FROM the KSM Blog, reposted with Permission – Rick

ESOP employee-owned companies have a unique issue to consider during these challenging times: how does the COVID-19 pandemic impact ESOP valuation? Each company’s situation will be uniquely impacted by factors including the ESOP plan document, the valuation date, and the size of the ESOP stock distributions required for this plan year. For employees who help administer their ESOP plan or serve in a fiduciary role, the following observations about valuation and benefit plan concepts can help determine the best actions to take.

The Dec. 31, 2019 Valuation Date

Many ESOP plans have a Dec. 31 year-end date, which leads to an annual update of the stock valuation. However, the sudden health and economic crisis of COVID-19 has unfolded in the midst of “valuation update season” for many ESOPs. In fact, some Dec. 31, 2019 valuations were already complete (or close to completion) before quarantines and stay-at-home orders began. Other Dec. 31, 2019 valuations were just beginning.

How should the COVID-19 pandemic be considered when determining ESOP valuations using the Dec. 31, 2019 date? Perhaps this question needs to be restated to not ask “how” it should be considered in value, but rather “if” it should be considered when using the 2019 year-end date. COVID-19 is an example of a Subsequent Event, whose business and economic impact was only known after the valuation date. Valuation standards compel the appraiser to not consider subsequent events that were not “known or knowable” as of the valuation date.

The AICPA Statement on Standards for Valuation Services (SSVS-1) describes the concept as follows:

“…Subsequent events are indicative of conditions that were not known or knowable at the valuation date, including conditions that arose subsequent to the valuation date. The valuation would not be updated to reflect those events or conditions. … In situations in which a valuation is meaningful to the intended user beyond the valuation date, the events may be of such nature and significance as to warrant disclosure (at the option of the valuation analyst) in a separate section of the report in order to keep users informed … Such disclosure should clearly indicate that information regarding the events is provided for informational purposes only and does not affect the determination of value as of the specified valuation date.” (SSVS-1, AICPA, Section 43, pages 20-21, emphasis added.)

Alternatives to Using the Dec. 31, 2019 Share Value: An Interim 2020 Valuation

What can an ESOP company do if their business has been negatively impacted in value by COVID-19? Should this Dec. 31, 2019 valuation (which did not account for subsequent events) be used to govern the price paid for ESOP shares during 2020?

The good news – alternatives may exist for the ESOP valuation. It is important to closely review the ESOP plan document to better understand the plan provisions related to valuation. Many ESOP companies receive valuation of their ESOP shares more than just once annually, and a subsequent valuation (i.e., using an interim 2020 date) might be allowed under the plan. Use caution here, because some plan documents may not allow for interim valuations. A company’s circumstance might compel the plan sponsor to consider an ESOP plan amendment or other remedies related to an interim 2020 valuation.

The use of an interim 2020 valuation might allow the ESOP company to honor the payout of ESOP share distributions, diversification elections, and other stock-related transactions at a share value that reflects the current economic conditions and does not place undue repurchase obligation pressure on cash flow. Alternatively, if the ESOP only has a small number of stock distributions to make this year, using the Dec. 31, 2019 valuation without incurring the time and expense for an interim valuation might be the prudent course of action.

The bottom-line – assessing the potential need for an interim 2020 valuation will require input from multiple parties, including valuation or accounting advisors, plan fiduciary (trustee or co-trustees), and ESOP legal counsel. Other resources include websites for The ESOP Association and the National Center for Employee Ownership. For more information, please contact a member of KSM’s ESOP Services Group or complete this form.

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