Valuations and fairness opinions for ESOPs



FW moderates a discussion on valuations and fairness opinions for ESOPs between Jeffrey S. Buettner, a managing director at Butcher Joseph Hayes, and Kenneth E. Serwinski, chief executive officer at Prairie Capital Advisers, Inc.

FW: Reflecting on the past 12-18 months, what trends have you seen in ESOP valuations, particularly against the backdrop of current economic conditions?

Buettner: In general, most ESOP-owned companies experienced financial trends commensurate with macroeconomic trends. Any year-over-year improvement in financial performance occurred at a slow, gradual pace. Although increasing competitiveness may have pressured prices and, thus, somewhat restrained revenue growth, earnings continued to benefit from cost savings initiatives and operational efficiencies instituted in response to the recession. Companies remained cautious about making major capital expenditures and preferred to use cash flow to repay debt or build up cash on the balance sheet.  

Serwinski: Though the economy has improved dramatically since the recession of 2008-2009, we continue to see valuation issues raised regarding material changes in value – ‘stock drop’ cases – concern about the validity of management financial projections provided and deal structuring that some have deemed aggressive. These so-called stock drop cases have their beginnings in deals done in the 2004-2008 years when valuations were peaking and banks were aggressively funding deals. In the years of the recession, company performance languished and values fell. This has led some to believe that the more could have been done by valuation firms to have ‘handicapped’ the possibility of recession, which I believe is ludicrous. My opinion has been substantiated by our Federal Reserve Bank itself which has said that there was no way to have predicted this economic disaster. As a result of increased scrutiny by the US Department of Labor (DOL), financial projections provided to valuation firms have become a hot topic. While I will admit that many private companies sometimes struggle to provide valuation firms with good projections, it is not because they are not trying, but rather that the economy continues to be suspect and developing good projections is not easy.

FW: Could you explain the importance and necessity of valuations and fairness opinions when structuring an ESOP?

Buettner: When an ESOP purchases stock of a sponsoring company for which no public market exists, the Department of Labor (DOL) requires that the ESOP trustee determine that the ESOP’s purchase was consummated as of the date of the transaction for adequate consideration as defined in the proposed regulations of the Employee Retirement Income Security Act (ERISA). The trustee must arrive at a determination of fair market value through a prudent investigation and application of sound business valuation principles. The experience and expertise required to ensure the application of sound business valuation principles necessitates the use of a skilled financial adviser as part of the trustee’s deliberations. The receipt by the trustee of a valuation and fairness opinion is an important component in prudently considering an investment decision.

Serwinski: Every ESOP has a trustee that is charged with acting in the best interest of the plan participants. The trustee engages a valuation firm to act as its financial adviser. The role requires the adviser to value the company, review and assist in the deal structure and then opine on both adequate consideration and fairness. Adequate consideration refers to the idea that the trustee is not paying more than fair market value while fairness looks at all components of the transaction and opines that the deal is fair from a financial point of view. The trustee truly takes on the role of purchaser in a transaction so the valuation becomes critical for establishing a range of value that the trustee can feel comfortable negotiating. In most cases, the trustee can be competitive in its efforts to close a transaction because the value ranges provided are similar to those offered by financial buyers. The deal components must also be closely analysed and in some instances, stressed tested in order to assure the financial adviser that the deal is fair so a fairness opinion can be written.

The trustee truly takes on the role of purchaser in a transaction so the valuation becomes critical for establishing a range of value that the trustee can feel comfortable negotiating.
— Kenneth E. Serwinski

FW: What role do valuations and fairness opinions play in assisting the process of making or approving decisions concerning strategic and financial events for ESOPs?

Serwinski: The idea for establishing ESOPs usually revolves around shareholders seeking liquidity and ESOPs providing same. By law, independent valuation firms must establish value, currently, to form the basis of the transaction. On an ongoing basis, an annual valuation must be performed for administrative purposes to provide plan participants with a value for shares allocated to their retirement account. Though never formalised by regulation, the DOL issued guidelines for ESOP transactions in the late 1980’s that have been interpreted to require that all transactions have opinions related to both adequate consideration and fairness. Various court cases over the years have provided us with other ‘best practice’ uses of opinions required under certain circumstances.

Buettner: An ESOP-owned company is required to have its common stock valued at least once a year for administrative purposes. The product of valuing a company this frequently is that company management can become more cognisant of the economic implications of strategic decisions. Estimating a company’s value requires information from, and cooperation with, company management. The annual interaction of management and financial advisers enhances management’s acumen on factors driving company value. Over time, company management becomes increasingly astute as to how the economics of a decision may impact value. A greater understanding of value drivers helps decision makers avoid value-detracting decisions in favour of value-enhancing decisions. Among others, decisions involving the sale or acquisition of assets, debt restructuring, or corporate recapitalisations may require a fairness opinion. An independent review of the economics of a major transactional decision helps insure sound decision making and provides assurance.

FW: What other events may give rise to the need for a fairness opinion?

