COVID-19’s Effect on ESOP Valuations

Thoughtware Article Published: Apr 15, 2020
Woman using laptop

Spring is prime time for many employee stock ownership plan (ESOP) valuations. ESOP companies with December 31 year-ends are in the process of submitting their five-year forecasts to their ESOP appraiser. The effect of the SARS-CoV-2 virus and incidence of COVID-19 has created many questions regarding the annual valuation and administrative process.

Keep in mind that a valuation performed for the plan at December 31, 2019, should be prepared using only information known as of December 31, 2019. At December 31, 2019, the idea that COVID-19 could have a major effect on the U.S. economy wasn’t being seriously considered by the general population. Therefore, any projections being prepared by management should ignore COVID-19’s effects, regardless of how material those effects may be on the current business.

This means the valuation to be reported on the 2019 Form 5500 and on the 2019 ESOP participant statements may not reflect the current fair value of the ESOP shares. This can create several concerns, including whether an updated fair value reflecting the effect of COVID-19 should be prepared and used in determining the value of ESOP distributions. It’s possible that your ESOP plan document already contains language that allows not only for a valuation at the end of the plan year but also other interim valuation dates if deemed necessary by the plan administrator to protect the interests of ESOP participants. The plan administrator is typically the company or a person(s) or entity assigned by the company’s board of directors. You should carefully review your plan document to determine if it already includes language that allows for an interim valuation date. If your plan doesn’t already contain this language, you should consult with your ERISA attorney to see if an amendment is possible and advisable. There may be some concerns about amending the plan to provide for an interim valuation date if that affects the ESOP distribution of a participant who terminated prior to the amendment. 

If your plan document allows you to use an interim valuation date, you may not want to immediately act on this ability. The current situation is certainly a fluid one, and information can change rapidly. There’s much uncertainty as to whether the economic effect of the current crisis will be short-lived (with a possible recovery later in the year) or will spur a longer recession. No one has the answer to this question right now, which makes preparing projections for an updated interim valuation a very difficult (if not impossible) task. 

If your business has been affected by COVID-19 in a material way and you think this has adversely affected the value of the ESOP stock, you should consider the effect this may have on participant distributions. It’s important to consider that declaring an interim valuation date is considered a fiduciary decision of the plan administrator. The plan administrator has a duty to make decisions in the best interest of the participants as a whole. If participant distributions are paid at a higher value than is reflective of the current fair value, i.e., based on December 31, 2019, this could be detrimental to the remaining ESOP participants. If the participants are paid at a lower interim value and the company quickly returns to previous profitability levels, those participants could claim they were unduly harmed by the interim valuation.  

Many ESOP administrators are choosing to take a wait-and-see approach. Hopefully we’ll have more clarity on the outlook over the coming weeks and months. The good news is we have some time to develop a thoughtful approach. For a December 31 year-end ESOP, the Form 5500 isn’t due until July 31, 2020. That return can then be extended until October 15, 2020. Even if you typically don’t extend your Form 5500, filing for an extension this year could be a good option for buying additional time to evaluate the options. 

If you do decide to delay your normal process of distributing participant statements, you should consider taking a proactive approach to employee communication. Employees are often accustomed to receiving their statements at a particular time of year. If the statements are delayed, that may create questions in your participants’ minds. It’s important to be transparent with your employees to retain trust during these challenging times. Although you may not provide all the details, you may consider communicating that COVID-19 has had a material effect on the company’s business. This in turn has affected the company’s financial forecast and the ESOP valuation. Letting the employees know the company is working with its trustee, valuation firm and advisors to determine the effect on the ESOP is a good step toward opening the lines of communications.

As with most topics related to COVID-19, changes are being made rapidly. Please note that this information is current as of the date of publication. For more information on ESOP valuations and COVID-19’s effect on the annual ESOP administrative process, contact your BKD Trusted Advisor or use the Contact Us form below. 

Related Thoughtware

Kate & Ben — How can we help you? Contact Us!

How can we help you?