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Editor's Note:-Whether you’re looking to decode ESOPs or someone trying to deal with compliance, this blog will help you understand FMV and its calculation, taxation, etc. in the simplest way possible!
In the simplest terms, FMV refers to an asset’s estimated value if it is sold in the open market today. In the context of Employee Stock Ownership Plans (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.
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.
The process of calculating the FMV of a listed stock is based on the opening and the closing price of the stock on the stock exchange.
If listed on one stock exchange,
FMV = Average of the opening and the closing stock price on the exercise date.
If listed on multiple stock exchanges,
FMV = Average of the opening price and closing price on the exchange with the highest trading volume.
If not traded on the exercise date,
FMV = Closing price on the preceding date.
For unlisted stocks, it is the price determined by a merchant banker or valuation experts. Some of the most common methods for this include:
Find the stock’s current trade price by checking the closing price on a specific date. For example, say you are calculating the FMV on September 7th, and the stock’s closing price on that date was $150 per share.
You can also take into account the volume-weighted average price (VWAP) over a certain period to get a more accurate reflection of its value. But for simplicity, we’ll use the closing price.
If you own 100 shares of the stock and the closing price was $150 per share, the FMV of your total holdings would be:
FMV=Number of shares×Stock Price
(100×150=15,000)
So, the FMV of your 100 shares is $15,000.
Fair Market Value Calculators for non-listed stocks are the merchant bankers or valuation experts who help the companies calculate the FMV. Some of the most common methods include:
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.
As per the provisions of 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. The ESOP Fair Market Value is used in calculating the perquisite tax at the time of exercise.
Taxable perquisite = Difference between the Fair Market Value (FMV) of the shares as on the date of exercise and the Exercise Price
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)
And, that’s it! Understanding FMV and everything about it will help you be in control of your equity. Hope this helps. Good luck!
In case the Fair Market Value is lower than the Exercise Price then the employee’s stock option plan will be considered “underwater”, which means that it wouldn’t make any financial sense to exercise the options at that period.
No, it is not similar because the exercise price is the price at which the employees can buy shares from the organization, whereas FMV is the current value of the stocks in the market. Generally, FMV is higher than the exercise price.
The ESOP fair market value (FMV) is the estimated price at which a company's shares would be traded. It's important to understand FMV as it helps with tax calculation and regulatory compliance.
In case of listed companies, FMV is calculated based on the market price of shares on the stock exchange on the date of exercise. For unlisted companies, FMV is calculated by a merchant who uses methods like discounted cash flow, comparable company analysis, or book value approach.
Company financials, market conditions, growth prospects of the company and competitor positioning are some common factors that affect the FMV of shares for ESOPs.
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