Fair Market Value Meaning
In the simplest terms, FMV refers to an asset’s estimated value if it is sold in today's open market. In the context of ESOPs, FMV is the estimated value of the company’s stock on the day. This value is calculated based on the valuation of the company.
Valuation, in turn, is typically performed by independent valuers or valuation experts who use various methods to arrive at the FMV, taking into account factors such as the company's financial performance, market conditions, and other relevant data.
In this article, we’ll explore what FMV means for ESOPs and stocks and its importance for private markets.
Importance of Fair Market Value for ESOPs
FMV is crucial in the operation and administration of ESOPs as it is involved in the calculation of valuation and tax. The key reasons for its importance include:
- ESOP Shares as per valuation: The FMV of the company's stock is used to determine the value of the ESOP shares that are allocated to participating employees.
- Compliance and Regulatory Requirements: Compliance with regulations for legal and taxation reasons often requires that the ESOP's stock is valued at FMV.
- Reporting and Documentation: Accurate and up-to-date FMV valuations are essential for proper record-keeping, financial reporting, and documentation for the ESOP.
- Strategy and decision-making: It can influence decisions about stock allocations, diversification options, and the overall health and performance of the ESOP.
Valuation of stocks in the private market is usually done by independent appraisers or valuation experts who use various methods to arrive at the FMV, considering factors such as the company's financial performance, market conditions, and other relevant data.
How to Calculate FMV for Stocks?
The process of calculating the FMV of a listed stock is based on the opening and closing price of the stock-on-stock exchange.
For listed stocks traded on one stock exchange, it is the average of the opening and the closing stock price.
In case, on the date of exercise of the options, the shares are listed on more than one recognized stock exchange, the FMV shall be the average of the opening price and closing price of the share on the recognised stock exchange which records the highest volume of trading in the shares.
Do You Want to Know Fair Market Value Works?
Get insights on its benefits, influencing factors, calculation methods, and more
For listed stocks not traded on the stock exchange, it is the closing price on the preceding date of Exercise.
For unlisted stocks, it is the price determined by merchant bankers or valuation experts. Some of the most common methods include:
- Market capitalization method
- Comparable Company Analysis (CCA)
- Discounted Cashflow analysis
- Book-value method
- Asset-based approach
- Earnings multiplier method, etc.
What are the factors that affect the FMV?
Some of the common factors that affect the FMV of stocks are:
- Company Financials (Metrics like revenue, net income, earnings growth, and profitability)
- Market Conditions & Sentiment
- Industry and Sector
- Earnings and Dividends
- Growth prospects
- Competitive position
- Management quality and policies, etc.
It's important to note that the FMV is not a fixed value but rather an estimate that can change over time due to these and other factors. In practice, determining FMV is often a complex process that requires consideration of multiple variables and can be influenced by market sentiment and investor behavior.
Role of FMV in ESOP Taxation
As per the provisions of the Income Tax Act, 1961 (the Act), the tax implications get triggered at two stages — at the time of exercise of options and then at the time of sale of shares. Fair Market Value is used in calculating the perquisite tax at the time of exercise.
At the time of exercise of ESOPs by employees
Taxable perquisite = Difference between the Fair Market Value (FMV) of the shares as on the date of exercise and the Exercise Price
At the Time of Selling the Exercised Shares
The difference between the Selling Price & the FMV at the time of Exercise is termed as Capital Gain and the same is taxed as per the Capital Gain tax rates (Long Term/Short Term)
Frequently asked questions
About Vega Equity
Vega Equity offers companies an effective, intuitive, and paperless platform for managing equity. It provides accurate cap table management, customized user experiences, and precise information. Additionally, it assists in measuring KPIs, analyzing data, and tracking performance towards goals.
Create a Culture People Want to Stick to
Get a demo
- Give ESOPs within a few clicks
- Personalized templates
- Build a community
- Dashboard views