Valuation of AIF
Neeraj Agarwal
I Neeraj Agarwal, am a Fellow Member of ICAI, practicing under the banner of M/s AAN & Associates LLP, a firm based out of Banglore Mumbai.
I am also registered under Insolvency and Bankruptcy Board of India as a Registered Valuer for valuation of Security or Financial Assets (Passed in Feb 2020)
I am also holding Bachelor of Commerce (B. Com) degree from Calcutta University (Passed in 2011).
I have corporate working experience in Wipro. After working in Wipro for a short period I started my practice in late 2013 and have been in practice so far for the last 10 years. I have also completed a Certificate Course by ICAI on IND-AS in 2020. I have also cleared Social Auditor Exam conducted by NISM.
I have been inducted as a Special Invitee to the Sustainability Reporting Standard Board, ICAI for the FY 2023-24.
Introduction
The Securities and Exchange Board of India (SEBI) published a circular standardizing the Alternate Investment Fund (AIF) valuation methodology on June 21, 2023. According to the circular, at least 33% of SEBI-registered AIFs must be represented by an AIF industry group that has approved the rules for valuations. To ensure compliance with international best practices, these criteria were chosen based on suggestions made by the Alternative Investment Policy Advisory Committee (AIPAC).
What is an Alternate Investment Fund (AIF):
In India, an investment option known as an alternative investment fund (or “AIF”) is created or formed as a limited liability partnership, corporation, trust, or corporate entity. Apart from cash, stocks, and bonds, AIFs are funds of funds that make investments in other asset types.
An AIF works by pooling investor funds and allocating these sums to various investment possibilities that are outlined by the Securities and Exchange Board of India.
Who is Eligible to Invest in an AIF?
An investor may purchase AIFs to diversify their portfolio, provided they meet the following qualifying requirements:
- Non-Resident Indians (NRIs), Resident Indians, and foreign citizens can invest in these funds.
- The minimum investment limit for investors is Rs. 1 crore, while the minimum investment amount for directors, employees, and fund managers is Rs. 25 lakhs.
- AIFs have a minimum lock-in period of three years.
- Except for angel funds, where the maximum is raised to 49 investors, all schemes have a 1,000-investor cap
Who can do the Valuation of Alternative Investment Funds (AIFs)?
1. Independent Valuer Registered with SEBI or Recognized Body:
To prevent conflicts of interest with the fund management, trustee, or sponsor, SEBI mandates that AIFs designate an impartial valuer. The valuer must be totally independent and unaffiliated with the people in charge of running or supervising the AIF.
Qualifications for Independent Valuers:
An eligible independent valuer fits into one of the following categories:
- SEBI-Registered Category-I Merchant Banker: These professionals are permitted to provide valuation services due to their capital market expertise and regulatory compliance.
- Valuers registered under the Companies Act, 2013: These valuers are overseen by the Insolvency and Bankruptcy Board of India (IBBI) oversees these valuers and requires them to be registered with an approved Valuation Professional Organization (RVO). To value particular asset classes, they need to be certified.
2. Internal Valuation Team (Allowed for Category I and II AIFs):
Under certain circumstances, Category I and II AIFs may carry out valuations using an internal team.
Requirements for Internal Valuation Teams:
- Must be specifically approved by SEBI regulations or the fund documents for the AIF.
- It is necessary to have a registered valuer or independent auditor oversee the internal valuation.
- The group must guarantee accuracy and consistency in reporting while adhering to accepted valuation standards.
- Although this strategy allows for operational flexibility, it must nonetheless adhere to independence and transparency norms to protect investor interests.
a. IBBI Registration: These experts must be registered as valuers with the IBBI under the appropriate asset class (e.g., securities, financial assets, land and buildings, or plant and machinery).
b. Connected to a reputable VPO (Valuation Professional Organization).
Methods of Valuation of AIF:
Valuation is an important part of AIF management since it influences investor reporting, NAV computation, and regulatory compliance.
1. Income Approach: The income approach determines an asset’s worth based on its potential to provide revenue in the future.
a. Discounted Cash Flow (DCF) Method:
- Estimates future cash flows for a firm or asset.
- Apply a discount rate to determine the present value of the cash flows.
- With realistic cash flow estimates, this method is particularly suitable for startups, private equity firms, and growth-stage organizations.
b. Earnings Capitalization:
- Uses a single-period DCF model.
- Normalized earnings are used, along with a capitalization rate.
- Common in mature enterprises with a steady income.
2. Market Approach: Evaluates an asset’s value by comparing it to similar market-traded organizations or transactions.
a. Comparable Company Multiple Method:
- Applies multiples such as EV/EBITDA, P/E, or Revenue multiples to publicly traded companies in the same industry.
- Adjustments are made for size, growth, and risk.
- Suitable for private equity and venture capital funds.
b. Comparable Transaction Method (Precedent Transactions):
- References actual transactions involving similar companies/assets.
- Reflects actual market action and investor opinion.
- Best used in merger and acquisition (M&A) situations.
3. Cost Approach: Evaluates the cost of replacing or reproducing an item, adjusted for depreciation and obsolescence.
- Typically applied to plant, machinery, or specialized real estate assets.
- Less relevant for equity or startup valuations, but useful for funds with a high concentration of tangible assets.
Conclusion:
An Alternative Investment Fund’s (AIF) valuation is essential because it offers a precise and equitable evaluation of the fund’s assets and overall performance. Transparent and accurate financial reporting is essential to maintaining investor confidence, and valuation practices help ensure this outcome.
For any clarifications or queries, please feel free to reach out to us at admin@fintracadvisors.com
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