Employee Stock Ownership Plans Basics of ESOP Stock Valuation

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Employee StockOwnership PlansBasics of ESOP
Stock Valuation

• 21st Annual Ohio Employee Ownership Conference
• Fairlawn, OH
• April 20, 2007
• Richard A. Schlueter, ASA
• rschlueter_at_comstockvaluation.com

COMSTOCK VALUATION ADVISORS ? 1 Levee Way, Suite
3109 ? Newport, KY 41071 ? Phone (859)
957-2300 ?
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Defining the Appraisal Assignment

• Assess the purpose of the valuation
• Identify the interest being valued
• Identify the characteristics of interest
• Select an appropriate standard of value
• Identify appropriate level of value
• Determine the date of the valuation

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Purpose for ESOP Valuation

• ESOP Feasibility
• ESOP Transaction
• ESOP Plan Administration
• Review of Appraisal

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Interest Being Valued

• Invested Capital or Enterprise Value
• Equity Interest in a Company
• Stock Options, Warrants or Synthetic Equity
• Specific Tangible or Intangible Assets of the
  Company

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Interest Being Valued
Payables ST Accruals
Current Assets
Invested Capital
Short Long Term Interest- Bearing Debt
Fixed Assets 1. Tangible fixed assets 2.
Intangible fixed assets
Shareholder Equity
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Characteristics of Interest

• Equity interest purchased by an ESOP must be the
  highest class of stock or convertible into the
  highest class of stock issued by the company.
• ESOP securities take the following forms
• Common Stock
• Super Common Stock
• Convertible Preferred Stock

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Standard of Value - Fair Market Value

• The price at which the companys stock would
  change hands between a willing buyer and a
  willing seller, neither being under any
  compulsion to buy or sell and both having
  reasonable knowledge of all relevant facts.

• Assumes a transaction of the ownership interest
  has occurred
• Hypothetical parties
• Parties willing and able to complete the
  transaction
• As of a specific valuation date
• Value in cash or equivalent

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Levels of Value
Total Equity Value (Controlling
Shareholder) Financial Buyer of a Company
Discount for Lack of Control
Control Premium
Marketable Minority Interest Value Publicly
Traded Equivalent Value
Discount for Lack of Marketability
Non-Marketable Minority Interest
Value Non-Controlling Shareholder of a Private
Company
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Control vs. Minority Ownership

• An ESOP that buys greater than 50 of the stock
  may pay a control premium.
• An ESOP can buy less than 50 of the stock and
  may be able to pay a control premium if the ESOP
  will acquire control in a reasonable period of
  time.
• The ESOP should have voting control and
  control in fact in order to justify the control
  premium.
• Degrees of control exist based on rights under
  state and federal law.

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Marketability for ESOPs

• Marketability Discount, as defined by the ASA, is
  an amount or percentage deducted from an equity
  interest to reflect lack of marketability
• Under ERISA, there is a put right back to the
  company for non-publicly traded stock that
  creates a market for the ESOPs shares.
• Discounts impacted by
• Level of control
• Ability of company to redeem stock
• Extent of pre-funding of repurchase obligation
• Policy regarding immediate redemption versus
  payout using a note with up to a 5-year term.

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Valuation Date

• Valuations must be prepared as of the date of
  purchases or sales of stock involving
  transactions with parties at interest.
• Annual (or more frequent) valuations are required
  for plan administration purposes.

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Other ESOP Financial Concepts

• Adequacy of Consideration
• The fair market value of the security, as
  determined in good faith by the trustee or named
  fiduciary of the plan, in accordance with
  regulations issued by the Department of Labor.
• Financial Fairness
• Absolute Fairness - The ESOP may pay no more than
  fair market value when it buys the stock.
• Relative Fairness - The ESOP must receive terms
  that are fair in relation to the terms given to
  other investors.

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Qualifications of the Appraiser

• Experience Expertise
• Independence of Appraiser
• Appraiser reports to ESOP Trustee
• Appraiser represents the interests of the ESOP
• Defensibility
• Timeliness
• Adherence to Valuation Standards

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Appraisal Standards

• Uniform Standards of Professional Appraisal
  Practice
• IRS Revenue Ruling 59-60
• Proposed regulations on Adequacy of Consideration
  by U.S. Department of Labor
• Requirement of professional business appraisal
  organizations like ASA, NACVA, IBA, AICPA

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Valuation Basics

• Nature of business and history of enterprise
• Economic and industry outlook
• Book value of stock
• Financial condition of business
• Earnings capacity of company
• Capacity to pay dividends

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Valuation Basics

• Goodwill or other intangible value of the
  enterprise
• Recent sales of stock, the price, and size of
  blocks sold
• Market price and book value of publicly traded
  stock of corporations engaged in a similar line
  of business

Source Revenue Ruling 59-60
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Valuation Process

• Issue engagement letter
• Gather financial information and other documents
• Prepare financial analyses
• Tour facilities and interview management
• Prepare valuation analyses
• Issue a draft report containing preliminary
  findings and supporting documentation
• Submit draft for review by Trustee
• Present valuation to Trustee and/or ESOP
  Committee and answer questions
• Issue final valuation report and opinion letter

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Valuation Report Content

• Valuation Opinion Letter
• Executive Summary
• Company Profile
• Economic and Industry Outlook
• Financial Performance and Adjustments
• Identification of Guideline Companies
• Determination of Discount or Capitalization Rates
• Application of Valuation Methods
• Control/Minority and Marketability
• Reconciliation and Conclusion on Value

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Pre vs. Post-Transaction Value

• Depending on the structure of the ESOP
  transaction, the value of the stock may decrease
  if leverage is used in the transaction.
• Dilution may be reduced through the use of super
  common and convertible preferred stock or through
  the substitution of ESOP benefits for other
  existing benefits.

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Thank You

• Any Questions?