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Why Do I Need a Valuation? Employee Stock Ownership Plans

June 11, 2018


Why Do I Need a Valuation? Employee Stock Ownership Plans

This blog discusses the importance of engaging a Chartered Business Valuator to assist in the process of designing an ESOP.

Motivated employees are creative, efficient and hard working. So how can you keep your employees motivated? Companies, often under the direction of their human resource departments, have a wide variety of incentive programs at their disposal, such as promotions, pay raises and bonuses. In addition to traditional incentives, however, privately-owned companies are increasingly considering a less common type of incentive – employee stock ownership plans.

Employee stock ownership plans (commonly referred to as “ESOPs”) allow employees who meet certain criteria to become shareholders. Once employees are eligible for the plan, they can either purchase shares of the company at a predetermined price or they can receive those shares as a bonus. As a result, employees technically own a small portion of the company for which they work.

ESOPs have become increasingly popular because of their highly flexible nature. Any percentage of a company can be transferred to employees through an ESOP. Having an ownership interest in the company allows for employees to directly benefit from company successes, as they would result in increased share values, and could lead to increased dividend payments. This alignment of employee interests with management interests is key in providing motivation for employees.

Consider the situation of Tyler, an employee at a small marketing agency. Over time, Tyler has acquired 1% of the company through an ESOP. Tyler’s 1% interest in the company is currently valued at $20,000. If Tyler brought in a new client that increased the company’s value by 5%, not only would he likely receive a bonus, but the value of his shares in the company would increase by 5% to $21,000. Because Tyler is an active participant in the growth of the company, he will have increased motivation to work hard as an employee.

It is important to engage a Chartered Business Valuator to assist in the process of designing an ESOP for two main reasons. First, if a company is gifting or selling a fraction of its shares, it is important to know what that fraction is worth. A valuator can determine the value of each share, helping management decide how many shares they are willing to sell or gift.

Second, a Chartered Business Valuator can help determine the exit strategy for an ESOP. Unlike shares of publicly traded companies, shares of privately-held companies can be difficult to sell. There is typically no active market for employees to sell the shares they’ve received through an ESOP. Every company handles this issue differently, but often a company agrees to buy back those shares after the employee resigns, retires, or is terminated. A valuator can assist management in determining what price the company should pay to buy back shares from its employees.

Employee stock ownership plans are increasingly becoming a tool of human resource professionals to motivate and compensate employees. If you’re considering instituting an ESOP, give the professionals at Davis Martindale a call. We’d love to work with you.