Serwinski: Though I can think of a number of reasons fairness opinion can be needed, the two that come to mind relate to the purchase or sale of a business, or some form of recapitalisation. As you might expect, ESOP companies operate like any other company. They are presented with opportunities for growth which are either organic or external. In either case, financing is usually required which can adversely affect the balance sheet and hence, the company valuation. In the case of an acquisition, the company seeks to make an accretive purchase. It, however, must compete for assets and companies with other buyers. What it pays for and how it finances that purchase is important to the trustee as dilution could adversely affect the stock held by the plan participants. A fairness opinion is usually required with acquisitions that are material in nature. There are other instances where companies have entered into a period of very rapid growth. This growth is on such a steep trajectory that outside capital needs to be brought in to help fund the growth. Usually, this recapitalisation takes the form of mezzanine or subordinated debt. This balance sheet change can materially change the balance sheet. Analysis must be performed to determine if the capital received which has diluted the shareholder can be transformed into future revenue and profitability growth. The trustee will want to get comfortable with those projections in order for them to approve the recap. A fairness opinion addressing the use of the capital infusion is almost always necessary.

Buettner: Fairness opinions can be used in a variety of events in which a fiduciary seeks assurance from an independent party that it has fulfilled its duty of loyalty and care to represented shareholders.  Fairness opinions are most commonly associated with change of control transactions involving company stock. Additional events that may give rise to a need for a fairness opinion include, among others, tender offers, equity offerings, an ESOP purchase of a minority block of stock, a sale transaction, debt restructuring, leveraged recapitalisations, down-round investments, and divestitures. 

FW: Could you provide some insight into how ESOP valuations and fairness opinions are conducted? What kinds of methods and processes tend to be employed?

Buettner: ESOP valuations and ESOP fairness opinions are typically conducted in accordance with proposed ERISA regulations relating to the definition of adequate consideration, as well as factors under Revenue Ruling 59-60 of the Internal Revenue Code. Generally accepted valuation methodology – market approach, income approach, asset approach – is considered and selected based on what provides the most supportable conclusion given available information. The application of the methodology and the process for gathering pertinent information may vary by financial adviser, but usually involves interaction with the key members of company management who are in a position to address financial questions, and provide an overview of the qualitative factors driving financial performance. A narrative report is presented to the ESOP trustee that documents facets of the business, its financial performance, and discusses support for major underlying assumptions. The ESOP trustee ultimately determines the value based on its prudent investigation and reliance on its financial adviser.

Serwinski: The process of conducting a valuation should be rigorous. Initially, there is an extensive information request list that consists of historical financial information, budgets, projections, customer information, product and service information, management information, bank information and other data. This information is reviewed and processed prior to on-site due diligence. The diligence meeting can last the better part of a day and would include deeper discussions about the information provided and plant or site tours to learn about the company’s internal processes. Upon our return, analysis begins on the numbers provided and research is begun on the industry and geography the company operates within. Simultaneously, research begins on understanding market guideline companies and market transactions that have occurred in the company’s space. The valuation approaches employed can include both this market analysis and formulating a discounted cash flow analysis which takes the information provided along with capital expenditure, working capital and other data to develop a proposed valuation. Ideally, market and cash flow results provide you a result which is in a reasonable range of both approaches and a value is developed within a range. The entire process can take 30-45 days but, of course, can be accelerated based on the timing requirements. The opinion process includes everything mentioned plus an understanding of the deal. The requirements for an opinion can be for a new ESOP transaction, acquisition or divestiture, or recapitalisation. In any case, the components of the deal are usually identified in either a term sheet or letter of intent. The financial adviser needs to model those terms and consider all terms in their entirety. In the ESOP company, it’s institutional trustee relies on the financial adviser to assist in the negotiations as issues of price are accompanied by financing, employment contracts, synthetic equity, earn outs or other contingent payments and any other issue that you would find in any M&A transaction. I guess that’s the point really, ESOP transactions from a fairness perspective are not that different from opinions in the non-ESOP world.

FW: What risks and challenges are inherent in the process of delivering a valuation and fairness opinion?

Buettner: One of the biggest challenges inherent in the process is the interpretation of data to formulate a supportable conclusion for a privatly held company. Without conducting a market clearing process, business appraisers are required to use their experience and judgment of market conditions for an individual asset based on facets of the business relative to a larger peer set. Risks inherent in the process include a misinterpretation of data, lack of meaningful data, or the inappropriate application of financial theory, which may all lead to conclusions inconsistent with, or not supported by, market evidence.

Serwinski: The risks and challenges really are no different than other corporate finance deals. The smaller the company, the more likely that the financial controls, financial statements, processes and procedures, and depth of management might be suspect. More intense scrutiny is required to determine value drivers than you would have with larger companies with more depth and controls. The biggest challenges revolve around deal terms. Since most sellers of companies to ESOPs are doing so for the first time, they are naive or unaware that the reps and warranties, the financing requirements, their continued involvement or support are not unlike the sale of the company to a financial buyer. Yes, they may still be involved on a go forward basis, but they have sold the company. Some remain challenged with that concept even after the deal has closed and the money is in their account. If not said previously but something that needs to be said, sellers should get capable advice to be able complete these transactions.

