Enterprise Services, Inc. Business Transitions and Valuations
Frequently Asked Questions
Questions About ESI

How long has ESI been in business?
ESI was founded by Scott Miller in 1993.

What types of clients do you serve?
Our clients are typically privately-held, small to medium sized businesses.

What types of industries does ESI serve?
ESI serves clients in a number of industries. We, too, come from industry and understand the underlying operational and management forces faced by business owners and managers. These industries include:

  • Construction
  • Manufacturing
  • Distribution
  • Professional Services
  • Retail
  • Environmental Services
 
  • Communications and Technology
  • Hospitality
  • Transportation
  • Finance and Insurance
  • Agriculture and Food
  • Medical and Healthcare

What makes ESI different?
The professionals at ESI represent one of the largest and most respected valuation teams in the nation, and clients in over forty-four states appreciate the national perspective we bring to transition planning, valuation and ESOP related issues. Our combination of professional credentials and senior management industry experience set ESI apart.

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Questions About Business Transition Planning (also called Succession Planning)

Is there one best strategy for exiting a closely-held business?
No. It depends on your situation. You could sell your business to a family member, a competitor, inside managers, an Employee Stock Ownership Plan (ESOP), or someone not even familiar with your particular business. Each strategy has advantages and disadvantages based on the timeline and overall goals of the business owner.

When is the right time to start thinking about an exit from a business?
The well-prepared business owner has a wide range of transition options to consider. The actual timing and exit from the business depends on a number of factors related to the type of exit strategy you want to utilize. Generally, the sooner that planning begins, the more options available to meet overall owner objectives.

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Questions About ESOPs

What is an ESOP?
The technical definition of an Employee Stock Ownership Plan is a “tax qualified” defined contribution employee benefit plan of deferred compensation intended to be “primarily invested” in the securities of the employer (plan sponsor). An ESOP is a vehicle to provide an equity interest to employees in the securities of their employer. Certain rules have been adopted by the plan intended to protect the interests of the plan participants. In return for the protective rules, the ESOP receives certain tax benefits.

Unlike other qualified employee benefit plans, an ESOP may borrow money to acquire company stock. In turn, the contributions for stock purchase are generally tax deductible. Contributions for stock purchase are generally tax deductible

What are the main tax advantages in structuring an ESOP to both the company and the selling shareholder?
In the case of a buyout where debt is used, debt repayment is made using after-tax dollars. With an ESOP, principle payments are tax deductible to the company. This provides a decisive tax advantage, resulting in a savings of 35% to 40% of the overall transaction cost. On the selling shareholder side, two benefits are derived. First, financially, it is possible to defer taxes on the sale of the stock: a seller can elect a 1042 tax deferral if the company is a C Corporation and the transaction size is at least 30% of the outstanding securities. The second benefit comes in controlling the timing of exit. For the seller that does not want to exit immediately, as is often the case with a 3rd party sale, an ESOP provides a longer term exit strategy that the selling shareholder can dictate.

Who votes stock held by an ESOP?
ESOP shares are held and controlled by a trust established for the benefits of the plan participants; they do not normally get distributed directly to employees out of the ESOP. As a result, the plan trustee votes the shares. Under certain circumstances involving matters such as the sale or liquidation of the Company, the ESOP trustee is required to “pass-through” the vote to the participants.

Who appoints the ESOP trustee?
Corporate governance is often an area questioned with ESOPs. The ESOP trustee is appointed by the board of directors through a board resolution. When the ESOP holds a controlling interest in the Company, the board is ultimately controlled by the trustee’s vote because the trustee elects the directors. Although this seems propitious for the trustee, existing directors may have staggered terms and therefore are subject to re-election at different times. When a controlling interest ESOP is established, an agreed upon board structure may be put in place to balance the corporate governance objectives of the Company, the ESOP trustee, and non-ESOP shareholders.

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Questions About Valuations

Why do I need a business valuation?
Unlike a public firm that is traded on open, public markets dictating the price of its securities, a privately held business may not know the value of its stock. There are many reasons for valuing ownership interests in a closely held company including purposes such as gift and estate tax planning, buy and sell agreements between principals, mergers and acquisitions, divorces, insurance requirements, and the sale of a business. The purpose of the valuation often has an impact on both the standard of value, e.g., fair value, investment value, or fair market value, and the approach used to determine a value or a range of values.

What is Fair Market Value?
The most widely known standard of value is Fair Market Value (‘FMV’) as defined by the IRS and other government bodies. FMV represents the price at which the property will exchange hands between a willing buyer and a willing seller; neither being under any compulsion to buy and sell, and both having reasonable knowledge of the relevant facts. FMV assumes a hypothetical transaction, a financial buyer, and terms of cash. The concept of FMV may also include producing a reasonable rate of return to the investor in a private company given the risk characteristics of that specific company.

Is a controlling interest more valuable than a minority interest?
A controlling interest in a business is typically worth more than a minority position. There are a number of prerogatives that accrue to the benefit of a controlling shareholder. Those benefits include such things as: establishing company policies, selection of directors, shareholder voting, setting officer compensation, amending company by-laws and articles of incorporation, and determining dividend payment policies. Due to such benefits, there is an enhanced certainty regarding use of Company resources, which enhances value. As such, the investment community assigns a higher value to a controlling interest above a minority interest in the same company.

What general concepts are used in valuing businesses?
The principal objective of a business valuation is to parallel how hypothetical investors would determine whether to acquire an interest in a firm. As such, determining the economic return that is likely to accrue to the investor is paramount to estimating value. There are three basic approaches used to value a business: market approach, cost approach, and income approach. Depending on the nature of the valuation assignment, some or all of these may be more appropriate than others. Each of these approaches considers financial factors derived from the company. In addition, financial, market, and economic conditions of the firm compared to other similar companies in the same or similar industry are considered in a business valuation.

What is a market approach to valuation?
A market-based approach typically compares a company's financial performance against its public company counterparts. Often multiples from acquisitions of similar businesses or stock prices of comparable publicly traded companies are used in the comparative analysis to derive value. The market approach to valuation is based on the principal of substitution, namely that one will pay no more for an item than the cost of acquiring an equally desirable substitute. Thus, the value is determined based on prices that have been paid for similar items in the relevant marketplace.

What is a cost approach to valuation?
The cost approach, often referred to as an asset based approach, is generally an indication of the value that has accumulated over time. Typically, assets and liabilities are adjusted to their fair market value with a consideration of tax consequences. This method is useful when a firm’s assets prove more valuable than any measures put on the earnings; it is seldom used when the company’s assets do not fairly reflect, when liquidated, a true measure of the earnings that are derived from their employment.

What is an income approach to valuation?
Income approach is often the best estimate of value for a private business because it relates future economic benefits with associated risks to the overall opinion of value. The estimated future returns are often based on market and economic conditions of the firm compared to other similar companies in the same or similar industry.

What is a Discount for Lack of Marketability?
The valuation of stock in a private company requires the assessment of the degree of marketability of the shares in question. Unlike public company securities that have a liquid and ready market, most closely held stock has an absence of marketability. Research supports the view that this lack of marketability of privately held securities is a pronounced negative for investors and has a significant impact on value for which an investor must be compensated. This is referred to as a discount for lack of marketability (“DLOM”).

Enterprise Services, Inc. Business Transitions and Valuations
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