| > | | | | above those being enjoyed by the selling parties. |
| ESOPs have become an effective tool in | | | | Examples are the prospects of increased sales of |
| corporate finance and tax planning. Not only do | | | | the buyer’s products to the seller’s |
| they provide retirement benefits and incentives to | | | | customer base or lower overall materials costs |
| employees but an ESOP can provide unique ways | | | | due to volume purchase discounts, etc. Whether |
| to transition company management in tax | | | | or not a control premium is appropriate in the |
| favored environments. An ESOP can even be | | | | purchase of shares by an ESOP must be |
| used to increase cash flow or convert debt to a | | | | determined on the facts in the individual case. |
| pre-tax environment. | | | | Moreover, since the ESOP generally |
| ESOPs have become an effective tool in | | | | doesn’t control a company itself, there is |
| corporate finance and tax planning. Not only do | | | | much debate as to whether or not an ESOP can |
| they provide retirement benefits and incentives to | | | | pay a control premium for shares purchased, |
| employees but an ESOP can provide unique ways | | | | even if purchasing a controlling percentage. |
| to transition company management in tax | | | | How do ESOP valuations differ from valuations |
| favored environments. An ESOP can even be | | | | for other purposes?Because of the regulatory |
| used to increase cash flow or convert debt to a | | | | requirement established in the Employee |
| pre-tax environment. Why do we need to engage | | | | Retirement & Income Security Act of 1974 |
| an outside party to value our ESOP shares?From | | | | (ERISA) that an ESOP pay no more than |
| a strictly regulatory standpoint, a valuation of | | | | adequate consideration in the purchase of |
| ESOP shares by an independent third party is | | | | employer securities, ESOP valuations must |
| required by the Department of Labor (DOL) and | | | | support the decisions of the trustees and must |
| the Internal Revenue Service (IRS). The | | | | also withstand review by DOL and the IRS. |
| regulatory requirement stems from the practical | | | | Valuations that are subject to being reviewed by |
| need to insure that the value is determined by a | | | | third parties, whether for ESOP or other |
| party who does not have a personal or financial | | | | purposes, must include considerable discussions on |
| interest in the valuation result. The valuation, | | | | the methods and factors employed as well as |
| moreover, should be performed on behalf of the | | | | explanatory information on the sponsoring |
| ESOP trustee since it is the duty of the trustee | | | | company’s financial and operating history |
| to insure that transactions with the ESOP are | | | | and the industry in which it competes. For similar |
| consummated at fair market value. | | | | reasons, valuations supporting tax related values |
| What is meant by fair market value?Fair | | | | for gift and estate or charitable deduction |
| Market Value (FMV) is a concept and not a price | | | | purposes must also include considerable |
| that emerges from application of some standard | | | | background detail so that potential third party |
| formula. In simple terms, FMV is the price for | | | | reviewers will have a clear understanding of the |
| which property would sell under the existing | | | | process leading up to the value conclusion. In |
| market conditions for such property as | | | | addition, ESOP regulations place various obligations |
| established in arms-length negotiations between | | | | on the sponsoring employer and allow for |
| knowledgeable and independent parties. The | | | | limitation of the voting rights of ESOP shares. |
| market implied in definitions of FMV | | | | These, and other features specific to the ESOP |
| encompasses all potential buyers and sellers of | | | | require special consideration in the determination |
| the property involved. | | | | of the fair market value of ESOP owned |
| How is fair market value | | | | securities of privately held companies. It is |
| determined?There are many method used in the | | | | strongly recommended that an ESOP trustee |
| determination of FMV. The nature of the property | | | | utilize an appraiser who is knowledgeable in the |
| being evaluated determines what methods are | | | | design and use of ESOPs since they are |
| appropriate. For example, the FMV of a single | | | | extremely unique in their different applications. |
| family home is determined by the price for which | | | | What is the cost of an ESOP valuation?The fees |
| similar property is selling in the area in which such | | | | charged for ESOP valuations vary considerably |
| property is located. The FMV of business interests | | | | from one valuation firm to the next. There is no |
| that is generating earnings, however, is | | | | set industry standard or prescribed range. This is |
| determined to a large degree on the basis of | | | | due to the wide variation in the amount of work |
| what a knowledgeable buyer would be willing to | | | | that may be involved between one engagement |
| pay for the earnings stream considering available | | | | and another. As a general rule, the cost of an |
| rates of return on relatively risk-free investments | | | | initial valuation for a newly formed ESOP will be |
| and the risks associated with the investment | | | | higher than the subsequent annual update |
| being appraised. Although not the only method | | | | valuations. This is because of the amount of time |
| that might be considered, the present value of | | | | and work involved in gathering and analyzing all of |
| future earnings using a risk adjusted market rate | | | | the financial, industry and other pertinent |
| is one of the most common approaches, referred | | | | information for the initial report. The update, on |
| to in business valuations as Discounted Future | | | | the other hand, need only focus on changes in |
| Earnings (DFE). | | | | financial and other factors that have occurred |
| Reference to the results of mathematical | | | | since the prior report. |
| formulas is not the sole determinant of FMV. The | | | | Are there different types of ESOP |
| judgment and experience of the valuation analyst | | | | valuations?Because few companies are willing to |
| is also a critical element since there can be many | | | | adopt an ESOP before determining whether or |
| factors that can not be quantified by reference | | | | not the value of company stock will support |
| to the underlying financial information alone. | | | | management objectives, Greenstein, Rogoff, |
| What is meant by a control premium?A | | | | Olsen & Co., LLP offers limited valuations for |
| control premium is that amount which a buyer | | | | feasibility purposes to reduce the initial costs of |
| may be willing to pay to acquire a controlling | | | | implementing an ESOP. Since this valuation is for |
| interest in a business over and above the value of | | | | company management purposes, all of the time |
| the interest based solely on the underlying financial | | | | consuming company and industry background |
| factors. The element of control, in this case, has a | | | | report writing can be eliminated. The |
| value which is added to the value that can | | | | company’s management is fully aware of |
| otherwise be ascribed to the assets and earnings | | | | these matters and need not pay for the privilege |
| of the business. The payment of a control | | | | of reading about them in a valuation report |
| premium in the purchase of a business does not | | | | prepared exclusively for management use only. All |
| necessarily add any value to the business. | | | | pertinent factors are considered in the analysis |
| Synergy value, unlike control, is susceptible to | | | | leading to the value conclusion and all requisite |
| being measured in more concrete terms of | | | | financial data and valuation methods used for a full |
| increased financial benefits to the buyer over and | | | | report are outlined in the limited report as well. |