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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.
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.
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.
Here is the step-wise example to calculate the FMV of a stock that is publicly listed on a stock exchange. Here's how you can do it:
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 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.
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)
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.
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