Inštitut za ekonomsko demokracijo

Notes on Valuation in ESOP Transactions

Author: David Ellerman

Notes on Valuation in ESOP Transactions

A valuation of shares for an ESOP is quite different from a valuation for a sale to some outside third party. When a valuation is done for the purposes of setting up an ESOP (e.g., a net-asset valuation), the seller should not think this is what he would get from selling to a strategic buyer (e.g., a competitor) or to a private equity firm.

The ESOP is a complicated mechanism in comparison to a third-party sale. The outcomes are quite different in at least two important respects.

Firstly, the ESOP serves several other social or moral purposes such as:

• rewarding the employees who helped build up the company,

• keeping the business alive in the community for the jobs, wages spent, and taxes paid,

• keeping one’s legacy intact (unlikely in the case of a competitor who would slowly move the customers to their main business and wind down the sold company taking advantage of the depreciation expenses and savings from no new investment).

Secondly, the payments to the seller at the appraised value are not coming from an outside third party but from the increased productivity and tax benefits of the ESOP, and any shortfall needs to be compensated for by the seller’s other motivations outlined above. The comparable transaction would be a sale to a relative or a friend—and in the ESOP case, the employees are the “friend.”

Hence it is just an entirely different situation from a purely commercial sale to an outside party. There is no implication that the ESOP valuation would equal what the seller could get from an outside sale or from a flotation on a stock market (for a big enough company). ESOP legislation or regulations should not require that the company be valued as in a sale to a third party or strategic investor, e.g., by using some multiple of profits or cash flow. The best and relatively objective valuation for ESOP transactions would be at net asset value, so that should be allowed by any legislation or regulations.

Many sellers may confuse the ESOP valuation and the outside-buyer valuation—not taking into account that for an ESOP valuation and sale, the value the sellers are receiving is not all in cash.

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