ESOP floor price

[Guest lolalin]

How does a fiduciary of an ESOP justify the use of floor prices above the valuation provided by an independent apprasier? Can the fiduciary use the mechanism to protect retirees requesting a distribution when the stock price is severely depressed?

Thank you

[RLL]

Hi lolalin ---

The use of a "floor price" in an ESOP is usually justified only when the ESOP is acquiring additional shares in a leveraged transaction which will result in a reduction in value of the ESOP's existing shares. In such a case, the ESOP fiduciary may bargain for a floor price as part of its agreement to engage in the transaction. The floor price guarantee usually comes from the employer as part of the put option triggered in connection with ESOP benefit distributions. An ESOP should not subsidize benefit distributions which exceed the fair market value of the "distributable" shares.

[Kirk Maldonado]

RLL:

Would your answer be any different if the "subsidy" (i.e., the portion of the repurchase price in excess of the fair market value of the stock) were funded by someone other than the employer or ESOP (e.g., a shareholder)?

[RLL]

Hi Kirk ---

I think that a third-party (including a shareholder) guarantee of the floor price is OK or maybe even better than a guarantee by the employer. One difference may be a slightly enhanced value of employer stock by reason of the fact that it's not the employer guaranteeing the subsidized value. I think that a guarantee by the ESOP itself is a problem, since one group of participants should not be subsidizing ESOP benefits for other participants.

What do you think?

By the way, Kirk, I'm very impressed that you've become a BenefitsLink Super Moderator.

[Kirk Maldonado]

RLL:

I think that the funding of the portion of the purchase price that is in excess of the current fair market value of the stock ("Subsidy") by a third party should be permissible.

I agree with you that the ESOP paying the Subsidy is conceptually problematical for the reason you posited.

I also think that the employer paying the Subsidy is also troubling because that action diminishes the value of the employer, which is against the interests of all of the other ESOP participants. While this impact is minimized if the ESOP does not own 100% of the company, that fact does not eliminate the problem.

[QDROphile]

What if you achieve the floor price by the design of conversion features of convertible preferred stock?

[RLL]

Kirk ---

The fact that the employer's guarantee of the floor price may adversely affect the value of employer stock for all other ESOP participants MUST be taken into account by the fiduciary in its determination of "adequate consideration" and negotiation of the purchase price for purposes of the new leveraged stock purchase transaction.

QDROphile ---

Convertible preferred stock designed to provide "floor price" protection may be effective in some situations....but it will complicate the ESOP transaction and subsequent administration by adding in a recapitalization and creating an additional class of stock on an ongoing basis....and it won't eliminate the potential negative effect on valuation of any common stock that the ESOP (or other shareholders) may own. All the ESOP's stock could be convertible preferred stock unless the ESOP was the 100% shareholder. You would not be able to use convertible preferred stock if the employer is an S corporation.