Business Valuation

With reference to a guidance document issued by the China Appraisal Society (“CAS”) in relation to discount rate calculation, the China Securities Regulatory Commission (“CSRC”) launched the Regulatory Guidance - Valuation (the “Guidance”) in January 2021 to standardize the parameters of discount rate calculation in the income approach.
 
The Guidance provides specific requirements for the parameters in Capital Asset Pricing Model (“CAPM”) and Weighted Average Cost of Capital (“WACC”), including risk-free rate, market risk premium, beta, capital structure, specific risk premium and expected return of debt.
 
With AVISTA’s experience in business valuation, the key points of the Guidance for the discount rate calculation are outlined below.
 
Background and Objective 
 
The discrepancies for the current valuation practices in the income approach have been prevailing among valuation entities (“Entities”), ranging from sample selection, parameters’ determination and calculation methodology. Meanwhile, the valuation process may also be influenced by complicated and subjective judgment, which would impact the reliability of company’s financial data and valuation result.
 
Accordingly, the CSRC formulates the Guidance in order to standardize the discount rate calculation, thereby enhancing the regulations in the valuation industry.
 
Fundamental Requirements 
 
The Guidance enumerates 3 fundamental requirements to the Entities highlighting the consistency and reasonableness in the discount rate calculation.
 
<ol>
<li>The Entities must formulate a set of consistent principles and methods for discount rate calculation. Upon formulation, the principles and methods could not be revised at discretion afterward to ensure the consistency of valuation projects. </li>
<li>The Entities must ensure the reasonableness of discount rate calculation on multiple valuation dates. The Entities should clarify any significant changes of parameters from the previous valuation date in the valuation report. </li>
<li>The Entities must ensure the alignment between discount rate and expected return, which requires CAPM in line with the Free Cash Flow to the Equity (“FCFE”) and WACC in line with the Free Cash Flow to the Firm (“FCFF”). </li>
</ol>
Instructions on Parameters
 
The Guidance provides instructions for 6 parameters typically used in the discount rate calculation. In general, the Guidance requires the Entities to disclose parameter-related methods, analytical processes and data sources in the valuation reports. The details of the instructions to each parameter are specified below.
 
<ol>
<li>Risk-free rate
<ul style="list-style-type: square;">
<li>China 10-year or above government bond and its yield to maturity should be adopted under the assumption of going concern. </li>
</ul>
</li>
<li>Market risk premium
<ul style="list-style-type: square;">
<li>If the primary business of the target company to be valued (the “Target”) is within China’s territory, the historical risk premium data of China Securities Market index should be adopted as a priority. </li>
</ul>
</li>
<li>Beta
<ul style="list-style-type: square;">
<li>The Entities should take into account the enterprise size, profitability, growth, etc. in their consideration of comparability of comparable company to determine the beta, as well as select the beta with the appropriate time horizon. </li>
</ul>
</li>
<li> Capital structure 
<ul style="list-style-type: square;">
<li>The Entities must conduct analysis for the discrepancies between the Target and comparable company as well as the development stage of the Target with reference to the adopted capital structure, alongside disclosure and clarification. </li>
<li>The debt-to-equity ratio should be measured by market value. Clarification should be provided in the valuation report if book value is used. </li>
</ul>
</li>
<li>Specific risk premium 
<ul style="list-style-type: square;">
<li>The Entities must evaluate the Target’s risk characteristics, enterprise size, core competitiveness, etc. when determining the specific risk premium. </li>
</ul>
</li>
<li>Expected return of debt 
<ul style="list-style-type: square;">
<li>The Entities must assess the Target’s operating performance, capital structure, credit risk, etc. if Loan Prime Rate (“LPR”) is taken as reference. </li>
<li>The Entities must assess the Target’s financing options, cost of debt, solvency, etc. if non-market interest rates are adopted. </li>
</ul>
</li>
</ol>
To read the full Regulatory Guidance released by CSRC, please click <a href="http://www.csrc.gov.cn/pub/newsite/ztzl/jggzsyzy/202101/t20210122_391113.html" target="_blank" rel="noopener">here</a>. (Available in Chinese version only) 
AVISTA’s Professional Services for Business Valuation
 
As a professional valuation and financial advisory firm, AVISTA provides reliable business valuation services and accommodates the valuation needs in various transactions, including merger and restructuring. Our valuation experts are ready to advise you on asset valuation in compliance with the latest regulatory guidance.
 
