Valuation Basics
An Employee Stock Ownership Plan, or ESOP, is a qualified retirement plan that gives employees an ownership interest in a company through employer stock.1 The Employee Share Ownership Trust, or ESOT, holds that stock for the benefit of participating employees.
Most closely held companies don't have a public market setting a stock price every day. When an ESOT buys company stock from a business owner, an independent valuation determines its fair market value. The owner can't simply name a price and sell the stock to the ESOT. The ESOP trustee represents the interests of the employees participating in the plan and generally can't cause the ESOP to pay more than fair market value for the stock.4
Ongoing Valuation
The first valuation determines what the company stock is worth when the ESOP transaction takes place. It considers how the company is performing, its financial condition, its prospects, its risks, and other factors that affect value. But that valuation is a snapshot.
The valuation process continues after the transaction closes. In a closely held company, stock owned by an ESOP generally has to be independently valued at least once each year.11 Each new valuation looks at the business again and determines what the stock is worth at that point.
If the business becomes more valuable, that increase shows up in later valuations. The value of the stock held for employees can rise with it.
What the Owner Gives Up
When an owner sells company stock to the ESOT, the valuation establishes what that stock is worth on the date of the sale. If the ESOT buys 49% of the company, any increase in the value of that 49% after the sale belongs to the ESOT.
For the owner of a growing company, that can mean giving up a lot of future value.
Some financed ESOP transactions use warrants to let the seller share in some of that later increase in value. A warrant gives the holder the right to buy stock later at a specified price and under specified terms.10 How much the warrant is ultimately worth depends on its terms and what happens to the value of the company.
Warrants can recover some of the value the seller gave up, but they don't replace everything the owner could have gained by continuing to own the stock.
The 4ESOT Difference
4ESOT provides employee ownership without requiring the owner to sell the business they already own and operate.
Under the 4ESOT structure, employees receive their ownership benefits through a separate S corporation owned by the ESOT. The business owner and family continue to own the operating company.
The stock owned by the ESOT still has to be independently valued, generally at least once each year. That valuation determines the value of the stock held for employees, not the value of the owner's operating company.
The owner keeps the operating company. If it grows in value over the years, that increase remains with the owner and family.