Two amicus briefs were recently filed in Lee v. Argent Trust Co., 2019 U.S. Dist. LEXIS 132066 , which is on appeal. The Lee case arose out of the 2016 sale of shares in a construction company to an ESOP. The ESOP paid $198 million for an 80% ownership stake in the company. The transaction was financed with a loan from the company and the selling shareholders received warrants that would enable them to acquire additional voting stock. A 2016 year-end annual appraisal, which came 18 days later, valued the equity in the ESOP at $64.8 million. The plaintiffs attacked ESOPs as a tool of the owners to enrich themselves at employee expense and suggested that the two figures showed the trustee caused the ESOP to overpay for company stock.

The case was dismissed because the complaint is based upon a fundamental error. The company and ESOP trust are two different entities. Each has a different value based upon it’s worth and debt that it carries. The first brief, submitted by The National Center for Employee Ownership, notes that the plaintiff confuses equity value of the ESOP and enterprise value of the company. That’s a pretty basic error, and the case was dismissed upon the lack of an injury to the plaintiff.

NCEO advocates for the ESOP as a true benefit to employees with higher returns than other retirement options. While the ESOP paid $198 million, at the same time it borrowed funds to supply it with cash to do the deal. It’s apparent that the net value in the Plan at formation is less than the $198 million paid for the stock because debt is used to fund the ESOP. In fact, many ESOPs are formed with net zero equity, and over time debt reduction and the increase in company value provide above-market leveraged return to employees.

A second brief, submitted by the American Society of Appraisers, addresses the aspect that ESOP appraisal is done at Fair Market Value (FMV), not Investment Value (IV). This is an important side issue that repeatedly drags ERISA controlled investments into court after an acquirer buys out a company at a premium to value. The valuation industry feels the Department of Labor is creating its own unique value standard varying from written law.

Valuation happens under a value standard. FMV and IV represent two basic types of value standards known as Value-in-Exchange and Value-to-the-Holder. Exchange Value represents what a business on the whole sells for, and Value-to-the-Holder which represents value in a specific use. In this case ASA is saying that investment value for the buy-out transaction is based upon the in-use value of the buyer, and we cannot continue to confuse the results of buy-outs with appraisal at FMV.

In-use value is an economic concept dating back to Adam Smith, but still the professional valuation organizations do not provide enough specifics to define an appraisal so that we avoid these disputes. In the buy-out premium, synergy creates value greater than stand-alone value. So I will close with five premises of value that can be inserted into valuation reports to ensure that the conclusions are applied correctly:

1. Piece Value (now called liquidation value);
2. Value in Place (now called going concern – value as a stand-alone business);
3. Value in Consolidation (value from cost savings combination);
4. Value in Synergy (value from new growth combination); and
5. Breakup Value (value after separating from holding entity).