Employee Stock Valuations (E.S.O.P)
The Employee Retirement Income Security Act ("ERISA") of 1974 created Employee Stock Ownership Plans ("ESOPs") as a means to give employees a share of company ownership. The authors of ERISA hoped that employee empowerment would increase the US workforce's overall efficiency. ESOPs are commonly structured as separate, legal trusts. The trust borrows money at a favorable rate to repurchase owners' shares. Employees may then buy shares in the trust. The company makes contributions to the trust to repay the loan.
To provide an incentive to company owners to create an ESOP, Congress included significant tax and estate planning benefits for ESOPs, such as:
- Business owners are allowed to sell their shares to the ESOP and reinvest the proceeds tax-free;
- Shareholders of the ESOP benefit from tax deferral and savings; and
- Interest and principal loan repayment contributions made by the company to the ESOP are tax deductible.
When the ESOP is originally formed, the initial purchase from the owner must be fairly priced. The shares owned must be re-valued annually to determine the repurchase price in the event of employee retirement, death, or departure. Both of these circumstances require independent valuation. In addition, ERISA requires an ESOP to pay no more than "adequate consideration," or fair market value, when investing in a business' stock. Consequently, plan fiduciaries must determine the fair market value. The IRS, the ESOP trustees, and the Department of Labor often scrutinize these ESOP valuation assertions. As a result of all these, an appropriate ESOP valuation must be well documented, unbiased, and supportable.