the price of the
right issue of listed shares would be determined on the basis of prices of such shares at the time
of issue, which gives more appropriate basis of pricing.

Grey Areas

Some areas have been left untouched by the New Notification and require greater clarity from the
government:

• In relation to pricing of shares, the New Notification defines three methodologies; it is


unclear whether these methodologies are to be read independently or cumulatively.

• The meaning and scope of a preferential allotment, particularly in the case of a private
limited company is not spelt out and consequently the treatment of cases that would not
qualify as a preferential allotment is also unclear.

• The status of the applicability of pricing guidelines on share application money received
but pending allotment on the effective date of notification is not clear.

_______

The Author is Chartered Accountant and a licentiate Company Secretary and is a Partner with NMA, a
boutique CA Firm. He has more than 8 years of experience in Tax and Regulatory matters and has also
worked with Deloitte Haskins & Sells. Nirav is also a Lead Advisor to Promaynov (www.promaynov.com), a

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firm engaged in providing executive training and mentoring programmes to CAs and Lawyers which helps the
participants get through BIG4s, MNCs and top Law Firms.

Source : -

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