Shares are the fundamental building blocks of any company, as they represent ownership and form the basis of a company's capital structure. In most cases, companies raise funds by issuing shares in exchange for cash. This conventional approach helps the company gather the necessary capital to operate and expand its business. However, there are instances when shares are issued for consideration other than cash. For example, companies often issue sweat equity shares to reward employees for their technical expertise. These non-cash transactions typically benefit existing employees who have already contributed significantly to the company's growth.

This article explores an alternative approach: issuing shares in exchange for non-cash contributions from individuals who are not part of the company's regular workforce, such as consultants or external advisors. Such transactions can bring in fresh expertise and new perspectives, helping companies innovate and adapt in a competitive environment. However, exchanging shares for non-cash assets requires a reliable method to determine the true value of these contributions.

Under the Companies Act and the Companies Registered Valuers and Valuation Rules, 2017, any non-cash asset used as consideration must be valued by a registered valuer. The role of the registered valuer is critical, as they ensure that the asset's value is fair and accurately determined according to its asset class—whether it is land and buildings, plant and machinery, or securities and financial assets.

Valuation

Under the Companies Act, a company may issue shares in exchange for assets or other non-cash considerations. However, when a company opts for such an arrangement, the asset being offered must be properly valued. This valuation must be conducted by a registered valuer in order to ensure that the worth of the asset is determined fairly and accurately.

The process of valuation is governed by the Companies Act, specifically Section 247,and the Companies Registered Valuers and Valuation Rules, 2017. These rules set out the framework and responsibilities for valuers who provide these critical services. The rules are designed to maintain transparency and protect the interests of all stakeholders involved by ensuring that the asset's value is not under- or over-estimated.

A key concept in this area is that of an "asset class." An asset class is a group of assets that share similar characteristics and therefore require similar valuation techniques. Common examples of asset classes include Land and Building, Plant and Machinery, and Securities or Financial Assets. Because each of these asset types has its own unique features, they require specialized expertise to assess their value correctly.

Registered valuers are organized into different categories based on the type of asset they are qualified to evaluate.

There are three main categories:

1. Land and Building: Valuers in this category typically have a background in civil engineering, architecture, or town planning. For those with a graduate qualification, five years of experience are required. Alternatively, candidates who have completed a postgraduate course in these fields or in real estate valuation—which is usually a two-year full-time program—need to have three years of experience.
    
2. Plant and Machinery: Professionals who value plant and machinery generally hold degrees in disciplines such as mechanical, electrical, electronics, production, chemical, textiles, or metallurgy. Graduates in these areas are required to have five years of experience. However, if they have pursued postgraduate studies in these disciplines or related fields in valuation, the experience requirement is reduced to three years.
    
3. Securities or Financial Assets: For valuing financial assets or securities, the typical qualifications include membership in professional bodies like the ICAI, ICSI, or ICMAI, or a postgraduate degree such as an MBA with a focus on business management. Additionally, a postgraduate qualification in finance is acceptable. The standard requirement for experience in this asset class is three years.

For any other asset class not specifically mentioned, the qualifications and experience required will be determined by the Central Government. This ensures that there is a consistent standard for valuing various types of assets, even those that are less common or require a different set of skills.

Issuance of Shares for Non-Cash Consideration

Under Section 62 Companies Act, a company is allowed to issue additional shares to any person—not just to existing shareholders or employees under schemes like ESOP. This means that shares can be offered in exchange for cash or for other types of consideration, provided that the process is approved by a special resolution passed at a general meeting.

When shares are issued for non-cash consideration on a preferential basis, the valuation of the asset received must be conducted by a registered valuer. This valuer submits a detailed report justifying the assessed value. If a registered valuer has not yet been appointed, the valuation report may be prepared by an independent merchant banker registered with SEBI or an independent Chartered Accountant with a minimum of ten years' experience. It is essential that the price at which these shares or securities are issued is not less than the value determined by the valuation report. For companies listed on a recognized stock exchange, however, obtaining a valuation report from a registered valuer is not mandatory.

For companies that are not listed, the procedure for preferential allotment is governed by Rule 13 Companies (Share Capital and Debenture) Rules, 2014. In such cases, the company must first have the authority to issue shares as per its articles of association. Following this, the issue must be approved by a special resolution passed by the members. The company is also required to disclose relevant details in an explanatory statement and must complete the allotment of securities within twelve months from the date of the special resolution. If the allotment is not completed within this period, another special resolution is needed to extend the timeline.

Additionally, the treatment of non-cash assets used as consideration depends on their nature. If the asset is depreciable or amortizable, it must be recorded on the balance sheet in accordance with the applicable accounting standards. If not, it should be expensed following the relevant standards.

In scenarios where convertible securities are offered on a preferential basis with an option to convert to equity shares, the conversion price is determined either upfront using the valuation report prepared at the time of the offer, or by obtaining a new valuation report within 60 days prior to the conversion eligibility date. The eligibility date must be at least 30 days after the valuation date, and the company must decide on the method at the time of the offer.

This framework not only provides flexibility in raising capital through non-traditional means but also ensures that all transactions are conducted at fair and justifiable values, thereby safeguarding the interests of both the company and its stakeholders.

Conclusion
In summary, companies are permitted to issue shares for consideration other than cash not only to employees but also to external advisors and consultants. However, the current regulatory framework restricts such transactions to assets that fall within clearly defined classes—namely, Land and Building, Plant and Machinery, and Securities or Financial Assets since these categories have established valuation methods by registered valuers.

Unlike the provision for sweat equity, which rewards employees for their technical know-how, there is no similar mechanism for non-employees. This is primarily because technical know-how is not recognized as a distinct asset class under the prevailing valuation rules. As a result, until the government formally categorizes technical know-how as an asset, it cannot be reliably valued by a registered valuer, and shares cannot be issued based on this type of contribution.

Addressing this gap could potentially broaden the avenues for compensating external contributors. For now, companies must adhere to the existing asset classifications to ensure that the valuation of non-cash contributions remains transparent, fair, and compliant with regulatory requirements.

References:

1. https://ibbi.gov.in/uploads/rules.pdf