For further information or enquiries regarding the potential valuation impact of the CSRC’s regulatory guidance on discount rate calculation, please feel free to contact us.

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CSRC Regulatory Guidance on Discount Rate Calculation in Income Approach

A growing attention to the Biotech sector has been shown in the accelerating investments by Venture Capital funds and IPOs, as well as the expectation of innovative therapies amidst Covid-19. This article, therefore, provides a guide on Biotech investment analysis with highlighting the “3H” characteristics of Biotech industry—High inputs in R&amp;D, High Rewards, and High Risks, and demonstrating related valuation approaches for quantitative analysis.
 
Click <a href="../../../../../uploads/Investing_in_Biotech_-_A_Guide_to_Risk-Return_Analysis_with_Valuation_Techniquesv2_d1bdf4f384.pdf" target="_blank" rel="noopener">here</a> to read the full article.
 
<a href="../../../../../uploads/Investing_in_Biotech_-_A_Guide_to_Risk-Return_Analysis_with_Valuation_Techniquesv2_d1bdf4f384.pdf" target="_blank" rel="noopener"><img src="../../../../../uploads/cover_51fccbbb2f.jpeg" width="600" /></a>

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Investing in Biotech - A Guide to Risk-Return Analysis with Valuation Techniques

The International Valuation Standards Council (“IVSC”) Financial Instruments Board (“FI Board”) has published the Exposure Draft (the “Draft”) with proposals to improve the valuations of financial instruments outlined in IVS 500 Financial Instruments (“IVS 500”). The IVSC FI Board has launched the consultation to invite comments on the proposals in the Draft, which covers (1) Standards objectives and agenda, (2) Guidance on governance around valuation process, and (3) Principles of data taxonomy and control. As a professional valuation advisory firm, AVISTA has outlined the key points in the Draft for the latest proposals of improvements of financial instruments valuation.
 
Standards Objectives and Agenda
 
In review of IVS 500, the FI Board aims to establish the principles that will enable entities to develop fit-for-purpose valuations of financial instruments adaptable to varying market conditions or circumstances and to different reporting purposes, including financial, tax, and regulatory reporting. The proposals made by the FI Board are principles-based guidance requiring valuation processes in line with the concepts outlined in IVS 500. Meanwhile, considering the potential conflicts with the requirements in other International Valuation Standards (“IVS”), the Standards Review Board is also proposing consequential amendments to IVS 101 Scope of Work to IVS 105 Valuation Approaches and Methods.
 
The improvements to IVS 500 will be considered in stages, where the Draft firstly focuses on the areas of Governance and Data. The two remaining areas of Methods and Models, and Controls and Reporting will be considered and published in subsequent documents that will also contain revised proposals on Governance and Data based on received comments for the Draft. This practice is to address the interdependencies among different areas and facilitate the comments from the stakeholders on the proposals.
 
Guidance on Governance around Valuation Process 
 
The Draft proposes the guidance over the valuation processes that entities should follow to ensure adequate governance around financial instrument valuations. A valuation process should be (a) systemic, (b) consistently applied, (c) economically sound, and (d) controlled. To be specific, the governance around valuation process requires the valuation of financial instrument with similar portfolios, financial principles and market practice to be developed consistently, with end-to-end documentation and controls’ implementation.
 
The Draft, in the meantime, also highlights a series of principles covering the governance and controls over financial instruments valuation, including (a) ownership, (b) accountability, (c) transparency, (d) consistency, (e) review and challenge, (f) diversity, (g) documentation. In general, the principles emphasize clear responsibility for execution among different functions and individuals, transparent documentation for consistent valuation methods, as well as independent and diverse assessment for valuation processes.
 
Principles of Data Taxonomy and Control
 
The Draft highlights the importance of data as inputs to the valuation process to derive fit-for-purpose valuation. The quality of data adopted in the valuation process should ensure the objectivity and the effective communications of the valuation decisions.
 
The Draft proposes a data taxonomy differentiating static data and dynamic data to establish the standardized best practice for participants both within and across the entities involved in the valuation processes. It is not mandatory to adopt the taxonomy outlined in the Draft, but any taxonomy developed and adopted by an entity should be consistent with the principles proposed in the Draft.
 
