Valuation Issues for ESOPs

Business Advisors|Business Valuation

By Stephen Thimons

The Employee Benefits Security Administration (“EBSA”) shares responsibility for administration and enforcement of the Employee Retirement Income Security Act (“ERISA”). As part of its role, the EBSA has identified certain national enforcement projects for its field offices to focus on in investigations.

One of those projects is the Employee Stock Ownership Plan (“ESOP”) project which is designed to identify and correct violations of ERISA in connection with ESOPs. The EBSA has stated that, “One of the most common violations found is the incorrect valuation of employer securities. This can occur when purchasing, selling, distributing, or otherwise valuing stock.”

An important function of the trustee of an ESOP is determining the value of shares of stock held by the Plan. Although a trustee often engages an independent appraiser to value shares of stock, the trustee still has a fiduciary duty to exercise due diligence when reviewing any report and/or analysis prepared by the appraiser. In fact, the Internal Revenue Manual for ESOPs states that, “The independent appraisal will not in itself be a good faith determination.”

Unfortunately, determining the value of any asset or business is complicated. A typical valuation considers cash flow projections, discount rates, market multiples, discounts for lack of control and marketability and normalization adjustments among many other important factors. However, valuing stock owned by an ESOP often brings with it additional unique considerations. Some of these unique factors include, but are not limited to:

  • Discounts for Lack of Marketability – Most ESOPs have a “put option” where participants’ shares must be purchased by the company. This readily available market tends to lower any discount for lack of marketability associated with shares of stock owned by the ESOP.
  • Control Premiums – The Department of Labor proposed rules that for a control premium to apply to shares being bought or sold by an ESOP, the ESOP must have both voting control and “control in fact.” Identifying when this occurs can depend on a number of factors.
  • Repurchase Obligation – Because a company is obligated to repurchase shares of stock owned by the ESOP, many valuations consider this future obligation when determining the cash flows of the company. However, if the obligation cannot be directly quantified, some analysts adjust the discount for lack of marketability to reflect the risk that the company may not have adequate funds to repurchase shares.
  • Treatment of ESOP Debt – ESOP debt repayment may be deductible as a plan contribution under IRS rules, which could create a tax benefit.

These and many other factors should be considered as part of a review of an appraisal of stock owned by an ESOP. It is important that a person reviewing an ESOP valuation has an understanding of these issues and their potential impact on value.

Schneider Downs has significant expertise in providing valuation services. For more information about Schneider Downs’ valuation and other business advisory services, please contact Steve Thimons at 412.697.5281 or sthimons@schneiderdowns.com or Tom Claassen at 412.697.5330 or tclaassen@schneiderdowns.com.

© 2013 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2019 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.