The Wall Street Journal on Increased Oversight of ESOP Transactions

The Wall Street Journal ran an interesting, if superficial, story on tougher scrutiny of ESOP transactions and how that is impacting smaller companies with ESOP programs. As the article pointed out, ESOPs in that context are very much a tool for the owner/founder class to cash out their equity developed by building the business – including for the purpose of transforming the business into a retirement nest egg – without having to go out into the open market to sell it, by instead selling it in an essentially captive transaction to the employees. But the interesting thing about that is that the former – selling the company into the open market – comes with the built in valuation discipline of an open market, with the company having the value that informed buyers are willing to put on it relative to other potential investment options open to those buyers. ESOPs, as a tool for the owner/founder class to cash out their equity, don’t come with the protections and tools for valuing the worth of the company that are inherent in selling into an open market; the pricing, and thus the amount of cash out open to the owner/founders, is instead determined artificially, independent of an open market, by an appraisal process that is supposed to be watched over, on behalf of the employees, by the plan fiduciary.

The Journal article discusses the fact that DOL initiatives in this area are driving up the cost and requiring somewhat more disciplined oversight of the process by companies proceeding with ESOPs. The article, however, references that it is simply driving up the cost of appraisals from an average of $10,000 to $11,000, and that certain legal and related fees are higher for companies that want to ensure that there are no perceived or actual conflicts of interest in the transaction. If that is all the additional cost for ESOPs that are caused by enhancing the protections of employees in such a transaction, then that isn’t much cost at all to give the employees at least some of the protections that the marketplace would give to a third party buyer.