How to Calculate Fair Market Value for ESOPs?

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.

Need a Fair Market Value Calculator?

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:

Step 1: Gather Market Data

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.

Step 2: Consider Other Market Factors (Optional)

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.

Step 3: Calculate the FMV

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:

• 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

Fair market value vs. fair value

• 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.

What will happen if the FMV of the shares is lower than the Exercise Price?

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.

FMV is similar to Exercise price in ESOPs?

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.