ESOP Valuation - Part 1

What Is It and Why Do I Need It?

 
What is a Valuation?

Valuation is a process and a set of procedures used to estimate the economic value of an owner's interest in the business.  The valuation process is used by buyers and sellers of closely held businesses to determine the price they are willing to pay or receive to consummate a sale of a business.  Valuations also are used for a wide variety of purposes such as financial reporting, stockholder buy/sell matters, and resolving disputes related to estate/gift taxation and marital dissolution.

The appraisers and analysts at Acclaro spend a significant amount of time on valuations for a particular purpose: determining value in the context of employee stock ownership plans (ESOPs). 

Why Would I Need an ESOP Valuation?

An independent appraiser is one who does not have a conflict of interest in a specific engagement. Independent ESOP valuations of closely held stock are needed primarily for the following reasons:

ESOP Feasibility.  In the process of potentially establishing an ESOP, one preliminary step is an ESOP feasibility study.  An independent valuation is used in this study, along with the consideration of other facts and circumstances, to determine whether it makes sense to proceed with the creation of an ESOP.  A key determinant in the creation of any ESOP is whether the fair market value determined by the independent appraiser reaches a level which induces the selling stockholder(s) to agree to a transaction. 

ESOP Transaction.  In an ESOP transaction, the ESOP either purchases employer shares from the sponsor company (either in an initial transaction or in a subsequent transaction "phase") or sells employer shares back to the sponsor company (i.e. an ESOP termination). 

ESOP Annual Update.  The Internal Revenue Service (IRS) and the Department of Labor (DOL) have oversight responsibility with respect to ESOPs and have over the years enacted standards and regulations that govern ESOPs.  ESOP trustees are required by law to set the employer stock price at least annually which in turn allows the ESOP's third-party administrator to perform the mandatory annual accounting and testing procedures that culminate in the issuance of annual ESOP participant statements.  An ESOP participant statement includes the participant's account balance as of the end of the plan year. An important distinction mentioned previously bears repeating:  The ESOP trustee is actually charged with determining the fair market value of the employer stock.  However, most trustees will delegate the valuation analysis and report writing to an independent appraiser. The trustee will then typically rely on the independent valuation but is ultimately responsible for setting the stock price.

Given the regulatory scrutiny that may be applied to ESOP valuations, it is important for the ESOP trustee to hire a qualified independent appraiser. The most important criterion in choosing a qualified appraiser is to select one that routinely renders ESOP valuation opinions.  There are unique intricacies related to ESOP valuations; therefore it is important for the appraiser to be familiar with the various Employee Retirement Income Security Act (ERISA), IRS, and DOL guidelines and proposed regulations that affect ESOPs.  In addition, it is important to retain an appraiser who has the requisite experience, education, professional accreditations, and professional association memberships.

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