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Pre-Employee Share Ownership Plans (“ESOP”) – Key Valuation Considerations

Sep 6 2019

Developing an ESOP is new territory for both employer and employee. Many owners may already have a clear plan mapped out and have shared this plan with their employees, whilst others are less advanced in the ESOP process.

It is important for the business valuator engaged in the ESOP process to determine which end of the spectrum their client is on as this will have a bearing on the terms of the valuation engagement and the assistance required.

Irrespective of where your client is on their ESOP journey, the following key principles should be followed throughout all stages of the valuation process:

  • Transparency – through an independent valuation;
  • Communication – through regular updates to employees on the valuation process;
  • Setting and Managing Expectations – communicating any changes to % ownership offered, price, terms, etc. in real time.

Engaging the Business Valuator – the “When and “Why”

When should you engage a Business Valuator? – It is never too early…

Early Planning Considerations from the Owner’s Perspective:

  • Purification of Company (for tax purposes) if the owner is selling their shares;
  • Is a share freeze required if value of shares may be too high (expensive0 for employee to buy in;
  • Corporate Reorganization – removal of non-operating assets from company;
  • Adequacy of share structure – what if issued share capital is only 1 share?
  • Early indication of value may help determine how employee is buying shares:
    • Purchase from Owner – can the employee afford the shares?
    • Purchase from Treasury – is there a need for a share freeze prior to buy -in?
  • Potentially an early reality check on Value from owner’s perspective.

Early Planning Considerations from the Employee’s Perspective:

  • The sooner in the process Value is established, the sooner the employee can determine:
    • Can they afford to buy in; and,
    • Do they want to buy in.
  • It may also help determine how the shares are going to be purchased:
    • Purchase for Cash – employee savings, RSP’s, TFSA’s
    • Purchase in lieu of bonuses;
    • Purchase through payroll deductions;
    • Employer Financing or Corporate Guarantees to employees:

Why should you engage an Independent Business Valuator?

It is extremely important to get the initial valuation RIGHT as:

  • It establishes the initial buy-in price for the employees;
  • It sets the benchmark for measuring future growth and increase in share value.

Owners often resist or question the need for an independent valuation based on cost. So why is it so important?

  • It IS Independent:
    • Eliminates owner bias as to Value;
    • Provides transparency to employees – it is not the owner’s number!
    • The Business Valuator is available to provide independent information and analysis to both employer and employee without professional conflict.
    • Lends credibility to the determination of Value – important to employees as potential investors and to third party lenders.
  • Independent Valuation establishes a credible basis for future valuations and a formula/methodology going forward.

Valuation Engagement Process

  • Who is engaging and paying the Business Valuator?  Irrespective of whom, the concept of independence must be clearly communicated.
  • What Level of Report is required? A higher level of assurance may be more important to the employee than employer. Two most common types of Report:
    • Calculation of Value – basically uses owner’s numbers with little or no corroboration;
    • Estimate of Value – independent assessment of business and economy – higher level of corroboration.
  • Other Valuation Considerations:
    • Valuation Date – should be current;
    • What is being valued – 100% of shares (en bloc) of specific percentage;
    • Basis of Valuation – Fair Market Value, Fair Value, Net Book Value?

In conclusion, the valuation process will ultimately be driven by the circumstances in each specific situation, and the likelihood of a smoother process and positive outcome increases the earlier in the process the Business Valuator is engaged.

Contributed by Andrew Dey from Mowbrey Gil. This article is from the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America. These articles are meant to pursue our mission of being the best partner in your success by keeping you aware of the latest business news.

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