Valuation of Infrequently Traded Shares under Regulation 165 of SEBI ICDR Regulations

In the Indian capital market ecosystem, preferential allotments are among the most frequently used mechanisms for raising capital by listed companies. While the pricing framework for frequently traded shares is largely formula-driven under the SEBI ICDR Regulations, 2018, the situation becomes significantly more complex when shares are infrequently traded.

In such cases, Regulation 165 of the ICDR Regulations assumes critical importance. The regulation introduces a valuation-based pricing mechanism intended to protect minority shareholders and ensure that capital is not raised at an unfair or manipulated price merely because market liquidity is weak.

For listed companies, promoters, merchant bankers and valuers, Regulation 165 is not merely a compliance provision — it is a framework built around fairness, transparency and professional valuation judgment.

Regulation 165 forms part of the broader valuation and pricing framework prescribed by SEBI for listed company transactions and capital raising exercises. A comprehensive overview is available in our guide on valuation and pricing norms under SEBI regulations for listed companies.

Understanding Preferential Allotment under ICDR Regulations

A preferential allotment refers to the issue of specified securities by a listed company to a select group of investors on a private placement basis. Such issuances are governed by Chapter V of the ICDR Regulations and are widely used for promoter infusions, strategic investments, private equity participation, debt conversion and restructuring transactions.

Under the ICDR framework, pricing of preferential allotments depends primarily on whether the shares are frequently traded or infrequently traded.

Where shares are actively traded on the stock exchange, the market price itself serves as a reliable benchmark. However, when trading volumes are negligible or sporadic, market quotations may not accurately reflect intrinsic value. In such situations, Regulation 165 mandates an independent valuation approach.

A detailed discussion on the pricing framework applicable to frequently traded shares can be explored in our guide on preferential issue pricing under Regulation 164 of SEBI ICDR Regulations.

Meaning of Infrequently Traded Shares under ICDR Regulations

The ICDR Regulations classify shares as “infrequently traded” when trading turnover on the recognized stock exchange during the specified review period does not meet the prescribed threshold. In practical terms, these are shares where market participation is limited and trading data may not provide a fair indication of value.

This situation is commonly observed in:

• SME listed companies
• Closely held listed entities
• Companies with low public float
• Thinly traded securities
• Companies with limited institutional participation

Infrequent trading creates a significant regulatory concern. If pricing is determined solely on the basis of thin or illiquid market trades, the allotment price may become vulnerable to distortion or manipulation. A few isolated transactions cannot always represent the true economic value of the company.

For example, a fundamentally strong company with limited trading activity may have a quoted market price substantially below its intrinsic value. Conversely, low-volume trades can also artificially inflate prices in certain situations. Therefore, SEBI requires valuation-based pricing to ensure fairness and investor protection.

This is particularly relevant because preferential allotments directly impact shareholder dilution. Existing shareholders must be protected against issuance of shares at unjustifiably low prices.

Regulation 165 – Legal Framework and Valuation Requirement

Regulation 165 of the ICDR Regulations provides that where the equity shares of the issuer are infrequently traded, the price determined for preferential allotment must take into account valuation parameters including:

• Book value
• Comparable trading multiples
• Industry valuation benchmarks
• Other customary valuation parameters

Unlike Regulation 164, which prescribes a mathematical pricing formula based on volume weighted average price (VWAP), Regulation 165 relies substantially on professional valuation judgment.

The regulation also requires submission of a certificate from an independent valuer to the stock exchange. This introduces an additional layer of scrutiny and accountability in the pricing process.

The overall transaction framework generally involves multiple professionals, including:

• Registered valuers
• Merchant bankers
• Legal advisors
• Company secretaries
• Statutory auditors

Among them, the valuer plays a central role in determining whether the proposed issue price is fair and justifiable based on accepted valuation methodologies.

The regulatory philosophy behind Regulation 165 is clear: where market price is unreliable, fair value must be established through independent professional analysis.

