Stock options are an enticing component of employee compensation, offering a chance to share in a company’s success. Yet, converting these options into real financial gains can often seem complex and confusing. One of the most direct ways to achieve liquidity from stock options is through a company buyback program. This blog aims to answer the key questions employees commonly have when a company proposes to repurchase their stock options. Understanding how these buybacks work, their financial implications, and the choices available can empower employees to make informed decisions that maximize their benefits.
Frequently asked Questions
How does buyback of stock options help me earn returns as an employee?
When your company buys back stock options, it offers a price generally linked to the fair market value (FMV) of its shares at the buyback date. If the exercise or strike price of your options is lower than the buyback price, you benefit from the difference. This gain is considered a perquisite income.
Illustration: If the buyback price is INR 100 and the exercise price is INR 10, your gain is INR 90 (before tax).
How is the fair market value (FMV) determined?
FMV of shares is assessed based on their listing status:
- Listed shares: FMV is based on the market price on the exercise date.
- Unlisted shares: FMV is determined by a recognized valuer engaged by the company.
On what amount is income tax calculated in case of gains from a buyback of options?
The taxable amount is the difference between the buyback price and the exercise price, considered perquisite income. For instance, with a gain of INR 90 (as illustrated above), tax is calculated on INR 90. The company deducts TDS (Tax Deducted at Source) at the time of payment.
Is it mandatory to participate in an option buyback offer?
Participation in a buyback offer is entirely voluntary. Employees are not obliged to accept the offer. If you believe holding onto your options could yield higher returns in the future, you can choose to reject the buyback offer or surrender only a portion of your vested options. In some cases, the company may buy back all the offered options, provided it is not against your interest.
What happens to my vested options if I reject the option buyback offer?
If you reject the buyback offer, your vested options remain unchanged. You must wait for the next buyback program or another opportunity to sell your options. However, in the case of a compulsory buyback, you must surrender the vested options.
What happens to my options if my employment is terminated by my employer?
Stock option plans specify how options are treated upon termination of employment. Typically, termination results in the cancellation of vested options, eliminating the possibility of buyback.
If I am no longer associated with a company as an employee, can I still participate in the option buyback offer?
Yes, former employees holding vested options can participate in buyback offers. Companies often buy back vested options at the time of an employee’s exit to streamline administration.
Can I accept to surrender only part of the vested options I hold under the option buyback offer?
Most companies allow partial surrender of vested options. For example, if you have 100 vested options and the company offers to buy back 50%, you can choose to surrender 50 options or a lesser amount.
Is it mandatory for a company to buy back stock options?
No, companies conduct buybacks based on their financial capacity and desire to provide liquidity to employees.
Will I become a shareholder of the company after my vested options have been bought back?
No, you will not become a shareholder if all your vested options are bought back.
Can I participate after the buyback offer period is closed?
No, buyback offers are time-sensitive. You must decide within the specified period. If you miss the window, consider reaching out to HR for any possible exceptions.
What are the advantages and disadvantages of an option buyback?
Advantages:
- Provides liquidity to employees holding stock options.
- Builds confidence and contributes to wealth creation, particularly in companies delaying going public.
Disadvantages:
- If all options are surrendered, you miss out on potential future gains if share prices rise.
Option buybacks offer a practical way for employees to convert their stock options into cash, providing a significant financial benefit and a sense of security. However, the decision to participate should be made carefully, considering both the immediate financial gain and potential future value. By understanding the details of how buybacks work and their implications, employees can make informed choices that align with their financial goals and career plans.
