ESOPs are making millionaires out of employees of India’s largest tech startups. In 2021 alone, a dozen tech companies such as RazorPay, CRED, and Zerodha announced $100+ million worth of ESOP buyback plans – the highest ever recorded in history of ESOPs in India.
Reportedly, the total ESOP gains for Indian startup employees in 2021 were in the tune of a whopping $335 million.
Naturally, the question arises: How are these ESOPs valued? Before we dive into that question, let us quickly understand what ESOPs are and why they are used.
What are ESOPs?
ESOP stands for Employee Stock Option/Ownership Plan which is an employee benefit plan that is offered to the employees by the company to encourage their ownership in the future based on their performance over a period of time. The shares are given away at reduced rates or completely free to the employees and become part of their income. A flourishing company or startup will have valuable stocks.
Why Do Startups Issue ESOPs?
The main purpose behind distributing the Employee Stock Option or Ownership Plan is to retain talent and motivate them toward employee ownership and share the wealth earned by the company. However, it is important for you as an employee to note how many ESOPs you are getting and how much is each worth; the timeframe within which you will be getting these ESOPs; what is the minimum amount of time you will have to serve with a startup company to be eligible for ESOPs; after leaving the company how much time will you get to exercise these options.
ESOPs are earning opportunities for employees of a company where the value of the shares increases over time in case of large funding, or even overnight in case of acquisitions by more influential companies.
To minimize unfair practices, all businesses should develop transparent selection criteria for ESOPs.
How To Evaluate ESOPs?
An ESOP valuation firm will adopt either of the two methods to evaluate ESOPs:
- Intrinsic Value Method - “Is the excess of the market price of the share under ESOP over the exercise price of the Option.”
- Fair Value Method - Various factors are taken into consideration in this method like the expected life of the Option, the exercise price, fair value per share, expected volatility of share price, expected dividend yield, and risk-free interest rate.
- To retain the talent pool that helped the company to accomplish its end goals, and to incentivize them to become an owner by acquiring those ESOP stocks at a predetermined date at a predetermined price
- It is in keeping with the Indian Income Tax Act, 1961, and the notification issued by CBDT (The Central Board of Direct Taxes). ESOP stock valuation is important to determine the value of the taxable shares.
- Employers should have knowledge of the fair market value of the equity share in which they are investing and stock-holding to make profitability in the future.
Why is ESOP Valuation Critical For Startups?
ESOPs encourage employees to continue long-term in a company as there are huge monetary gains to make with an accompanying sense of ownership of the company.
A SEBI registered Merchant Banker is qualified to make ESOP valuations. You may contact consultants at a registered ESOP valuation firm who will help to determine the exact value of ESOPs and ESOP stock valuation.
The following are the key reasons for which ESOP valuation becomes mandatory for startups-
Final Thoughts
ESOPs are a favorable means of employee compensation and are a huge hit with companies these days. However, diligent planning and valuation of ESOPs are necessary to reap their intended benefits.
If you want to know more or you’re looking to get expert advice on ESOP stock valuation, RNC can help. As a leading ESOP valuation firm, we offer trusted ESOP valuation and identify risks and opportunities in ESOP models of companies of all sizes.
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