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ESOPs

ESOPs

Stern Brother’s provides the expertise for business owners to confidently exit their business and reward their employees for their hard work. We have set up over 300 ESOPs for business owners and their employees. In addition we estimate the value of over 120 ESOPs annually. Our team has spoken at dozens of conferences and consulted other consultants on demystifying the benefits of ESOPs.

An employee stock ownership plan valuation engagement is more than the analysis of fair market value.

An employee stock ownership plan valuation engagement is more than the analysis of fair market value. No matter who our client is, ultimately the valuation is subject to challenge from four primary sources – the buyer or the seller of the security, the Internal Revenue Service and the Department of Labor. The valuation must be carefully constructed so that other involved parties are also convinced that fair market value has in fact been persuasively demonstrated.

The Department of Labor has published regulations relating to the definition of “Adequate Consideration” (29 CFR Part 2510) under the Employee Retirement Income Security Act of 1974 and the Federal Employees’ Retirement System Act of 1986 for pension and welfare benefits administration. Adequate Consideration means “fair market value” as determined in good faith by the named trustee or fiduciary. Proposed [2510.3-18(b)(3)(ii)] focuses on two factors, which must be present in order for the Department to be satisfied that the fiduciary has acted in good faith. First, the fiduciary must apply sound business principles of evaluation and conduct a prudent investigation of the circumstances prevailing at the time of the valuation. Second, the fiduciary making the valuation must itself be independent of all parties to the transaction (other than the plan), or the fiduciary must rely on the report of an appraiser who is independent of all parties to the transaction.

The trustees of an ESOP may be subject to liability if they breach their fiduciary duties. The selection of an appraiser with solid credentials who is independent, certified and experienced will lessen substantially the potential liability associated with the valuation of the stock.

The ESOP Association presents the results of court cases involving valuations. The following paragraph is an excerpt from their 1989 publication, Valuing ESOP Shares.

“In general, in those cases where the plaintiffs prevailed, the valuation that was found wanting was arrived at by someone who was not independent of the employer company and/or did not fully and adequately reflect all the factors relevant to the valuation of the subject stock. It is hoped that these problems will be alleviated to some extent by the requirement in the Tax Reform Act of 1986 that all ESOPs have the stock appraised at least annually by an independent, qualified appraiser of such stock. Certainly, however, we will hear of many additional employee plan stock valuation challenges over the next few years.”

Therefore, it is appropriate that an appraiser meet three basic criteria:

    1. Be a person or firm that regularly engages in the valuation of businesses or business interests. The extent to which the Department of Labor reviews a valuation as reflecting fair market value will be affected by an assessment of the level of expertise demonstrated by the individual or parties making the valuation.
    2. The appraiser should be skilled in their field and TRULY represent the interests of the ESOP in estimating the value of the stock.
    3. The appraiser should be independent with respect to the issuing company and parties to an ESOP transaction.

Treasury Regulation Section 54.4975-11(d)(5) states: “An independent appraisal will not in itself be a good faith determination of value in the case of a transaction between a plan and a disqualified person. However, in other cases, a determination of fair market value based on at least an annual appraisal independently arrived at by a person who customarily makes such appraisals and who is independent of any party to a transaction under Section 54.4975(b)(9) and (12) will be deemed to be a good faith determination of value.”

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