When a new company is incorporated, it requires the capital for which it issues the shares. The Memorandum of Association has the information on the authorised share capital, number of shares and face value of each share. Authorised capital is defined as the maximum amount of share capital that the company is authorized by its constitutional documents to issue to shareholders. Part of the authorized capital can remain unissued. The authorized capital can be changed with shareholders’ approval. The face value is the initial cost of the share fixed by the company. Face Value never changes. The market value of stock however increases or decreases based on company’s performance and demand & supply of the share. Market Value usually never goes below Face Value. The difference between what shareholders pay for a share and the face value is referred to as additional paid-in capital or premium. Out of amount you pay, only amount equivalent to face value is your contribution to company and rest goes to seller as premium. That’s the reason, company pays dividend on face value amount only.
Now if the company requires to sell the shares or wants an angel investor to invest in the company then as per the concept of valuation of shares it can sell the shares at a higher price.
The important question is why an angel investor is interested in investing at higher price. The reason being angel investor invests in early stage or start-up companies in exchange for an equity ownership interest. The angel investors are interested in:
- The quality, passion, commitment, and integrity of the founders.
- The market opportunity being addressed and the potential for the company to become very big.
- A clearly thought out business plan, and any early evidence of obtaining traction toward the plan.
- Interesting technology or intellectual property.
- An appropriate valuation with reasonable terms.
- The viability of raising additional rounds of financing if progress is made.
Therefore, the accountants are called upon by the company to value the shares by following the methods depending upon the need of the company:
- Asset-backing method
- Yield-Basis Method
- Fair Value Method
- Return on Capital Employed Method
- Price-Earning Ratio Method
The value of share of a company depends on so many factors such as:
- Nature of business.
- Economic policies of the Government.
- Demand and supply of shares.
- Rate of dividend paid.
- Yield of other related shares in the Stock Exchange, etc.
- Net worth of the company.
- Earning capacity.
- Quoted price of the shares in the stock market.
- Profits made over a number of years.
- Dividend paid on the shares over a number of years.
- Prospects of growth, enhanced earning per share, etc.
The need for valuation of shares may be felt by any company in the following circumstances:
- For assessment of Wealth Tax, Estate Duty, Gift Tax, etc.
- Amalgamations, absorptions, etc.
- For converting one class of shares to another class.
- Advancing loans on the security.
- Compensating the shareholders on acquisition of shares by the Government under a scheme of nationalisation.
- Acquisition of interest of dissenting shareholder under the reconstruction scheme, etc.
Factors Influencing Valuation
- Current stock market price of the shares.
- Profits earned and dividend paid over the years:
- Availability of reserves and future prospects of the company.
- Realisable value of the net assets of the company.
- Current and deferred liabilities for the company.
- Age and status of plant and machinery of the company.
- Net worth of the company.
- Record of efficiency, integrity and honesty of Board of Directors and other managerial personnel of the company.
- Quality of top and middle management of the company and their professional competence.
- Record of performance of the company in financial terms.
- RBI master directions: FEMA
- Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017
- Technical guide on valuation of shares by ICAI
- Foreign Direct Investment (FDI) in India – Issue/Transfer of Shares or Convertible Debentures – Revised pricing guidelines
- PricewaterhouseCoopers article