A recent DOL settlement agreement has the ESOP advisory community abuzz with talk about its impact on ESOP transactions.  We believe it’s a good thing all the advisors are talking about the agreement as it is motivating everyone to re-assess their current advisory procedures and practices. 

The settlement agreement was negotiated through a mediation process and filed in June between the Department of Labor and a nationally recognized, experienced, independent trust company that specializes in ESOP transactions.  It outlines a specific process that the trustee must follow in selecting its financial advisor (appraisal firm) and requires the trustee to conduct an inquiry to assess possible conflicts and the financial advisor’s experience, and requires oversight by the trustee of the valuation process itself, among other things.

Trustees and valuation firms actively working in the ESOP space will probably find that the requirements described in the settlement agreement create more of an administrative issue than a fundamental change in the way they do business already.  However, trustees and appraisers with less disciplined processes may be well advised to use this settlement agreement as an opportunity to develop a process similar to the one  recommended.  And while the terms of the settlement agreement apply only to the trust company the agreement offers something of a checklist for best practices and should be seen as a window into how the DOL is likely to review ESOP transactions. 

We also expect a more diligent assessment of financial projections, capital structure and financing terms.  It will no longer be sufficient to put a generalized growth rate on sales.  For example, companies with multiple business lines or divisions will likely be required to build up the revenue and gross profit by division, rather than estimate an enterprise-wide growth rate.  But again, this is a practice that makes sense regardless of the specific terms of the settlement agreement.

Ultimately, we believe all constituents in ESOP transactions, including sellers, employees and advisors, will benefit from more a more critical financial review process in preparing for a sale.  Because a key factor of a sustainable ESOP company is a reasonable stock valuation, a rigorous appraisal process provides the foundation for a successful transaction.

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