Valuation of ESOPs and Sweat Equity

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    Valuation of ESOP’s and Sweat Equity

    An Employee Stock Option Plan (ESOP)allows a company to awards/compensate its employees in form of stock options, basis their performance. Under stock option, employees have the right and not an obligation to buy the shares of the company, at a predetermined price, on a predetermined date. In recent times, ESOPs have gained lots of significance with more and more companies coming out with ESOP Schemes as a tool for retention, employee motivation and creating a sense of belongingness amongst employees. With increased number of ESOP schemes, the requirement of Valuations of ESOPs for regulatory, compliance and tax purposes have also increased many fold.

    Along side ESOPs, higher management people are also being awarded with Sweat equity shares. Sweat equity’s 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’. In case of Sweat Equity, the consideration is either ‘not’ paid or included in the normal consideration or monetary compensation payable under employment contract or compensation contract.

    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. Further, the tax impact on perquisites value of ESOPs needs to be determined at time of exercise of options. Also, the compensation expenses results in the fall of EPS of the company and the probability of of higher 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.

    For unlisted companies, Income Tax Act, 1961, mandatorily requires a SEBI-registered (Cat-I) merchant banker to do ESOP valuation for determination of perquisite tax payable in hands of employees.

    However, for listed companies, there is no specification other than the valuation methodology; however, as it impacts the financial statements, auditors prefer valuations being carried out by trusted and efficient valuers with decent track records.

    Also, estimating the value of equity awards and share-based payments depends on a number of variables and often requires intricate modeling to incorporate unique terms and complex risks.

    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.

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

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

    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