Valuation is at issue in an ESOP. It is the central issue: How much is the company worth? The answer to this question establishes the transaction price and the shares that are, in turn, owned by the trust.
The role of valuation in ESOPs has been making the news lately. A recent Wall Street Journal article, “U.S. Increases Scrutiny of Employee-Stock-Ownership Plans,” profiles several complicated cases involving troubled valuations.
That valuation is at issue in 15 lawsuits where the Department of Labor (DOL) is involved is not surprising. If there is a problem with an ESOP, the valuation is likely at the root of the issue. That the number of lawsuits has gone up since the beginning of the recession is not surprising either. Many companies saw a precipitous drop in value during the recession. It stands to reason that the value of shares held by an ESOP would have dropped as well, likely causing the employees to be unhappy.
Putting the risk into perspective
Looking at the DOL’s caseload alone might make it easy to draw the conclusion that all ESOPs are risky, when in reality the vast majority likely have solid valuations performed with integrity. 6800 companies with ESOPs. 15 lawsuits. It’s a bit like my wife, a critical care nurse, deciding that all motorcycle riding is risky based on the number of motorcycle riders she sees at work. Of motorcycle riders that end up in the ICU, most are in bad shape. Compared to the 99.9% of motorcycle riders that get home safely, however…the numbers aren’t so bad.
That said, I agree with the DOL. Valuation is the first, second, third, and fourth consideration if you are thinking about an ESOP. You should get an accurate determination of the value of your company. Then determine if an ESOP helps accomplish your objectives. Don’t determine how much you’d like to get and see if you can justify the purchase price, or you’re more likely to end up like those motorcyclists in ICU—struggling to survive.
Let’s extend the analogy…
Motorcycle riders increase their chances of making it home safely by knowing the rules of the road and investing in safety equipment and protective gear. Likewise, to keep your company out of the ICU, learn the rules of the road from experienced professionals who can help you navigate the ESOP process. If the DOL thinks that the first four issues with ESOPs revolve around valuation, it seems that investing in a quality valuation is an important piece of “protective gear” for the former owners, trustees, and ESOP participants.