ESOP Valuation and Appraisal: Ensuring Accuracy and Fairness for Employee Stock Ownership

October 24, 2023

All Employee Stock Ownership Plans (ESOPs) undergo valuations, both at the initial creation of the ESOP (called a Feasibility Study) and annually thereafter. The annual ESOP stock valuation determines the fair market value of the company’s shares. Since this ESOP appraisal is so critical to the legal administration of the plan, and the ESOP trustee is required by law to act only in the employees’ best interest, it’s important to ensure the utmost accuracy and fairness during the valuation process.

Understanding ESOP Valuation and Appraisal

The ESOP trustee first needs to hire an independent appraiser to determine the fair market value of the ESOP’s shares. According to the IRS, the fair market value is defined as follows: “The price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.” At Aegis, we utilize an experienced fiduciary advisory committee as well as an independent financial advisor to appraise organizations.Once the ESOP valuation is complete, the ESOP trustee reviews it - as well as the method used (more on those methods, below) - to ensure that it is fair and accurate. Finally, the Department of Labor reviews all ESOP valuations, which are filed with the IRS. It’s important to note that an ESOP’s viability rests on the accuracy of these valuations, which must also comply with ERISA, the Employee Retirement Income Security Act of 1974. Failing to adhere to these regulations, alongside all IRS requirements, can endanger the viability of the ESOP.

Methods and Approaches to ESOP Valuation

The method used to determine the fair market value of ESOP shares will depend on the company’s industry, its size, and available market data. Three main methods of valuation are typically used:

Method 1: Discounted Cash Flow
The most common valuation method for ESOPs is “Discounted Cash Flow,” which is based on the anticipated future cash flow of the company. This calculation uses a discount rate referred to as the “weighted average cost of capital” to determine a risk-adjusted, present value of those cash flows. This valuation method also takes into account current interest rates and makes assumptions about the business’ projected performance, debt-to-equity ratio, tax rate, and the company’s competitive market.

Method 2: Public Market Comparables
Another ESOP valuation method is “Public Market Comparables” which takes financial information that is publicly available, to determine the value of a similar business. Since companies with ESOPs are privately held, this method can have some drawbacks, since a public company is not an apples-to-apples comparison.

Method 3: Precedent Transactions
A third ESOP appraisal method is known as “Precedent Transactions,” and is used when comparable public company data is not available. In this approach, industry-specific merger and acquisition (M&A) transaction data is used to make the valuation.

Factors Influencing ESOP Valuation

In addition to following one of the above methods to make the ESOP valuation, the appraiser takes the following information into consideration:

  • Non-operating assets and liabilities
  • Past financial statements
  • Year-to-date financial statements
  • 5-year projection plans
  • Operational data
  • Outstanding M&A offers
  • Recent valuations by another party

To learn more about the fiduciary’s responsibilities throughout the ESOP share valuation process, take a look at this article.

Ready to Take Your Next Step?

At Aegis, you’ll find specialists in all essential ESOP transactions and trustee services, including CPAs, attorneys, valuation experts, and administrators. Our well-rounded team works tirelessly to provide a seamless and comprehensive experience, reducing your reliance on third-party providers and the extra fees and difficulties that can come along with them. Contact Aegis today to start the conversation!

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DISCLAIMER: The Articles displayed on this website do not constitute legal advice, nor do they substitute for the advice of qualified professionals. While the Articles displayed on this website are designed to provide information regarding the subject matter covered, we cannot guarantee the accuracy of any statements contained therein. If any legal advice or expert assistance is required, the services of qualified professionals should be sought.

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