Valuation

How Valuation works

In a funding round the arithmetic is simple: post-money equals pre-money plus the money raised, the investor's stake is the investment divided by the post-money, and the price per share is the pre-money divided by the fully diluted shares before the round, counting outstanding options, the pool to be created and any convertible notes. The negotiation is over the pre-money and what sits in the fully diluted count. Compulsorily convertible preference shares are issued at that price and convert to equity on the agreed ratio at exit or an IPO.

Three sets of rules require a written valuation around a share issue. The Companies Act requires a report from a registered valuer (registered with IBBI under Section 247) for any preferential allotment or private placement under Sections 42 and 62(1)(c), and shares cannot be issued below that value. FEMA's non-debt instrument rules require shares issued to a non-resident to be priced at or above fair value certified by a SEBI-registered merchant banker or a practising accountant, using an internationally accepted method; a transfer from a resident to a non-resident follows the same floor, and the reverse a ceiling. Income tax Rule 11UA sets the fair market value for unquoted shares (net asset value, or discounted cash flow and five other methods added in 2023) which governs Section 56(2)(x) on the recipient of shares at a discount and Section 50CA on a seller below fair value.

ESOPs need a fourth valuation: the fair market value at exercise, certified by a merchant banker, which fixes the perquisite tax and the employee's cost of acquisition. For secondary sales between existing shareholders, the 11UA value sets the tax floor and the SHA's right of first refusal sets the process. The methods differ in output, so a company commonly has a DCF-based round price far above its 11UA net asset value; that gap no longer creates tax on the company since angel tax was abolished from 2024-25, but each report must exist, be dated before the allotment and be kept on file.

Mistakes we see with Valuation

• Negotiating the pre-money without agreeing whether the new ESOP pool is inside it, which can move the effective price by 10% or more.
• Issuing shares to a foreign investor on the registered valuer's report alone, when FEMA requires a merchant banker's or practising accountant's certificate as well.
• Dating the valuation report after the board meeting that approved the allotment, which the Registrar and investors' counsel both notice.
• Transferring founder shares to a relative at face value when the 11UA value is far higher, creating tax for the recipient under Section 56(2)(x).