Mercer Capital values scores of employee benefit plans for both financial institutions and corporate clients across the nation. We present the first in a series of “Ask the ESOP Valuation Experts” in Vol. 20, Issue No. 2 of Value Added™. Tim and Wendy begin by asking and answering a few fairly basic questions. In subsequent issues, they will tackle more specific valuation-related questions. To view those questions and answers, you can visit the Value Added archives. If you have an ESOP valuation need, contact Tim or Wendy.
What is an ESOP?
An Employee Stock Ownership Plan (ESOP) is a qualified retirement plan created in the form of a trust which is designed to own the capital stock of the sponsoring (employer) company. Eligible employees of a company become the participants (i.e. employee owners) in the ESOP by way of contributions made by the employer on the employees’ behalf. Most ESOPs are created by way of leveraged transactions whereby an ESOP borrows funds to purchase newly issued stock or stock sold by shareholders of the sponsoring company.
Are ESOPs regulated?
As qualified retirement plans, ESOPs must adhere to the Employee Retirement Income Security Act of 1974 (ERISA), which provides legal guidelines for private pension plan administration and investment practices. These plans are overseen and regulated by the Department of Labor (DOL). We would be remiss not to mention that the Internal Revenue Service is also a stakeholder in the ESOP universe as their interests extend to both the shareholder and corporate domains. Prospective ESOP companies must understand that an ESOP is a shareholder and a retirement plan beneficiary, thus the fiduciary responsibilities should not be taken lightly.
What are some of the incentives underlying an ESOP?
ESOPs can provide multi-faceted benefits for stakeholders. Sellers of stock to an ESOP can use the plan to achieve liquidity while in certain instances, deferring taxes on gains resulting from the sale. Employees can receive a potentially valuable retirement asset, which through their collective efforts can support the perpetuation of the company and the growth in value of the stock. Such ownership for many participants is likely the only way they would ever enjoy a capital ownership stake in their employer. Strategically, many well-run, viable businesses are better candidates for this form of internal ownership transfer than they may be for a transaction in the open marketplace. In many cases, an ESOP can provide sellers the opportunity to diversify shareholders’ wealth while providing enhanced liquidity and retain for selling shareholders the ability to direct the destiny of the company.
Reprinted from Mercer Capital's Value Added™, Vol. 20, No. 2, 2008.