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Last few years has brought entrepreneurship, startups and valuations to the forefront of mainstream discourse in India. A lot is to be associated with the startup renaissance and the creation of new heroes in the form of entrepreneurs.
Any business magazine or newspaper can’t be complete without the story of a recent fund raise and its corresponding valuation. Business valuation is not only a metric for a tech startup to track, but also for every business owner serving a multitude of reasons like business planning, tax purposes, retirement planning and financing.
There are more than 30 million such business owners and entrepreneurs in India who should be aware of this metric. Warren Buffet famously once said that if there was one course a business school should teach, it should be around business valuation. He quoted: “Business valuation is the heart of investing and risk management and without it you are blind.”
Apart from the obvious transactional purposes like buying/selling of businesses and equity financing, these are some of the reasons why knowing your business value is important.
Income tax reasons require businesses to report valuations under Rule 11U & 11UA by using globally accepted valuation methods. FEMA (Foreign Exchange Management Act) requires companies to do a valuation while transferring unlisted shares to a non-resident. SEBI (Securities Exchange Board of India) and Companies Act also specify certain specific valuation guidelines.
Succession & Will Planning
India is home to thousands of family businesses, and as time passes, the third generation is looking to carve their own career paths leaving family businesses without a proper successor. Succession planning will become more important in the coming years, and a robust plan would not be possible without knowing the value of the business.
A Buy-Sell agreement is a legal agreement among business owners that governs a situation when a business owner leaves out of choice or owing to death. Business valuation is important to determine the price at which
the shares of the departing owner would be transferred for.
Key Person Insurance
Key person insurance is a kind of business insurance taken by the employer on the exit of a key individual from the business. As we transition into a knowledge economy, individuals would be the most important asset for any business and protecting the firm against their departure would become essential. Estimating the value the key man adds to the business might require conducting a business valuation.
Employee Stock Ownership Plan (ESOP)
As businesses look to empower employees, ESOP is one of the most common and effective ways to grant
stock options to your employees. Pricing of the shares in the ESOP plan would require a business valuation
using some of the globally accepted practices.
Valuation is a performance metric that embodies profitability, growth, efficiency, goodwill, scalability and market conditions. This comprehensive outlook is essential for every business owner to truly understand where he/she stands rather than purely looking at profits.
As India goes through this transition, it’s important that valuation is not just episodic but a continuous dynamic process for business owners and their advisors to discover, monitor and optimize.
(This article first appeared in the Indian edition of Entrepreneur magazine (January, 2016 Issue).