Employee Stock Ownership Plans (ESOPs) have become commonplace in the United States, with 6,669 plans covering 14.4 million people. ESOPs are a fantastic option for private companies that want to reward and motivate employees by providing them with equity, but how and when share prices are valued is somewhat complex. Typical stocks are valued on a public stock exchange, meaning that the valuation and how it is attained is transparent and updated daily. ESOPs work differently. The Department of Labor mandates that an ESOP value its shares at least annually, which may seem extreme, but given how these share prices are determined, regular valuations are in everyone’s best interest. 

ESOPs must determine what their shares would sell for on the open market without the benefit of actually being traded on one. That means that the trustee of an ESOP typically sets the share price based on a recommendation from an independent, third-party valuation firm. There are several methodologies used for valuations, but all take historical and future projected financials into consideration. Most appraisals utilize an income approach, which relies heavily on financial data. The approach may examine historical results, dividing them by a capitalization rate to determine value. It may also forecast future cash flows, which are then discounted back to the present value. Either way, organizations and their employees benefit most when updated financial information is provided and analyzed annually, so that share prices are never severely outdated, reflecting values that are either considerably higher or lower than is appropriate. 

Similarly, other market factors that may change during the course of a year could have a profound effect on share prices. Industry performance plays a role, as does the competitive landscape. When major competitors are bought or sold, or when they experience an event that either leads to exceptional performance or bankruptcy declarations, these factors affect your industry standing and therefore inform value assessments. 

ESOP companies grow 2 to 3 percent faster than would be expected without an ESOP, and have lower turnover and 2.5 percent higher productivity. Furthermore, ESOPs that leverage an ownership culture throughout the organization grow 6 to 11 percent faster. In order to reap these benefits long-term, however, ESOPs need to be actively managed. This ensures that employees understand the true value of their compensation packages and can rely upon their future existence. When ESOPs are not frequently monitored, this often leads to the program’s termination. 

Over time, shares are allocated and debt is repaid, meaning that repurchase liability can accumulate quickly and consume a growing share of cash flow. If this has not been anticipated, cash that might have otherwise been used to fund growth initiatives is eroded in order to satisfy the company’s repurchase obligation. When the company’s growth is stifled, causing stock prices to drop, this burden becomes too heavy to shoulder. In order to properly manage ESOP obligations and ensure this does not happen, companies must regularly study their future repurchase obligations through the lens of regularly updated future stock price projections.  

Valuing ESOP stock prices annually not only fulfills the Department of Labor’s mandate to do so; it also ensures the long-term viability of the company, their program, and the ongoing high performance, productivity, and satisfaction of employees.