Valuation of ESOP’s and Sweat Equity

An ESOP is a plan through which a company awards stock options to its employees based on their performance. An employee stock option is a ‘call option’, meaning that under an ESOP the employees have the right and not an obligation to buy the shares of the company on a predetermined date at a predetermined price. The objective of ESOP is to motivate the employees to perform better and improve shareholders’ value. Apart from giving financial gains to the employees, ESOP also creates a sense of belonging and ownership amongst the employees. This has led to newer challenges for Valuation of ESOPs for regulatory, compliance and tax purposes.

ESOP valuation is required for accounting purpose for booking compensation loss in Profit and Loss account by company issuing ESOPs. The ESOP accounting valuation is performed at the date of grant of options and compensation loss is apportioned over the vesting period.

The tax impact on perquisites value of ESOPs needs to be determined at time of exercise of options. The compensation expense reduces the EPS of the company and the possibility of excess tax pay out by employees may turn the ESOP scheme unattractive. Thus, proper planning of ESOP is inevitable and valuation plays a critical role here.

As per Income Tax Act, 1961, only a SEBI-registered (Cat-I) merchant banker is authorised to do ESOP valuation of a company (not listed on a recognised stock exchange in India) for determination of perquisite tax payable in hands of employees.

However, for accounting valuation, there is no specification; however, as it impacts the financial statements, auditors look upon valuers having decent track record in such assignments.

Estimating the value of equity awards and share-based payments depends on a number of variables and often requires complex modeling to incorporate unique terms and complex risks. Transique Valuation Advisors assists both public and private organizations with stock compensation planning and financial reporting.

All option pricing models take into account, as a minimum, the following factors:

(a)   The exercise price of the option;

(b)   The life of the option;

(c)   The current price of the underlying shares;

(d)   The expected volatility of the share price;

(e)   The dividends expected on the shares (if appropriate); and

(f)    The risk-free interest rate for the life of the option.

Sweat equity shares are such shares that are issued by a company to its directors or employees at a discount or for consideration other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or ‘value additions’, by whatever name called for which the consideration is ‘not’ paid or included in:

1. a) The normal remuneration payable under the contract of employment, in the case of an employee; and/or
2. b) Monetary consideration payable under any other contract, in the case of non-employee.

Transique Valuation Advisors valuation models are tailored to our clients’ needs. We help companies select the most appropriate approach and estimate all required parameters. We deliver a well-supported valuation that fulfills financial reporting requirements of IND AS 102.

Transique Valuation Advisors assist both public and private organizations with stock compensation planning and financial reporting.

Transique Valuation Advisors has deep experience with the full range of Option valuation techniques, including:

Equity Valuation (Intrinsic Value)

• Fair Valuation (Option Pricing Models)
  • Closed form solutions such as the Black-Scholes formula
  • Binomial lattice models, customised to capture key features such as early exercise behaviour

• • Monte Carlo simulations, incorporating performance and/or market conditions and other complexities in the analysis.
• Valuation for Repricing and other award modifications

Our Team is expert in determining which approach is most appropriate, and tailoring the analysis to the specific situation at hand.