For both an employer and an employee, an Employee Stock Ownership Plan (ESOP) is an exciting way to keep employees engaged, retained and rewarded for helping a privately-owned business be successful. There also some major tax benefits for the corporation and ESOP members, but the upfront costs to set up a plan can sometimes be prohibitive.

For business owners interested in creating or maintaining an ESOP, an annual valuation of the company’s shares is required by the Department of Labor. The standard that is required for appraising shares of a privately owned business every year is its fair market value. The IRS defines FMV as the price at which a property would change hands between a willing buyer and a willing seller, neither under compulsion to buy or sell and both having knowledge of the facts.  

There are some foundational elements to an ESOP to be compliant with government regulations. First, ESOPs must have an appointed trustee who has fiduciary responsibility to make sure the employee ownership plan is operated for the sole benefit of plan participants. The trustee makes decisions using their own best judgement (independent) or under direction of an appointed committee (directed) and, in both scenarios, rely upon the counsel of qualified experts such as business appraisers, accountants, bankers and attorneys.  A key step when starting an ESOP is to conduct a comprehensive business valuation in accordance with the Employee Retirement Income Security Act (ERISA), the DOL and the IRS’s USPAP standards. The appraiser goes through an extensive process to reach an accurate appraisal of the company’s common stock based on past, present and future financial factors and indicators, using a variety of methods from the Income, Asset and Market based approaches. Once all parties are in alignment with the accuracy, legitimacy and defensibility of the appraiser’s report, the company and its trustee will need to plan ahead for annual valuation updates on common stock values and the share price impacts to the ESOP in accordance with DOL requirements. 

As for 409A compliance, there can be tax implications to your employees when they received deferred compensation in the form of common stock options such as granting options to employees or advisors and employees exercising their options. 409A provides “safe harbor” to comply with Internal Revenue Code 409A, whereby common stock must be valued at fair market value. A professional business valuation is needed to comply with the code so that companies and private company stock units can avoid penalties. 

Our business appraisal partners are well-versed in the dynamics of a successful ESOPs and 409A compliance for privately-held businesses, the pitfalls to watch for and the required steps needed to place a value on and issue common stock and how to maintain an updated, annual opinion of value. 

For more extensive reading on the dynamics at play for Employee Stock Ownership Plans (ESOPs), see below:

How an Employee Stock Ownership Plan (ESOP) Works

8 Things You Need to Know About Section 409A

What every valuation analyst should know about employee stock ownership plans (ESOPs)

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