Unlike valuation-driven mechanisms applicable to infrequently traded shares, QIP pricing under the ICDR Regulations follows a market-linked formula-based approach applicable to institutional capital raising transactions.

Valuation Parameters and Methodologies under Regulation 165

One of the most important aspects of Regulation 165 is the flexibility it provides in adopting appropriate valuation methodologies depending on the nature of the business and availability of financial information.

Discounted Cash Flow (DCF) Method

The DCF method is widely regarded as one of the most comprehensive valuation approaches for operating businesses with stable or projected future cash flows.

Under this method, projected future cash flows are discounted to present value using an appropriate discount rate.

DCF is particularly relevant for:

• Growth-oriented companies
• Technology businesses
• Expansion-stage companies
• Businesses with strong future earnings visibility

However, DCF valuation is highly sensitive to assumptions relating to:

• Revenue growth
• Profitability
• Working capital
• Capital expenditure
• Terminal growth rate
• Cost of capital

Therefore, assumptions and projections require careful evaluation and proper disclosure.

Comparable Companies Multiple Method

This method values a company based on trading multiples of comparable listed companies.

Commonly used valuation multiples include:

• EV/EBITDA
• Price/Earnings (P/E)
• EV/Sales
• Price/Book Value

The challenge in this approach lies in identifying genuinely comparable companies in terms of:

• Industry
• Scale
• Business model
• Profitability
• Growth profile
• Risk characteristics

In many SME or niche sector companies, finding appropriate comparables itself becomes difficult.

Net Asset Value (NAV) Method

The NAV approach is commonly adopted for:

• Investment holding companies
• Asset-heavy businesses
• Real estate companies
• Companies with substantial investments or underlying assets

Under this method, valuation is derived from the fair value of underlying assets and liabilities.

Where earnings may not adequately represent underlying economic value, NAV becomes particularly relevant.

Hybrid and Multi-Method Approaches

In practice, valuers often adopt a combination of methods to arrive at a balanced valuation conclusion.

A weighted average approach may also be used where different methodologies capture different aspects of business value.

Ultimately, Regulation 165 does not prescribe a single mandatory method. Instead, it expects the valuer to exercise professional judgment and adopt methodologies appropriate to the specific facts and circumstances of the company.

Role of Independent Valuer under Regulation 165

The independent valuer occupies a position of significant responsibility under Regulation 165. The valuation report is not merely a procedural document — it forms the foundation for determining whether the proposed allotment price is fair.

The valuer is expected to:

• Maintain independence and objectivity
• Use appropriate methodologies
• Evaluate management assumptions critically
• Ensure consistency with financial information
• Provide transparent reasoning and disclosures

Given increasing regulatory scrutiny in capital market transactions, valuation reports are expected to be technically robust, adequately documented and defensible from both commercial and regulatory perspectives.

A poorly supported valuation can expose the company and professionals involved to regulatory observations, investor disputes and reputational concerns.

Conclusion

Regulation 165 of the ICDR Regulations plays a crucial role in ensuring fairness in preferential allotments involving infrequently traded shares. Since market quotations in thinly traded securities may not accurately reflect intrinsic value, SEBI has adopted a valuation-driven framework to safeguard shareholder interests and maintain market integrity.

Unlike formula-based pricing applicable to frequently traded shares, valuation under Regulation 165 requires careful analysis, professional judgment and transaction-specific assessment. The process involves evaluating financial performance, business fundamentals, industry benchmarks and future earning potential through recognized valuation methodologies.

For listed companies, the focus should not be limited to regulatory compliance alone. A well-reasoned and defensible valuation enhances transaction credibility, reduces regulatory risk and strengthens investor confidence.

As SEBI continues to emphasize transparency and governance in capital market transactions, the importance of high-quality valuation practices in preferential allotments is likely to increase further. Listed entities undertaking such transactions should therefore ensure that valuation reports are comprehensive, objective and aligned with evolving regulatory expectations.