For employee stock ownership plan (ESOP) trustees, choosing the right valuation advisor is critical. The valuation of the company’s stock is arguably the most important component of the formation of an ESOP. It is also a regular focus of plaintiffs’ lawsuits and investigations by the Department of Labor (DOL), which often scrutinize whether the ESOP overpaid for the company’s stock. As fiduciaries, ESOP trustees must have assurance that the valuation provider followed a reasonable, defensible approach to determining fair market value.

While ESOP trustees can choose from valuation advisors of varying shapes and sizes — from “mom and pop” CPA firms to national accounting firms and investment banks — trustees should consider the range of skills and expertise of their potential advisor. We explain the key characteristics of a leading ESOP valuation advisor and why ESOP trustees are best served by partnering with a firm that has direct M&A, capital markets, and ESOP transaction expertise.

Five defining characteristics of a leading ESOP valuation advisor

  1. Knowledge of ESOP rules, regulations, and enforcement practices. Detailed knowledge of ERISA statutes and DOL enforcement practices are essential to a compliant and defensible valuation and to proactively identify potential risks.
  2. Extensive valuation expertise. Deep experience in financial modeling and valuation analysis are essential; the best advisors go beyond a textbook approach to inform valuations based on the prevailing market environment and direct M&A experience.
  3. M&A advisory track record. Deal experience separates advanced advisors from pure accounting and valuation firms; ESOP transaction experience and a deal track record across a variety of sectors and market environments is particularly valuable.
  4. Equity and debt capital markets expertise. Equity and debt capital markets experience provides the ESOP trustee with greater confidence in the valuation’s key assumptions, including transaction multiples and on the structure of subordinated debt.
  5. Ability to provide ancillary advisory services. The best advisors have a demonstrated ability to serve as a strategic partner and provide additional advisory services, such as strategic consulting on bolt-on acquisitions, refinancing, and restructuring.
  1. Knowledge of ESOP rules, regulations, and enforcement practices.
    The ESOP structure is a highly regulated business ownership structure that is governed by ERISA and overseen by the DOL. ERISA law is complex, and it is vital for ESOP trustees to ensure that an ESOP’s structure is in compliance with rules, regulations, and enforcement policies. Without a deep understanding of ERISA requirements, the valuation advisor may expose the trustee to greater risk of litigation.

    The DOL takes a very active approach to reviewing the validity of the assumptions and process of an ESOP valuation to ensure the interests of ESOP participants are being protected. Over the last decade, the DOL has become increasingly active in litigating ESOPs. Having an advisor who follows a proven, defensible process and is able to assist with DOL inquiries if and when they arise can be extremely valuable.

  2. Extensive valuation expertise.
    Valuation expertise is a must-have characteristic of a capable ESOP valuation firm. An effective valuation advisor must be able to assess a company’s financial dynamics and capital structure to determine an accurate and justifiable valuation for the company. But valuation advisory firms represent a wide range of valuation expertise. We believe ESOP trustees are best served by partnering with a valuation advisor that specifically emphasizes ESOP transactions given the complex nature of this ownership structure.

    In addition, many valuation advisors follow a “textbook approach” to valuations. This means they determine many of the key assumptions of the valuation based on their own research — such as information available online and through academic and industry-specific publications — rather than their first-hand knowledge and real-time deal experience. The best valuation advisors, however, formulate their valuations based on the prevailing market environment and direct M&A experience.

  3. M&A advisory track record.
    Deep M&A expertise is the dividing line between basic ESOP valuation capabilities and advanced expertise. Advisory firms with an extensive track record of buying and selling companies and raising debt and equity capital understand the current, prevailing market environment. This gives such advisors a clear frame of reference to assess specific proposals and analyze the necessary elements of the ESOP structure.

    As an analogy, consider who is best positioned to advise you on the value of your home: a real estate appraiser, or a real estate broker? The broker will value your home by comparing it to similar properties that have recently sold in your neighborhood coupled with their first-hand knowledge of the supply/demand dynamics in your area. The appraiser, on the other hand, will estimate value largely based on research and analysis of historical data — which is more of a textbook approach. We believe a market-based approach is the best way to determine true value. An effective advisor will have extensive knowledge of recent ESOP transactions and the broader M&A environment and can thus offer trustees an informed idea of whether a particular proposal is reasonable.

  4. Equity and debt capital markets expertise.
    ESOPs are financially complex leveraged transactions requiring in-depth knowledge of equity and debt instruments, including senior debt, junior debt, and deeply subordinated notes. It is highly advantageous, therefore, to use a valuation advisor that is an active participant in debt and equity capital markets. This allows the advisor to assess whether the ESOP’s proposed financing terms and structure are reasonable in light of current market conditions.

    For example, how do you determine the proper interest rate for seller financing? Using a textbook approach, an advisor may conduct research and locate sources that say 18% is an appropriate interest rate for subordinated debt. But what if the prevailing market environment indicates that a more appropriate rate is 15%? An advisor with first-hand experience raising debt capital will have a better understanding of the nuances of various forms of debt and where the market stands today.

    Active participation in the equity and debt capital markets is particularly important during periods of economic uncertainty and market volatility. During these times, equity and debt capital assumptions can fluctuate dramatically, making it much more difficult to assess whether the proposed financing terms of an ESOP transaction are reasonable under current and projected market conditions.

  5. Ability to provide ancillary advisory services.
    The best valuation advisors become more than just a valuation firm — they often turn into a strategic partner for ESOP trustees. Over time, an effective advisor may eventually be asked to advise on ancillary issues such as refinancing, recapitalization, acquisitions, and restructuring debt. After all, the best advisors will develop very detailed knowledge of a business during the annual valuation process.

How to value your valuation advisor?

At the end of the day, selecting an effective ESOP valuation advisor shouldn’t come down to which firm has the glossiest presentation materials, fanciest website, or jazziest sales pitch. It should come down to which firm has the most relevant and leverageable experience and expertise. We strongly believe that the best valuation firms not only understand ESOP rules and regulations and have the financial expertise to build a textbook valuation — they also have a deep track record of M&A and capital markets experience that provides real-time perspective on the prevailing market environment. This experience provides greater credibility and confidence in the key assumptions underlying an ESOP, putting ESOP trustees in the best position for success.

For more information on ButcherJoseph’s approach to ESOP valuations, don’t hesitate to contact us or reach out to me directly at 312.884.7371 or