India FDI M&A Pricing Guidelines Revised

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The Reserve Bank of India (RBI) rolled out its first bi-monthly Policy Statement on April 1st, part B of which constitutes Development and Regulatory Policies addressing several areas. As per the policy statement by the RBI:

As regards foreign direct investment (FDI), it has been decided to withdraw all the existing guidelines relating to valuation in case of any acquisition/sale of shares and accordingly, such transactions will henceforth be based on acceptable market practices. Operating guidelines will be notified separately.

The RBI notification no. FEMA 205/2010 dated April 7th, 2010 mandates the pricing of shares by applying the Discounting Cash Flow Method (DCF) of valuation. DCF is one of the most practical methods for share pricing as it is based on the Income Approach for valuation, which is in turn based entirely on the Future Cash Earning Capacity of any business. This accordingly enables the price to reflect the optimum value of the business.

However, DCF can be challenged by other factors, such as Start-up Valuation, Minority Interest and so on. DCF can be ineffective when reflecting the proper value of a business during the startup phase, an issue especially common within the e-commerce and IT sectors.

The RBI has accordingly recommended any sale or purchase of shares be valued as per best market practices. This opens up valuations to the use of not only the Discounted Cash Flow method, but the following methodologies may also now be considered when valuing FDI permissible instruments:

a)     Market Multiple Method

b)    Comparable Transaction Method

c)     Net Asset Value Method

d)    Any other appropriate method depending upon the nature of business.

The amendment in pricing guidelines is for the acquisition and sale of shares. The RBI has not yet addressed which approach will be used in the case of fresh issue of shares, and further clarification on this point will be required.

The change in the pricing guidelines is immediately effective from April 1st, 2014 and there will be no mandatory requirement to value FDI permissible instruments using the Discounted Cash Flow method. It can be any method as mentioned above depending upon the nature of business.

However, in hindsight, our view is that the DCF method is the best way to value FDI permissible instruments. Accordingly, our opinion is that the change has been triggered due to recent disputes with the Indian Income Tax Department relating to the pricing of shares in recent cases.

Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam in addition to alliances in Indonesia, Malaysia, Philippines and Thailand as well as as well as liaison offices in Italy and the United States.

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