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The Startup India initiative has been launched to provide a platform for startups for networking and growing. Valuation of shares is a process of determining the price per share of the business and it is necessary for determining the health of the business and also for regulatory purposes. A startup must obtain a Valuation Report by a Registered Valuer registered with Insolvency and Bankruptcy Board (IBBI) in the following circumstances:

  • Prior to issuing Equity shares, Partly or Optionally or Compulsory Convertible Preference Share or Partly Optional or Compulsory Convertible Debentures.
  • Prior to issuing shares other than cash.
  • Prior to issuing Sweat Equity shares either for cash or for consideration other than cash.

Exception
A valuation report for issuance of the right shares is not required as the shares are issued at the face value of the company.

  • Methods of Valuation
  • Valuation of Shares (Fresh Issue and Transfer) as Per Rule 11UA of Income Tax Rules 1962
  • Valuation of Shares in Case of Fresh Issuance
  • Valuation of Shares in Case of Transfer of Shares
  • Methods of Valuation

    Businesses are generally valued based on the following popular methods. However, all the methods do not suit the startups. Detailed below are the valuation methods and their popularity with startups:

    • Discounted Cash Flow Method (DCF)

    This method is widely used under the income-based valuation. The approach is to estimate the business value by calculating the present value of all future cash flows. It is an accepted method by businesses.

    • Net Asset Value method (NAV)

    This method takes the net value of the business by reducing the liabilities from the assets. This is not a popular method for startups as investments in startups are generally low however they have huge growth potential.

    • Market Value method (MV)

    The market value method is valuing a company based on its price on the stock market. However, this does not go well with startups as they are not listed companies and cannot be found on any stock market.

    As clearly evident, the Discounted Cash Flow method is the only viable method for the valuation of startups and hence also recommended by the Income Tax Rules for valuation of fresh issue of shares.

    Valuation of Shares (Fresh Issue and Transfer) as Per Rule 11UA of Income Tax Rules 1962

    Particulars

    Fresh Issuance

    Transfer

    Applicable Section and rule

    Section 56 (2) (viib)read with Rule 11UA(2)(a)

    Section 56 (2) (x) read with Rule 11UA (1)(c)(b)

    Valuation Method

    Discounted Cash Flow Method (DCF) or Book Value method

    Book Value Method

    Valuer

    Merchant Banker 

    Not prescribed

    Valuation of Shares in Case of Fresh Issuance

    Book value method prescribed under Rule 11 UA(2)(a) of Income Tax Rules, 1962.

    Fair Market Value (FMV) = (A-L) * (PV)/(PE)

    Where,

    A = Book Value of assets adjusted as follows

    • reduced by the amount of tax deducted or collected at the source or advance tax adjusted for refunds
    • any amount shown in the balance sheet as an asset including the unamortized amount of deferred expenditure which does not represent the value of the asset.

    L = Book value of Liabilities not including the following

    • the paid-up capital for equity shares
    • the amount set aside for dividends for equity and preference where such dividends have not been declared before the date of transfer at the AGM
    • reserves and surplus, even if the amount is negative, other than those set apart for depreciation
    • provision for taxation adjusted for tax payments and refunds to the extent of the excess of tax payable with reference to the book profits
    • the amount representing provisions made for liabilities other than ascertained liabilities
    • any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

    PV = Paid-up value of such equity share

    PE = Total amount of paid-up capital (equity) as per balance sheet

    Valuation Date = Date on which the property/ consideration is received by the taxpayer

    An audited balance sheet as on the date of valuation must be considered. If the balance sheet on the valuation date is not available, then the balance sheet adopted and accepted by in the AGM, drawn on the date immediately preceding the valuation date must be considered.

    Valuation of Shares in Case of Transfer of Shares

    Book value method prescribed under Rule 11UA (1)(c)(b) of the Income Tax Rules 1962.

    FMV = (A+B+C+D-L)* (PV)/(PE)

    A= book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) in the balance-sheet —

    • reduced by the amount of income tax paid adjusted against refunds claimed
    • any amount shown in the balance sheet as an asset including the unamortized amount of deferred expenditure which does not represent the value of the asset

    B = Fair value of jewellery and artistic work on the basis of valuation report from a registered valuer

    C = fair market value of shares and securities as per rule 11UA;

    D = Stamp value of immovable property;

    L = Book value of Liabilities not including the following

    • the paid-up capital for equity shares
    • the amount set aside for dividends for equity and preference where such dividends have not been declared before the date of transfer at the AGM
    • Reserves and surplus, even if the amount is negative, other than those set apart for depreciation
    • Provision for taxation adjusted for tax payments and refunds to the extent of the excess of tax payable with reference to the book profits
    • The amount representing provisions made for liabilities other than ascertained liabilities
    • any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

    PV= the paid-up value of such equity shares;

    PE = total amount of paid-up share capital (equity) as shown in the balance sheet

    Valuation Date = Date on which the property/ consideration is received by the taxpayer

    To conclude startups are a unique and emerging sector of the Indian economy and hence the provisions related to the valuation of shares of a startup company find their place in Section 56 (2) (viib)read with Rule 11UA(2)(a) for the fresh issue of shares and Section 56 (2) (x) read with Rule 11UA (1)(c)(b) for transfer of shares.

    Disclaimer: The materials provided herein are solely for information purposes. No attorney-client relationship is created when you access or use the site or the materials. The information presented on this site does not constitute legal or professional advice and should not be relied upon for such purposes or used as a substitute for legal advice from an attorney licensed in your state.

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