Having had some experience with dealing with raising FDI capital over the course of the last several years, I was somewhat perplexed with some of the strange rules.

Explain this:

India’s FDI rules have an interesting provision related to valuation of a private company. The rule basically states that an Indian resident (including a Company) cannot sell shares to a foreign resident at a price below its fair value.

Ok, fair enough. The government wants to protect Indian residents from potentially unfair foreign investors (don’t agree with the premise, but I guess I can understand that some could).

Now, here is where it gets interesting. In order to determine the fair value of the shares, a Discounted Cash Flow (DCF) analysis must be conducted, and the price arrived at based on the DCF is said to be “fair”.

Then, the foreign investor MUST invest at a price equal to or higher than the fair value, as determined by the DCF.

Obviously, from the Investor’s point-of-view, the DCF value is the fair value. In order for any investor to invest in an asset, they must believe that they are buying the asset at less than the fair value. However, the FDI rules pretty much guarantees that one cannot buy at less than the fair value. That basically means that either the Investor has a completely different valuation approach that somehow justifies paying more than the DCF valuation, or that the Investor is looking at a completely different set of projections than what is submitted to the Reserve Bank of India by the Investee Company.

Quite a bizarre rule. Pretty much forcing firms to fudge numbers. Hope better sense prevails when the new government revisits some of the existing laws.

Aman Chowdhury

March 2014

www.amanchowdhury.com