3/15/2011. Structuring an ESOP Transaction that Works. Determining Value in the ESOP World. Valuation for ESOP Purposes

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1 Valuation for ESOP Purposes Presented by Robert J. Gross Prairie Capital Advisors, Inc. One Tower Lane, Suite 3010 Oakbrook Terrace, Illinois Structuring an ESOP Transaction that Works Company Issues The ESOP Structure Balancing Act Sellers Expectations ESOP and Fairness Issues Determining in the ESOP World Valuation is at the core of all succession planning decisions including ESOPs and value trajectory are both relevant ESOPs exist in a regulated world An ESOP trustee reviews initial transaction and sets the value annually Independent valuations in the ESOP world require specialization 1

2 Some Basic Valuation Language A = L + C Net Working Capital Business Enterprise All Other Fixed and Intangible Assets Long Term Liabilities Invested Capital Equity Stockholders Equity Key Valuation Drivers We Want to Reflect the Economics of... The Company itself Its competitive marketplace The general economy and capital markets We must think like investors Thus, we look INSIDE and OUTSIDE the company This is how the market prices stocks, and we want to MIMIC the marketplace Valuing Businesses in General Looking INSIDE - The Income approach Discounted cash flow modeling Expected revenues, expenses, capex, etc. Riskiness of the cash flows Potential weakness: Are the projections reasonable? Looking OUTSIDE - The Market Approach Multiples are extracted from market data Public companies or private transactions Assess how our company stacks up Adjust the multiples for comparability differences Potential weakness: Are the comparables truly comparable? 2

3 Some General Valuation Subtleties T is a tiered valuation market... Pretax Earnings Multiple of P Size, public market, high growth, high visibility, etc. Unless, of course, you are a legitimate IPO candidate in a hot market More General Valuation Subtleties Whole companies are worth more than parts of companies Maximum Entire enterprises Fractional controlling blocks Marketable minority interests Non-marketable minority interests Minimum Some Fun With ESOP Premises Assume These Transaction Patterns... I II III IV V 1 100% 30.0% 70.0% 33.3% 14.3% % % % % 30.0% 33.3% 14.3% % % % Total 100.0% 100.0% 100.0% 100.0% 100.0% Absent any other facts, how should the ESOP purchases be priced? 3

4 Some ESOP-Specific Valuation Issues Tax treatment and ESOP Valuation Internal ESOP loan is typically funded by ESOP Contributions that are tax-deductible This creates an ESOP tax shield Tax assumptions regarding S-Corp. ESOPs ESOP stock marketability Statutory Put creates a better market than in most closely-held company settings The Discount for Lack of Marketability is typically lower The ESOP Repurchase Obligation The ESOP will have a cost as a benefit plan A Word on Post-deal ESOP Valuation The Company s equity value just before and after the ESOP transaction differs The Company has more debt just after the deal This reduces equity value of a business the same way a mortgage reduces the equity value of a home Enterprise value versus equity value The equity value recovers as the internal financing is Post-Closing Trajectory has implications Enterprise Equity repaid Now Then Recent Topics in the ESOP World Trends among established ESOPs Increasing to 100% is a frequent goal Impact on (and of) Repurchase Obligation Larger deals may require non-senior financing ESOP Ownership: Two ways to get t Traditional ESOP purchase of shares Small ESOP purchase followed by a Redemption The use of Synthetic Equity Is the value dilution worth it to the participants ESOP companies and acquisitions ESOP companies buying other ESOP companies 4

5 Bob Gross Bio Robert Gross ( Bob ) is Senior Managing Director of Prairie Capital Advisors, Inc., a recognized leader in providing financial advisory services to middle market companies. Integral to the firm s practice are its valuation capabilities, which provide a basis for succession planning, ESOPs, estate and gift tax filings, fairness opinions and a variety of other reasons. He is a frequent speaker on matters involving i valuation, ESOPs, and succession planning. He has qualified as an expert witness in State Courts, Federal District Court, and other venues. He has also been deposed on numerous occasions. Bob is active in a variety of professional groups, most notably National Center for Employee Ownership, ESCA and the ESOP Association, w he is a current member and past Chair of the Advisory Committee on Valuation and a member of the Interdisciplinary Committee on Fiduciary Issues. Questions? Robert J. Gross Prairie Capital Advisors, Inc. One Tower Lane, Suite 3010 Oakbrook Terrace, Illinois rgross@prairiecap.com 5