Foreign portfolio investors (FPIs) or private equity (PE) investors who invest in unlisted firms would finally be free to use any of the internationally acceptable pricing methods for valuing shares — while investing in or exiting from such unlisted firms — thereby encouraging more such deals.
The Reserve Bank of India (RBI) has finally notified the changes in Foreign Exchange Management (Fema) related to transfer or issue of security by a person resident outside India in an official gazetted notification published on July 8, 2014. This follows the announcement by RBI governor in monetary policy statement on April 1, 2014, to withdraw pricing norms for shares both at the time of initial investment as well as at the time of exit. The RBI indicated that such transactions would henceforth be based on “acceptable market practices” and operating guidelines would be notified separately.
According to the RBI notification dated May 23, 2014, the pricing guidelines have been liberalised from earlier standard DCF-based valuation used for pricing unlisted shares by making amendment in regulation 9(ii) and 9(iii).
Price of fresh shares issued to persons resident outside India under the FDI Scheme shall be made at a price not exceeding that arrived at as per any internationally accepted pricing methodology for valuation of shares (equity shares, preference shares or debentures of unlisted company) on arm’s length basis, duly certified by a Chartered Accountant or a Sebi registered merchant banker, according to revised clause.
“The guiding principle would be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment/agreements and shall exit at the price prevailing at the time of exit, subject to lock-in period requirement” added the RBI circular.
Sunil Kapadia, partner & leader - business tax services at Ernst & Young believes that changed pricing guidelines provide more leeway to private investors but one needs to wait and see how it evolves.
The pricing guidlienes change follows the concerns of private equity investors who were taken aback by stringent changes made by RBI in January 2014 by fixing the pricing mechanism for exits based on return on equity method to block assured returns while allowing the use of options in shareholder agreements with foreign investors.
The return on equity method would have fetched them lower valuations as it doesn't take into consideration future growth potential or valuation.