The Valuation Report Checklist: What Should ESOP Trustees Be Looking For?

Presented by:

Employee Ownership Conference

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The Valuation Report Checklist: What Should ESOP Trustees Be Looking For?

John Johnson, CFA John E. Johnson, LLC 209.369.1451 [email protected]

Daniel N. Janich Greensfelder, Hemker & Gale, P.C. 312.345.5003 [email protected]

Introduction

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•  Basic Purpose of Annual ESOP Valuation Report

•  Fiduciary Duties of ESOP Trustee •  DOL Guidance: Regulations, Agreements &

Case Law •  Issues for Trustees to Address When

Examining Annual Valuation Reports •  Review Fundamentals Addressed in Annual

ESOP Valuation Reports

•  ERISA requires ESOPs to pay no more than “adequate consideration” when investing in employer securities.

•  This means ESOP trustees and fiduciaries must determine in good faith the fair market value of employer securities.

•  IRS & DOL guidance for this determination.

Basic Purpose of ESOP Valuation Report

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•  ERISA: Trustee Fiduciary Duties •  Sole interest of participants -Loyalty •  Prudence •  Determine annual value of ESOP shares •  Hire independent valuation advisor

•  DOL Fiduciary Process Agreement •  Best Practices Checklist for Selection of

Valuation Advisors and Review of Valuation Reports

Should a Trustee Be Concerned About What’s In A Valuation Report?

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•  Fiduciary Duties •  Personal Liability – ESOP Litigation over

Valuation Issues •  Best Practices Checklist from DOL

Fiduciary Process Agreement •  Document Trustee Review Process

Thoroughly

ESOP Trustee Must Scrutinize Annual Valuation Report

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•  Qualifications and Independence •  What are your professional credentials? •  Can you provide professional references? •  Length of experience conducting ESOP

appraisals? •  Number of annual ESOP valuations

performed previously? •  What is internal process to review work? •  Any other work performed for company?

ESOP Trustee Questions for Appraiser

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•  Any other business or personal connections with the company?

•  Confirm engagement with ESOP Trustee •  Confirm Valuation Report to be addressed

to ESOP trustee •  Check appraiser’s previous involvement in

litigation involving his valuations.

ESOP Trustee Questions for Appraiser

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•  Guide to ESOP trustee in reviewing and assessing the valuation report.

•  Helpful to ESOP valuation practitioners in conducting proper analysis for valuation report

•  Helpful to ESOP administrators, attorneys and accountants to assess soundness of ESOP valuation report.

Multiple Purpose of Annual Valuation Report Checklist

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•  What Issues Must the Appraiser Address in Conducting Due Diligence and in Preparation of ESOP Valuation Report?

Contents of Annual ESOP Valuation Reports

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Identification of the Client

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•  The bottom line is that the appraiser works for the trustee

•  The company can pay the bill

Basic Engagement Information

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•  Correct company •  Correct appraisal date •  Correct basis of value – minority or

MAJORITY •  Correct definition of value •  Correct purpose – transaction or annual

update

Basic Company Information

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•  History •  Industry •  Services •  Competition •  Management

Economic and Industry Information

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•  Does the report include information about the economy?

•  Does the economic information relate back to the subject company? If not, then what value is it?

•  Is the industry information correct? It may be included in the market and competition discussion.

Financial Statement Analysis

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•  First – Is it correct? •  Second – Is it relevant? •  Third – Do you understand it?

If you answered No to any of these questions, contact your appraiser.

Selection and Application of Approaches

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•  The Approaches – Cost, Market and Income

•  Do you understand the explanations in the report?

•  Do you think they apply?

•  Should the value of your company be based on the value of its assets?

Cost Approach

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•  Does it make sense to compare your company to private companies?

•  Should your company be compared to public companies?

•  Is the math correct? •  Are the adjustments for lack of

marketability, control or lack of control correct?

If it is unclear talk to your appraiser.

Market Approach

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•  Are the income sources clearly defined? •  Are you able to understand the descriptions

in the report? •  Do you understand and agree with any

income/expense adjustments? •  Do you understand the discount rate and/or

capitalization rate?

Income Approach

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•  Were projections used? Who made them? Do they reflect the company’s prospects?

•  Is the level of earnings consistent with the level of value – minority or MAJORITY?

•  Are the adjustments for lack of marketability, control or lack of control correct?

Income Approach Continued

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•  Is the reason for any discount clear? •  Was the level of the discount impacted by

the ESOP? •  Are the source of data for the discount

disclosed?

Discount for Lack of Marketability

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•  Is the reason for the application clear? •  Should it have been applied at all? •  Are the sources of the data disclosed?

Control Premium or Minority Discount

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•  Are the indicators on a consistent basis – minority or MAJORITY

•  Does the overall result make sense given the indicators from the various approaches?

•  Does it pass your smell test?

Valuation Reconciliation

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•  Qualifications of the appraiser •  Statement of independence •  Assumptions and Limiting Conditions •  Is the report free of typographical and math

errors? •  Are the methods and approaches

consistent with prior appraisals?

Other Items

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Questions

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John Johnson, CFA John E. Johnson, LLC 209.369.1451 [email protected]

Daniel N. Janich Greensfelder, Hemker & Gale, P.C. 312.345.5003 [email protected]