You should be!
The valuation of ESOP stock is of particular importance to the ESOP trustees and ESOP participants. One of an ESOP trustees’ fiduciary responsibilities is to understand and approve the ESOP stock valuation. For participants, the ESOP stock value directly impacts their retirement benefits. These issues are enough keep you up at night!
Since ESOP valuations can seem daunting and confusing, we put together the following to help ESOP trustees and participants get a better night’s sleep!
First Things First!
ESOP valuations are somewhat unique and require that the valuation expert have sufficient experience in order to recognize the nuances of them. A business appraiser that only handles a limited number of ESOP engagements may not recognize certain issues that are specific to ESOPs.
Ask your appraiser about his/her ESOP valuation experience. How many ESOP valuations has he/she prepared? The ESOP appraiser should be knowledgeable of relevant ERISA and U.S. Department of Labor guidelines and issues.
Pinocchio had Jiminy Cricket but the ESOP valuation expert is your guide to thoroughly understand the valuation process. Not only should the ESOP appraiser lead the trustee through the valuation methodology and process, he/she should also make sure that the trustee understands the company specific factors that contribute to or detract from the ESOP stock value. The ESOP valuation expert should be ready, willing and able to answer ALL of your questions, no matter how simple or complex. Asking questions will foster a better understanding of the valuation process and conclusion.
ESOP conferences, such as those presented by The ESOP Association and The National Center For Employee Ownership, are a great resource for identifying ESOP related issues, providing a forum where questions are more than welcome and give the opportunity to network with other ESOP companies and share experiences and solutions.
A + B = Value
The ESOP stock value is a function of both controllable (internal) and uncontrollable (external) factors. Understanding what macro factors (technology, economy, competition) impact value and the critical company characteristics (capacity, reputation, depth of management) will give trustees and participants insight into what they can do to improve the ESOP stock value.
The company’s profitability and growth have the greatest impact on the ESOP stock value. Hence, every employee/ESOP participant can do their part to contribute to the company’s profitability by working efficiently to increase productivity and providing customer service in a manner that enhances the company’s reputation in the industry. Management has a responsibility to put the company in the best position to be innovative, expand markets and products/services and compete.
Analyze/vet/confirm the valuation’s underlying assumptions. Ensure that the appraiser was aware of and focused on ALL of the key issues impacting the company’s value. The underlying assumptions are typically developed using the company’s history as a base so make sure to fact check the analyses.
What the little voice is saying
The valuation expert examines the company, prepares financial analyses, creates models and ultimately, opines to the conclusion of the value of the ESOP stock. However, it is the responsibility of the trustees to determine if the conclusion makes sense before approving it.
The trustee should: (i) make sure that the valuation expert utilized the company’s most recent data (financial and other) and that it was used in an appropriate manner; (ii) confirm that the key issues and factors cited by the appraiser are consistent with management’s view of the business; (iii) verify that underlying assumptions are steeped in reality; and (iv) establish that growth expectations, which can have a significant impact on value, are reasonable, achievable and consistent with management’s and industry view.
The ESOP stock valuation should be consistent with market realities. The trustee will want to verify that the valuation multiples applied are reasonable for the company given its size, performance and industry. Required returns should take into account all of the company’s risk factors, including those specific to the industry.
The valuation report will bring all of the pieces together in a cohesive manner. A good report provides valuable insight into the key elements of the valuation (analyses, methodologies and conclusions) in a way that is easily followed and understood by the layman. The company’s “story” should be consistent from beginning to end.
The More You Know
In summary, becoming familiar with the valuation process from beginning to end is the best way for the ESOP trustees to become more comfortable with and confident that the ESOP stock value is reasonable and supportable. Sharing the valuation findings with ESOP participants will give them some degree of comfort that their retirement nest egg will be there for them when the time comes.
So now, sleep tight and don’t let the valuation bugs bite!