Meaning, Need for Valuation of Shares

Valuation of shares is the process of knowing the value of companys shares. Share valuation is done based on quantitative techniques and share value will vary depending on the market demand and supply. The share price of the listed companies which are traded publicly can be known easily. But w.r.t private companies whose shares are not publicly traded, valuation of shares is really important and challenging.

Need for the valuation of shares arises:

1. Where companies amalgamate or are similarly reconstructed, it may be necessary to arrive at the value of shares hold by the members of the company being absorbed or taken over.
2. Where shares are hold jointly by the partners in a company and partnership firm dissolved, it becomes necessary to value of shares.
3. Where a portion of the shares is to be given by a member of proprietary company to another member as the member cannot sell it in the open market, it becomes necessary to certify the fair price of these shares by an auditor.
4. When a loan advanced on the security of shares, it becomes necessary to know the value of shares on the basis of which loan has been advanced.
5. When shares are given in a company as gift it may be necessary for the purpose of assessing gift tax, to place a value on the shares.
6. When preference shares or debentures are converted into equity share it becomes necessary to value the equity shares for ascertaining the number of equity shares required to be issued for debentures or preference shares which are to be converted.
7. When equity shareholders are to be compensated on the acquisition of their shares by the government under a scheme of nationalization then it is necessary to value the equity shares.

Important of Valuation of shares:

• One of the important reason is when you are about to sell your business and you wanted to know your business value
• When you approach your bank for a loan based on shares as a security
• Merger, acquisition, reconstruction, amalgamation etc – valuation of shares is very important
• When your company shares are to be converted i.e. from preference to equity
• Valuation is required when implementing an employee stock ownership plan (ESOP)
• For tax assessments under the wealth tax or gift tax acts
• In case of litigation, where share valuation is legally required
• Shares held by an Investment company
• Compensating the shareholders, the company is nationalized

There are various reasons for adopting a particular method for share valuation; it generally depends upon the purpose of valuation. Using a combination of methods generally provides a more reliable valuation. Let’s see under each approach what the main reason is:

1. Assets Approach

If a company is a capital-intensive company and invested a large amount in capital assets or if the company has a large volume of capital work in progress then asset-based approach can be used. This method is also applicable for valuing the shares during amalgamation, absorption or liquidation of companies.

2. Income Approach

This approach has two different methods namely Discounted Cash Flow (DCF) or Price Earning Capacity (PEC) method. DCF method uses the projection of future cash flows to determine the fair value and if this data is reasonably available, DCF method can be used. PEC method uses historical earnings and if an entity is not in the business for a long time and just started its operations, then this method cannot be applied.

3. Market Approach

Under this approach, the market value of the shares is considered for valuation. However, this approach is feasible only for listed companies whose share prices can be obtained in the open market. If there are set of peer companies which are listed and engaged in the similar business, then such company’s share public prices can also be used.