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November 16, 2022 No Comments



Valuation Compliance for Startup in India

Valuation is more of an art than a science. It has gained lot of popularity in the space of Startup world. When the Startup is planning to raise funding, it has to go through many compliance under various laws in India like the Companies Act, 2013, the Income Tax Act 1961, the FEMA provisions etc. The applicability of any specific laws, regulations and sections will depend upon various factors.

1. Type of shares / securities used for fund raising:

The type of shares & securities that are issued by the Company are decided by many factors which can be; choice of the investors, exit mechanism, regular payments to be given to investors etc. The Share Subscription Agreement & Term Sheet consist of all the details regarding the types of shares & securities to be issued to the investors, investment amount, pre fund release and post fund release conditions to be followed, % to be diluted and many more.

The main types of the shares and securities issued in Startup funding in India can be broadly:

a.    Equity Shares: The equity shares are of two types, one is issued to the Founders at the time of formation of the Company and another is investors equity shares (another class of shares, which may consist of different voting rights as well).

b.   Preference Shares: The preference shares are the shares which has preference over equity shares of the Company. The most popular type of preference shares used for VC funding are Compulsory Convertible Preference Shares (CCPS), those will have certain % of dividend rights and ratio of conversion with equity shares to claim the ownership in the Company.

c.    Debentures: The debentures are type of debt instruments, generally Convertible Dentures are used for VC funding. These debentures can be compulsory convertible or optionally convertible debentures.

2.  Compliance from the perspective of the Companies Act 2013

The shares can be issued to the new investors via Private Placement or Preferential Allotment under the Companies Act 2013. The shares can be issued to the existing investors via right issue as well.

The following steps need to be followed for the compliance under the Companies Act 2013:

a.    Increase in Authorized Capital of the Company

b.   Board of Directors and Shareholders approval is required

c.    Valuation Certificate from Registered Valuer is required

d.   PAS 3, PAS 4, MGT 14 are required to file to ROC

Under Private Placement offer is made to specified investors to invest funds and they are not the existing shareholders of the company, while under preferential allotment, the shares are issued to the investors who are given preference over existing shareholders.

3. Compliance from the perspective of the Income Tax Act 1961

The Income Tax Act provisions are come into picture at the time of sale / transfer of shares / securities for the calculation of Capital Gain Tax to be paid. For the calculation of the Capital gain the Fair Market Value (FMV) should be considered, the FMV should be calculated as per rule 11UA of the Income Tax Rules. The rules provide two valuation methods, one is based on Book Value of the Company (NAV) and another is based on Discounted Cash Flow (DCF) methods.

4. Compliance from the perspective of FEMA guidelines:

Incase where the foreign investors are investing funds in the Company, then Advance Reporting Forms and FC GPR forms need to be submitted to RBI. Here the valuation certificate is required to be attached along with other documents as per the requirements.

5. Valuation Report and Registered Valuer:

The Valuation of Shares and Securities is now regulated under section 247 of the Companies Act 2013, where valuation reports to be obtained from registered valuer only. The valuer must be registered with IBBI, hence the Startups must insure that the valuation reports are obtained from registered valuer only.

About the Author: Mr. Aditya Chokhra is a Chartered Accountant by profession having more than 13 years of experience in the filed of Financial Management, Valuation of Companies, Financial Modelling, Project Finance etc. He is also an IBBI Registered Valuer for Securities or Financial Assets.

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