Understanding Fair Market Value for ESOPs

  • Written Written by Team ESOP 20 November 2023 | 4 min read
  • Editor's Note :

    In this blog, we delve into the intricacies of understanding Fair Market Value (FMV) within the context of Employee Stock Ownership Plans (ESOPs). We explore the key factors that influence FMV, ranging from financial metrics and market conditions to the unique dynamics of competitive positioning.

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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.

fair market value

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:

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.

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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:

What are the factors that affect the FMV?

Some of the common factors that affect the FMV of stocks are:

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

  • You might find different terms like Fair Market Value and Fair Value in different valuations.
  • Fair market value is the standard of value for income tax purposes, estate planning, and market transactions. The Fair Market Value of a stock is the cash price at which it would be exchanged in a freely accessible market when both the buyer (e.g., an employee) and the seller (e.g., the company) possess sufficient knowledge of pertinent information.
  • Fair value is a more comprehensive financial accounting and reporting concept, often used in the context of financial statements and business valuations. Fair Value (FV) is the price at which a stock could be willingly purchased or sold between parties not involved in a compelled or forced sale, such as a liquidation.
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