Payment Amount Based on Appraised Value of Company

[Jeff Kirtner]

Company would like a deferred comp plan to pay an executive 10% of the value of the company in 5 equal annual payments beginning 60 days after separation of service, where the value of the company would be determined as of the date of separation by an independent appraiser.  Does this proposal violate 1.409A-3(i)(1), which requires that "objectively determinable amounts" be payable on the payment dates, and says an amount is objectively determinable if it is "specifically identified," or if the amount may be determined "pursuant to an objective, nondiscretionary formula . . . (for example, 50% of an account balance)?"

The regulations don't define "specifically identified."  Is it broad enough to include the appraised value, or does it need to be an exact number or something close to it?  It wouldn't seem that the appraised value would satisfy the objective, nondiscretionary formula, unless the plan specifies how the appraiser is to come up with the value, which isn't the intent.

If the proposed plan doesn't satisfy 1.409A-3(i)(1), is there any way to argue that provision doesn't apply to payments based on separation from service?

[EBECatty]

Interested to hear others' thoughts, but I would think the "objective, nondiscretionary formula" would be satisfied by the "10% of" piece of the calculation, not necessarily a concrete valuation method of the entire company. In contrast to a payment calculation of, for example, "a percentage, to be determined by the board in its discretion, of the total valuation of the company as established by an independent appraiser as of the date of the employee's termination from employment."

You could make a similar argument about any unknown future amount. For example, if the formula was 50% of the employee's final base salary, you wouldn't necessarily have to spell out in the plan exactly how, from present date until retirement, the company would adjust the employee's base salary. 

It's also not an event-based payment, is not dependent on payments made to the employer, etc. so you get out of some of the more specific rules.   

 

[david rigby]

Just wondering about the practicality:  Is it possible to have an independent appraiser make such a determination within 60 days after separation of service?  if not, maybe some other formula?

Asking for a friend.

 

[QDROphile]

Many ESOP companies have a devil of a time with valuations in time for administrative needs, such as distributions, and the time mandates are more liberal than 60 days. However, valuation standards and practices for ESOPs are arguably more rigorous than would be required for nonqualified deferred compensation. Personally, I am somewhat cynical about valuations and what it takes to get a valid one for any particular purpose.

[rocknrolls2]

I would agree with the previous commenters that 60 days after separation may well prove to be a very unreasonable amount of time to both hire the appraiser, have them visit the company and its operations, review its financials and the competitors in the industry and arrive at a final valuation amount. In some industries, there is a rule of thumb that is often applied in valuing certain businesses in that industry, such as average gross earnings over the the last 6 months or 20 times weekly net earnings. If there is such a rule of thumb applicable to that industry, maybe it is not unrealistic to expect the valuation to be completed and a value arrived at within 60 days of separation.

[Luke Bailey]

I agree with EBECatty. You've got a formula. As long as the employer does not have effective control over the valuation I don't see a problem. See 1.409A-3(i)(1)(vi), Example 6.