Many companies mistakenly believe at the onset that an ESOP valuation can be used by outside accountants, estate planning attorneys, bankers, or other professionals to satisfy other needs of the business or individual stakeholder.
— Jeffrey S. Buettner

FW: What limitations and expectations should a firm be aware of at the onset of an ESOP valuation?

Serwinski: Valuation is not an exact science. The valuation firm is charged with testing the reasonableness of projections utilised in the valuation. Providing forecasts that have no semblance to past performance will be challenged. Certainly, there can be reasons for cash flow enhancements but they will be needed to be substantiated. Sellers need to understand that valuation firms know that the answer comes to them in the form of a range. Naturally, sellers seek the top end of the range while the ESOP seeks something less. In any case, sellers should be aware that negotiations will go on between the seller and the trustee because there is no definitive answer. The final per share price is negotiated and substantiated, and therefore is in a position to have an opinion rendered.

Buettner: The purpose of the valuation limits the applicability of its usage for other purposes. Valuations are typically prepared in accordance with the required standards of the regulatory authorities governing the specific purpose of the valuation. Regulatory standards and requirements may vary between governing authorities. Valuations prepared for ESOP purposes are governed under ERISA and the DOL whereas, valuations prepared for financial reporting purposes are not.  As such, companies or other stakeholders may not be able to simply use the value concluded for an ESOP appraisal to satisfy the requirements of another purpose. Many companies mistakenly believe at the onset that an ESOP valuation can be used by outside accountants, estate planning attorneys, bankers, or other professionals to satisfy other needs of the business or individual stakeholder.

FW: Could you explain the role and responsibilities of an independent financial adviser in connection with an ESOP, and why an outside party is needed to value ESOP shares?

Serwinski: The role of the independent financial adviser is to provide the trustee with valuation expertise in order to facilitate a successful negotiation followed by a closing which incorporates a need for opinions that address adequate consideration, fairness and financing.

Buettner: DOL regulations define adequate consideration as the fair market value of an asset resulting from the determination made by the plan trustee or named fiduciary in good faith. In short, the good faith requirement dictates that the fiduciary making the valuation either be independent, or must rely on the report of an appraiser who is independent. The fiduciary must have arrived at a determination of fair market value through a prudent investigation and application of sound business valuation principles. Valuing a privately held company requires a conceptual understanding of generally accepted valuation methodology and corporate financial theory, a keen understanding of prevailing market conditions, and comprehension of facets of a business that affect its value. The experience and expertise required to ensure the application of sound business valuation principles necessitates the use of a skilled financial adviser. 

FW: In your experience, what attributes should firms seek when appointing a financial adviser to deliver an opinion?

Buettner: Firms should give consideration to the familiarity that a financial adviser has with ESOPs, as well as how actively involved the firm is with negotiating and structuring liquidity transactions. Opinions of value are worthless if the conclusion is inconsistent with market evidence. Fairness opinions necessitate a familiarity with commercial transactions, including structures and terms to adequately opine on whether aspects of a particular transaction are consistent with a range of commercially reasonable terms. In addition, regulatory requirements governing ESOPs necessitate a familiarity with ESOPs that is difficult to ascertain with only limited participation in the industry. In the end, financial adviser judgment is the product of experience rather than coursework.

Serwinski: The most obvious attribute is one of experience. Institutional trustees know this and will only work with advisers who have demonstrated past successes. This not only true of the deal experience but as the company needs to be valued every year for administrative purposes, Trustees seek this experience and consistency to give them the confidence they need to fulfil their duties. If deals are internally trusted, the parties acting as trustees need to vet this experience level by checking multiple references and feeling very comfortable that the valuation or opinion firm will support their work if tested by the DOL or IRS.


Jeffrey S. Buettner is a managing director with Butcher Joseph Hayes, an investment bank headquartered in St. Louis, Mo. With over 15 years of valuation and financial opinion services experience, Jeff has provided advisory services for ESOP and non-ESOP companies in a multitude of industries. Jeff is a member of the NCEO as well as The ESOP Association where he serves on the Valuation Advisory Committee. Mr Buettener can be contacted on +1 (312) 884 7371 or by email:

Kenneth Serwinski is chief executive officer and co-founder of Prairie Capital Advisers, Inc. Mr Serwinski has dedicated his vast experience to providing closely held companies with the guidance and expertise needed for some of their most critical business decisions. Many companies seek out and trust Mr Serwinski and Prairie Capital Advisers for strategic guidance for their once-in-a-lifetime business decisions. Mr Serwinski is widely published in a variety of formats and is a frequent speaker around the nation on subjects including valuation, ESOPs and ownership transition planning. Mr Serwinski can be contacted on +1 (630) 413 5588 or by email:

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Jeffrey S. Buettner

Butcher Joseph Hayes


Kenneth E. Serwinski

Prairie Capital Advisers, Inc.

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