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Understanding ESOP Valuation and Why it is Important

By November 10, 2022June 17th, 2024Blog4 min read
Understanding ESOP Valuation

Organizations resort to many methods to hold back their employees in a time of crisis. They may be faced with employees leaving them. In an attempt to retain employees or as a general way of awarding deserving employees, organizations consider ESOP a valid option.

Simply put, ESOP or an employee stock ownership plan is stock ownership that employees can have. But it is not as simple as it sounds. It has to be regularly reevaluated for compliance.

This article takes an in-depth look at what ESOP is and its importance.

What are ESOPs in India?

ESOP or employee stock option plan is an incentive given to employees which allows them to subscribe to its shares at a fixed price for the future. It may be awarded to employees based on their performance. It is an employee stock option, which is also called a call option. Employees have the right to buy this stock, but not the obligation. This is done at a pre-decided price at a pre-decided date.

ESOP is a great way to improve the value of the shareholders in the company. When employees buy stocks, they gain a sense of ownership and belonging. They are encouraged to perform better and share the responsibility of working for the company’s welfare.

ESOP valuation is a necessary aspect of ESOP. Let us take a look.

Why is ESOP Valuation Necessary?

An ESOP valuation or a Sweat Equity valuation can only be done by a SEBI-registered (Cat-I) Merchant Banker as per the Indian Income Tax Law. Only then can the prerequisite tax payable be determined and controlled by the company’s employees and decision-makers.

ESOP valuation is critical to a company in its entirety. ESOP has to be listed as an expense by companies that offer it to their employees. It has to be part of the P&L statement.

For a startup, ESOP valuation is crucial as the valuation of the organization in its entirety. Companies that offer ESOPs must provide ESOPs as an expense in their P&L statement. The provision affects how distributable profits are calculated for factors like EPS calculations, MAT payments, dividend declarations, and senior management compensation.

Companies must conduct a fair ESOP valuation to quantify ESOP expenses, according to Ind-AS. Companies must expense appropriately in the P&L statement. The compensation expenses reduce the company’s EPS. Employees who pay too much tax may lose sight of the ESOP’s goals and benefits.

The compensation expenses reduce the startup’s EPS. On the other hand, employees paying excess tax may fade out the ESOP scheme’s purpose and value. So, startups must plan ESOPs carefully and have them evaluated regularly to ensure the ESOPs serve their purpose and prove mutually beneficial. To make sure ESOPs serve their intended purpose and prove mutually beneficial, startups must carefully plan them and have them evaluated regularly.

Shareholders can get minority stakes via ESOPs. Minority evaluation methods have to be employed to evaluate ESOP. The appropriate discounts have to be applied, and the basis of observation, experience-based evidence, and case-related facts have to be furnished when using particular control methodologies as part of minority valuation methods.

ESOP Valuation with Valuation India

Now that we know what ESOP valuation is and its importance, you need the assistance of an expert valuation firm to implement a successful ESOP strategy. You will find many valuation firms when you search for business valuation services near me. However, you should be careful while choosing a valuation firm as a lot depends on their expertise and whether their approach suits your needs. When you work with a reputed firm like RNC, you have the peace of mind of knowing your ESOP valuation will be done appropriately and profitably. At RNC, we have decades of experience and a team of business valuation experts trusted by some of the world’s largest organizations. Get in touch with us to know how we can help with our ESOP valuation services.