A Founder’s Guide to Valuation Certificates

Valuations! Yes, something no founder can get away from. While arriving at the valuation of your startup is a to and fro with your investors, once you get to it, there is a tonne of paperwork around it that a startup needs to negotiate.

In this blog, we have comprehensively covered valuation certificates, including definitions, when they should be issued, who can issue them, associated documents and requisites, and the various models used to issue valuation certificates.

Certificate of Valuation

A valuation certificate is a certified business valuation required to ascertain the fair market value or FMV of shares of a company.

A valuation certificate is required under the Companies Act 2013 when the company issues shares or raises funds. As per the Income Tax Act, this certificate can be procured from a registered valuer or merchant banker.

While raising funds, a startup is required to submit 2 types of approved valuer certificates:

1. From a registered valuer
   (Under the Companies Act)
2. From merchant banker
   (Under the Income Tax Act)

To understand, when a valuation certificate is required from both merchant bankers & registered valuers, or only from one of them, see the table below:

Note – DPIIT certified Startups must apply for Angel Tax exemption on the Startup India website – https://www.startupindia.gov.in/content/sih/en/Form-56.html. Then only the Valuation Certificate requirement is exempted. Note that this exemption is availed under Section 56(2)(vii) of the Income Tax Act and as per notification G.S.R. 127 (E). Also, note that the aggregate amount of paid-up share capital and share premium of the startup after the proposed issue of a share, if any, should not exceed INR 25 crore.

Valuation Certificate from a Registered Valuer

Typically, a registered valuer would need around a week to get the valuation report ready (provided all required documents are submitted beforehand). The valuer charges in the range of INR 30,000 – 50,000 depending on the method of valuation used.

Documents required under Companies Act, 2013 to get the certificate of valuation from a registered valuer:

• A detailed description of the business model of the company, including major risks
• Audited financial statements of the company for the past 2 years
• Financial statements of the company to date
• Financial projections of the company for 5 years, including income statement, balance sheet, and cash flow statement
• Latest cap table
• ESOP scheme document
• Cash position (as on the date of valuation)
• Justification for the major assumptions used in the projections like sales growth, working capital, and capital expenses
• Details of any prior investment in the company and the valuation report forming the basis of the said investment
• Major competitors of the company (listed and unlisted)
• Details of any recent funding in comparable companies, if available
• Term sheet

Valuation Certificate from a Merchant Banker

A merchant banker is someone who provides banking and consultancy services. They help clients with financial, marketing, managerial and legal matters.

As per SEBI rules, a merchant banker is a person who has obtained the registration under section 8A of SEBI (Merchant Banker) Regulations, 1992 and who is engaged in the business of issue management either by making arrangements regarding buying, selling, or subscribing to securities or acting as manager, consultant, or rendering corporate advisory services in relation to such issue management. A SEBI registered merchant banker is authorized to provide a certificate of valuation for a company, especially, if required, under the Income Tax Act.

To be recognized by SEBI as a merchant banker, one must meet the following eligibility criteria:

• Professional qualification: Degree in law, finance, or business management
• Compliance with capital adequacy norms: A merchant banker requires having a minimum net worth of not less than INR 5 crore
• Record: The individual must have a record including experience, reputation, etc.
  

Typically, a merchant banker would need around 10 – 15 days to issue a valuation report. And, the merchant banker charges approximately INR 50,000 – 65,000 for the same. Note that a merchant banker valuation report is not required if you are issuing the shares to the existing shareholders through a rights issue. However, a merchant banker valuation report might be demanded during income tax audits or while issuing shares to the new class of investors.

Documents required:

• A detailed description of the business model of the company, including major risks
• Financial statements of the company to date
• Major competitors of the company (listed and unlisted)
• Financial projections of the company for 5 years, including income statement, balance sheet, and cash flow statement
• Method to arrive at the projections

Different valuation models that are used by Registered Valuers & Merchant Bankers

• Net Asset Value: This is the most basic way to do a valuation. The sum of assets is taken, and the outstanding liability is subtracted from that value.
• Discounted Cashflow Method: This is the most common way to get the valuation done. Future projections are considered for arriving at the valuation. The projections, budgets, and cash flow for the next 5 years are prepared to go through this valuation.
• Comparable Company Analysis: In this method, a competitor is identified, and accordingly, a valuation is conducted.

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