In addition, the Draft requires the policies and processes in place to control the identification, assessment, aggregation and management of outsourced and internally generated data. In particular, the policies and processes should ensure (a) accuracy and integrity, (b) completeness, (c) adaptability, (d) timeliness, (e) transparency and (f) proportionality.
 
<a href="https://www.ivsc.org/files/file/view/id/1890" target="_blank" rel="noopener"><img src="../../../../../uploads/cover_586d37e853.jpeg" width="200" /></a>
 
To read the full Exposure Draft released by IVSC, please click <a href="https://www.ivsc.org/files/file/view/id/1890" target="_blank" rel="noopener">here</a>.
 
AVISTA’s Professional Services for Financial Instruments Valuation
 
As a corporate member of IVSC, AVISTA provides professional valuation and financial advisory services on financial instruments. The knowledge and experience of AVISTA can facilitate the most appropriate valuation service ensuring IVS-compliant valuation processes and reporting.
 
We are closely monitoring the latest development of IVSC consultation for valuations of financial instruments. For further information or enquiry regarding the Exposure Draft, please feel free to contact us.

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IVSC Exposure Draft on Improvements of Financial Instruments Valuation

The Cayman Islands Government introduced the <a href="https://www.cima.ky/upimages/commonfiles/PrivateFundsLaw2020_1581524961.PDF" target="_blank" rel="noopener">Private Funds Law, 2020</a> and the <a href="https://www.cima.ky/upimages/commonfiles/PrivateFundsSavingsandTransitionalProvisionsRegulations2020_1581526431.PDF" target="_blank" rel="noopener">Private Funds (Savings and Transitional Provisions) Regulations, 2020</a> (together as the “New Cayman Law”) in February 2020. One of the key highlights of the New Cayman Law is the mandatory enhancements over the independency and consistency of the valuation process in relation to the assets of private funds.
 
The operator of the private funds shall be responsible for compliance with the New Cayman Law.
 
Effective Period of the New Cayman Law 
 
A transitional period of 6 months was granted, implying that the private funds should be fully aware of the latest code arrangements and have prepared adequate compliance mechanisms in order to comply with the New Cayman Law by no later than 7th August 2020. The degree of compliance to the New Cayman Law will most probably be assessed from the financial year of 2020 onwards.
 
 Valuation Requirements under the New Cayman Law 
 
Under the New Cayman Law, private funds, which cover the majority of the closed-ended funds, are obligated to follow proper and consistent procedures to perform valuations on its assets.
 
In any case, the valuation of assets is required to be conducted at least annually. It shall be carried out at a rate that is appropriate and necessary to timely reflect the material changes on the fair value of the subject asset.
 
The Cayman Law explicitly stated that the appraisal should be performed by one of the followings:
 
<ol style="list-style-type: lower-roman;">
<li>An independent third party that is professionally qualified to conduct valuations in a non-high-risk jurisdiction; </li>
<li>The manager or operator of the private funds provided that: (a) The valuation function is independent from the management function of the funds; or (b) Potential conflicts of interest are appropriately addressed and disclosed to the investors of the private funds; </li>
<li>An administrator appointed by the private funds.</li>
</ol>
 
How AVISTA Can Help
 
One of the key takeaways of the New Cayman Law is the great emphasis on the independence and professoinalism of the valuation of assets, in order to provide the investors with a true and fair view of the value of the funds. Privates funds are required to conduct valuation of the assets at least annually with a rigorous and consistent approach in accordance with the rules and guidelines set forth in the Monetary Authority Law (2020 Revision).
 
As one of the leading independent professional valuation firms, AVISTA is experienced in valuing different types of equity investments and financial instruments with complex structure for financial reporting purpose. Our valuation experts are ready to advise you on how the assets in the funds can be valued for compiling your upcoming audited accounts under the new requirements in a cost effective manner.
 
For further information or enquiries regarding the potential valuation impact of the New Cayman Law to you, please feel free to contact us.

