Comments: A Follow-up Response to Michael McKean on ESOP Valuations

Robert Reilly Shares His Thoughts on Impressions

Should a valuation analyst accept an ESOP valuation engagement? That is the question raised by Michael McKean in his article written in response to the recent QuickRead article series by Robert Reilly. In this article, Mr. Reilly shares his thoughts on the subject matter.

I am old enough to remember the early television show, The Original Amateur Hour. I started watching the show in the 1950s, although it debuted on television in 1948 (before my time). I remember the spinning wheel and the phrase, “Round and round she goes, and where she stops nobody knows”. And, I remember the telephone number the audience was encouraged to call to vote for your favorite act: JUdson 6-7000. The TV show starred Ted Mack. The original radio show from the 1930s and 1940s (way before my time) starred Major Edward Bowes. Mostly I recall my childhood confusion: The Original Amateur Hour has only a half hour TV show.

Anyway, the professional practice of business and securities valuation is no amateur hour. The professional standards of every valuation professional organization (VPO) include some type of competency provision. This statement is true for the NACVA, AICPA, ASA, RICS, and other VPO standards. There is also a competency provision in USPAP. If an analyst is not competently trained, experienced, and supervised, that analyst should not perform that valuation service. That statement applies for valuations prepared for gift and estate tax, income tax, property tax, bankruptcy, family law, tort or breach of contract litigation, GAAP fair value measurements, shareholder rights fair value analysis, solvency assessment, transactional fairness analysis, or any other purpose you can think of. And, that statement applies to valuations prepared for ESOP and ERISA purposes—including valuations prepared for planning, transaction, and compliance purposes.

There is risk associated with performing any valuation service. There is risk associated with dissatisfied clients; there is risk from other parties who may rely on the valuation; there is also audit and regulatory risk. That risk can be managed with indemnifications and insurance. That risk can be reduced through analyst competency and effective internal quality control procedures. But there is some risk associated with any professional service that we offer. Some services may have slightly more risk than others. But I do not know that ESOP valuations are riskier than, say, gift and estate tax valuations. In both cases, there is audit and regulatory risk. The regulator is different (the IRS versus the DOL), but there is regulatory risk. There is risk in preparing a transactional fairness opinion—dissenting shareholders can sue all parties, including the analyst. There is risk in a valuation performed to implement a simple buy/sell agreement—either the company or the shareholder may claim negligence against the analyst.

Harry S. Truman famously said: “If you can’t stand the heat, get out of the kitchen”. That quote is often attributed to President Truman. It was stated by the younger Senator Truman while serving as a member of the war contracts investigating committee. I would not encourage analysts to get out of the kitchen. I would encourage analysts to obtain the training, education, and experience that they need to stand the heat—including the audit and regulatory heat of the ESOP valuation discipline.

There is a lot of such training available. Some years ago, I developed an ESOP valuation course for NACVA. It has been updated several times by other analysts, but it is still offered. The ASA and other VPOs offer ESOP valuation training. The NCEO and the ESOP Association offer frequent webinars, conferences, publications, and other training opportunities. Thinking of publications, there are numerous ESOP-related books available. Not to practice unabashed self-aggrandizement (well, maybe a little), I coauthored the Guide to ESOP Valuation and Financial Advisory Service with my Willamette colleague, Bob Schweihs. Schweihs and I also recently co-authored Best Practices—Thought Leadership in Valuation, Damages, and Transfer Price Analysis. The Best Practices book includes a five-chapter section called ESOP and ERISA Best Practices. The point is not to promote my books (well, maybe a little). The point is that there are a lot of ESOP-related publications, conferences, professional organizations, and other professional development opportunities available to ESOP valuation practitioners.

Maybe Truman should have said: “Don’t go into the kitchen until you learn how to cook”. However, once the analyst is sufficiently competent, the population of ESOP-owned companies and potential ESOP sponsor companies can benefit from the services of qualified and competent analysts.

I do agree that the ESOP discipline is a specialized discipline within valuation practice. I would also say that the property tax, bankruptcy, fair value measurement, family law, and every other discipline is a specialized discipline within valuation practice. I do not exactly know when the age of the valuation generalist ended, but it was probably around the time that The Original Amateur Hour went off the air.

I have one last confounding quotation. The psychologist Abraham Maslow (remember Maslow’s hierarchy of needs?) said: “If the only tool you have is a hammer, everything looks like a nail”. Like other valuation specializations, ESOP valuations have specific regulatory requirements and other considerations. The analyst needs a specialized tool bag and expertise in applying those specialized tools. But, like valuation analysts in other disciplines, the ESOP analyst should not be afraid of a regulatory review or a contrarian challenge. Most of our work is subject to regulatory review and contrarian challenge. Using those specialized tools, the trained, experienced, and confident analyst can provide thought leadership (and needed professional services) to the ESOP community.

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Robert Reilly, CPA, ABV, CFF, CFA, ASA, CVA, CMA, is a managing director of Willamette Management Associates based in Chicago. His practice includes business valuation, forensic analysis, and financial opinion services. Throughout his notable career, Mr. Reilly has performed a diverse assortment of valuation and economic analyses for an array of varying purposes.

Mr. Reilly is a prolific writer and thought leader who can be contacted at (773) 399-4318, or by e-mail to rfreilly@willamette.com.