Business valuation is the process of assessing the worth of the enterprise which is subject to merger or takeover so that the consideration amount can be quantified and price of one enterprise for the other can be fixed. Such valuation helps in determining the value of shares of the acquired and acquiring company to safeguard the interest of the shareholders of both the companies. The share of any member in a company is a movable property and can be transferred in the manner provided in the articles. A share represents a bundle of rights like right to elect directors, to vote on resolutions of the company, share in the surplus, if any, on liquidation etc. Valuation of shares in an amalgamation or takeover is made on a consideration of a number of relevant factors, such as stock exchange prices of the shares of the two companies, the dividends paid on the shares, relevant growth prospects of the companies, values of the net assets and even factors which are not evident from the face of the balance sheet like quality and integrity of the management, present and prospective competition, yield on comparable securities, market sentiments etc. Business valuation has to be tempered by the exercise of judicious discretion and judgment as it is a very crucial and complicated issue.
Need and Purpose of Business Valuation
There are a number of situations which trigger the need to know the value of a business — strategic partnerships, merger or acquisition of a business, employee stock ownership plans (ESOPs), joint ventures, etc. From the perspective of a valuer, a business owner, or an interested financial party, a valuation provides a useful base to establish a price for a business or to help increase a company’s value and attract capital. The necessity for valuation of shares arises inter alia, in the following circumstances:
Assessments under the Wealth Tax Act;
- Purchase of a ‘block of shares’, which may or may not give the holder thereof a controlling interest in the company;
- Formulation of schemes of amalgamation, etc.;
- Acquisition of interest of dissenting shareholders under a scheme of reconstruction;
- Conversion of shares;
- Advancing a loan on the security of shares.
For transactions involving a relatively small number of shares, which are quoted on the stock exchange, normally the price prevailing on the stock exchange is accepted. However, valuation by experts is called for when the parties involved in the transaction/deal/scheme, etc. fail to arrive at a mutually acceptable value or the agreements or Articles of Association, etc. The business valuation by a valuer becomes necessary when:
- Shares are unquoted;
- Shares relate to private limited companies;
- Courts so direct;
- Articles of Association so provide;
- Relevant agreements so provide;
- Statute so requires.
Business Valuation can serve many purposes – to establish a price, to help increase value, to attract capital and to meet governmental requirements.
The significance of business valuation is however, different in different areas. Business valuation is necessary for the decision making by shareholders to sell their interest in the company in the form of shares. Self evaluation may be done by the company being merged with another but it must be satisfied with the value of the shares, it’s shareholders should get in the form of shares of the merging company for effecting merger. Such satisfaction is necessary to weigh the over-valuation of shares of acquirer and/or under valuation of shares of the acquired or vice-versa. Therefore, to enable shareholders of both the companies, to take decision in favor of amalgamation; valuation of shares is needed and once they are satisfied and have approved it with requisite majority, the court approves the same while sanctioning their scheme of amalgamation, because it is the interest of shareholders which will suffer in the event of wrong valuation.
The value of a firm can be directly related to the decisions it makes — on which project it undertakes, on how it finances them and on its dividend policy. Understanding this relationship is the key to making value-increasing decisions and sensible financial restructuring. Valuation is the central focus in fundamental analysis. The underlying theme in fundamental analysis is that the true value of the firm can be related to its financial characteristics — its growth prospects, risk profile and cash flows. A deviation from this value is a sign that a stock is under or over valued.
Business Valuation plays a significant part in acquisitions: Valuation of the target in an acquisition is an important part of the process of determining the consideration to be offered to the target shareholders. The value that the bidder places on the target sets the maximum or ‘walk away’ price that the bidder can afford to offer the target shareholders. The value of the target from the bidders point of view is the sum of the pre-bid stand alone value of the target. On the other hand, target companies may be unduly optimistic in estimating value, especially in hostile takeovers, as their attempt is to convince the shareholders that the offer price is too low. Valuation of shares also depends on who the buyer is. A low-profile company can extract high price if a big company like Microsoft eyes the new profile company as a takeover proposition.