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The New Cayman Law Imposed Further Valuation Requirements for Cayman Private Funds 

The International Accounting Standards Board (“IASB”) has published the Discussion Paper Business Combinations—Disclosures, Goodwill and Impairment in March 2020 (the “Discussion Paper”). The Discussion Paper considers four major topics, including (1) improving disclosures about acquisitions, (2) improving effectiveness of impairment test, (3) simplifying the impairment test, and (4) changing the range of recognisable intangible assets. As an experienced valuation and financial advisory firm, AVISTA has outlined the key points in the Discussion Paper and potential impacts to valuation and corporate transactions.
 
Improving disclosures about acquisitions
 
In response to some investors’ concern on not having sufficient information for understanding the subsequent performance of an acquisition and achievement of the management’s objectives for the acquisition, the IASB believes that companies should disclose the strategic rationale and management’s objective for undertaking an acquisition, and the metrics for monitoring achievement of objectives at acquisition date. Subsequent to the acquisition date, disclosure regarding the information and metrics used by the management to monitor and measure the progress of objectives achievement should be required. The metrics to be disclosed could be financial (e.g. profitability) and/or non-financial (e.g. product launches).
 
Another suggested additional disclosure is the factors making up goodwill, such as nature, amount, and timing of, and related costs required for the synergies expected to be realised. The company is required to provide qualitative description of factors that make up the goodwill recognised and to quantify an estimate of expected synergies in determining and agreeing the acquisition price.
 
Improving effectiveness of impairment test
 
Under the current IAS 36 — Impairment of Assets requirement, companies have to test cash-generating units containing goodwill for impairment at least annually. The Discussion Paper has examined (1) ways to improve the effectiveness of impairment test at a reasonable cost; and (2) whether to reintroduce amortisation of goodwill.
 
Regarding the improvement on the effectiveness of impairment test at a reasonable cost, the Discussion Paper has preliminary concluded that it is not feasible to design a significantly more effective impairment test than the currently adopted one as required in IAS 36 — Impairment of Assets.
 
In the context of reintroducing amortisation of goodwill, the views among IASB members are controversial, with majority of them voting in favour of retaining the impairment-only model and not reintroducing amortisation of goodwill, as the determination of useful life of goodwill would be arbitrary and amortisation of goodwill could not be an effective measure of management’s accountability for acquisition decisions.
 
Simplifying the impairment test 
 
There are three reliefs proposed by the IASB to simplify the impairment test, including (1) removing the requirements for a company to perform annual impairment assessment for cash-generating units containing goodwill if there is no impairment indication, intangible assets with indefinite useful lives and intangible assets not yet available for use; (2) removing the restriction on including uncommitted restructuring and asset enhancement cash flows; and (3) removing the requirement to use pre-tax cash flows and pre-tax discount rates in estimating value in use.
 
The IASB is in the preliminary view that these measures could reduce the cost and complexity for performing impairment test.
 
Changing the range of recognisable intangible assets
 
The Discussion Paper has examined whether some intangible assets could be included in goodwill to reduce costs and complexity for companies in identifying and valuing particular intangible assets. Having considered varying views from stakeholders on this topic, the IASB concluded that there is no compelling evidence suggesting that a change in the range of recognisable intangible assets is favourable.
 
To read the full Discussion Paper released by IASB, please click <a href="https://cdn.ifrs.org/-/media/project/goodwill-and-impairment/goodwill-and-impairment-dp-march-2020.pdf">here</a>.
 
 
AVISTA’s Professional Services for Valuation and Corporate Transactions
 
AVISTA provides one-stop valuation and financial advisory services that help clients achieve additional growth and ensure their compliance with regulators’ stringent rules and disclosure requirements when implementing business decisions and strategies. 
 
<ul>
<li>Valuation Services for Transactions</li>
<li>Valuation Services for Financial Reporting</li>
</ul>
 
We are closely following up on the latest development of this accounting standard update. For further information or enquiry regarding the potential valuation impact of the Discussion Paper to you, please feel free to contact us.

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IASB Discussion Paper on  Business Combinations — Disclosures, Goodwill and Impairment

The Securities and Futures Commission (“SFC”) of Hong Kong has issued a statement on 4 July 2019 (the “Statement”) in which the directors’ duties when considering corporate acquisitions or disposals have been further stressed. The Statement listed out several key types of misconduct and deficiencies of the directors commonly seen in transactions, in particular, lack of independent valuation, lack of due diligence on target entity’s financial position, inappropriate valuation procedures, etc.  Further to the “Guidance note on directors’ duties in the context of valuations in corporate transactions” issued on 15 May 2017, the SFC once again reminds directors that they are liable for ensuring the information in relation to a planned corporate transaction should be compiled with due care. Apart from the financial forecast or profit guarantees, the historical financial position of the target entity also requires a thorough analysis in the process of a proper due diligence.  As an experienced independent valuation and advisory firm, AVISTA has outlined following common queries that corporates might raise when aligning directors’ duties with the SFC’s updated requirements in corporate transactions.
 
What are the appropriate procedures in considering any planned corporate transaction?
 
Although it is not expressly required by statutory law or under the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the “Listing Rules”), engaging an independent professional valuer, as well as a financial advisor, are recommended for directors in contemplating potential transactions.
 
A professional independent valuer is able to aid the directors in assessing the business performance and prospects of the target entity, so as to protect the interests of the company and its stakeholders.
 
In addition, in case of a connected transaction, an independent financial advisor (“IFA”) is required to be appointed under Chapter 14A of the Listing Rules. IFA will assist the directors in reviewing the overall reasonableness of the transaction, including but not limited to the terms of the potential transaction, the basis of determining the consideration and the valuation report.
 
Independent professional valuation has been obtained. Would that sufficiently fulfill the SFC’s requirements on directors’ duties?
 
Apart from conducting independent valuation, the SFC has also shown increasing concerns about the reliability of the target entity’s financial information.
 
As a matter of fact, financial and legal due diligence is becoming more commonly performed as a part of pre-deal due diligence. In particular, financial due diligence (“FDD”) is an extensive process for a thorough and complete assessment of the target entity's business, assets, capabilities and financial performance.
 
FDD enables the directors to scrutinize the quality of earnings and the financial position of the target entity, which is considered to be a prerequisite for any potential transactions. Such due diligence work allows the directors to identify any potential risk in early stage of the potential transaction, which could possibly enhance directors’ duty to exercise due and responsible care, skill and diligence in the discharge of their duties.
 
Why are the regulators still showing concerns even market approach has been adopted in the valuation? 
 
There has been an upward trend in the applications of market approach. However, the SFC has noted certain cases in which the valuation parameters have been “cherry-picked”.
 
In order to conform with the regulators’ standards, the valuation has to be carried out under a fair and reasonable basis. In adopting market approach, a systematic way of selection of comparable companies constitutes one of the essential parts of the valuation. Factors such as business nature, development stage, geographical location, etc. of the target entity should be considered such that an exhaustive list of comparable companies could be obtained.
 
To read the full statement released by the SFC, please click <a href="https://www.sfc.hk/web/EN/news-and-announcements/policy-statements-and-announcements/statement-on-the-conduct-and-duties-of-directors.html" target="_blank" rel="noopener">here</a>.
 
 
AVISTA’s Professional Services for Corporate Transactions
 
AVISTA provides one-stop financial advisory services that help clients achieve additional growth and ensure their compliance with regulators’ stringent rules and disclosure requirements when implementing business decisions and strategies. 
 
<ul style="text-align: left;">
<li>Valuation Services for Transactions</li>
<li>Financial Due Diligence Service </li>
<li>Risk Advisory Review on Target</li>
</ul>

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Avoiding Major Misconduct in Corporate Transactions: Q&A on HK SFC’s Latest Statements on Directors’ Duties

Previously, we are honored to be engaged by COSCO SHIPPING Holdings Co., Ltd. (1919.HK) in providing PPA valuation services for their Acquisition of Orient Overseas (Int’l) Ltd. (316.HK). This was the largest M&amp;A transaction in the global shipping industry in terms of deal price.
 
Please <a href="../../../../../uploads/CaseHighlight_COSCO_20190503_87da489474.pdf" target="_blank" rel="noopener">click here</a> to know more about the acquisition and its transaction synergy and our engagement. 
 
<img src="../../../../../uploads/a_a82449e3a4.png" alt="" width="700" height="495" /><a href="../../../../../uploads/CaseHighlight_COSCO_20190503_87da489474.pdf" target="_blank" rel="noopener"><img src="../../../../../uploads/a_e1c764fdde.png" alt="" width="700" height="493" /></a>