On Thursday, October 15, the Retire Through Ownership Act was signed by President Trump and became law. This was a great victory for employee owners, current and future ESOPs, fiduciaries, and professional advisors.
Now that the hard work of passing the legislation is over, a question I am hearing from many companies, trustees and ESOP professional advisors is, “what does this all mean”?
The ESOP Association was heavily involved at every step of the legislative process, from drafting the bill text to working closely with the leaders of the committees of jurisdiction in both the House and Senate. The Retire Through Ownership Act came about due to years of mounting frustration in Congress that the Department of Labor was not supporting ESOPs by issuing a formal rule on adequate consideration. Simply put, adequate consideration is the process that an ESOP trustee must follow to arrive at a fair market value for ESOP stock. It’s a foundational concept that underpins every ESOP in the U.S. And because ESOPs are a qualified retirement plan governed by ERISA, that valuation matters to every employee owner.
Working with some of the brightest legal and valuation experts in the ESOP field, we ultimately settled on an approach that was elegant in its simplicity: codify that an ESOP fiduciary may in good faith rely on IRS Revenue Ruling 59-60, which has defined the process for valuing private companies since 1959 and is widely accepted among all business appraisers.
IRS 59-60 does everything ESOP trustees and valuation experts need. It recognizes that valuation is not an exact science and instead must be made by sound, informed judgment, and identifies eight factors that must be considered when determining the fair market value for a private business:
- the company’s history
- economic and industry conditions
- the financial condition of the business
- the earning capacity of the company
- the dividend-paying capacity
- goodwill and other intangible value
- prior stock sales and the size of the ownership interest
- comparable publicly traded companies.
More than six decades of subsequent guidance and case law have built upon that framework. At the end of the day, we weren’t asking Congress to invent a new valuation standard. We were asking Congress to allow ESOP fiduciaries to rely on a well-established one. In the process, it also shifts the center of gravity for ESOP valuation regulation away from the Department of Labor and toward the IRS where the rules are longstanding and extremely stable.
That is essentially what the Retire Through Ownership Act does. As a matter of statutory law, an ESOP fiduciary may now rely in good faith on a valuation provided by an independent valuation expert or appraiser that applies the principles and methodologies of IRS 59-60.
The significance of this is difficult to overstate. Congress has now amended ERISA itself. The Department of Labor retains its authority to issue regulations interpreting the law, and we expect it to do so but the DOL will have to do so in consultation with the IRS and any significant departures from existing practice and guidance would have broader implications for all business valuations. Any future regulation must operate within the framework Congress has now established: an ESOP fiduciary may make a good-faith reliance on an independent valuation expert who applies the principles and methodologies of Revenue Ruling 59-60.
Valuing a business owned by employees does not require a departure from valuing any other business ownership model
Perhaps the most important consequence of the Retire Through Ownership Act is that ESOPs are no longer a special niche or obscure class of businesses with separate valuation standards. IRS 59-60 means that ESOPs now get valued by the same process that any other private business, large or small, must go through. This not only makes it much easier for businesses considering an ESOP transition. Future ESOP valuation disputes will also be considered against a well-developed body of valuation principles, guidance and precedent built around Revenue Ruling 59-60. The focus should therefore be where it belongs: whether the fiduciary followed a prudent, good-faith process, not simply whether another appraiser, looking at the same company, might have reached a different number.
Just as important is what the Retire Through Ownership Act does not do. It is not a safe harbor, and it does not absolve ESOP trustees and fiduciaries of any of their responsibilities to act with loyalty and prudence in the best interests of the plan participants, the employee owners. It’s not a “get out of jail free” card or an excuse to cut corners for trustees or business appraisers, as all the due diligence that goes into arriving at a fair market value and in selecting an independent valuation expert must still be followed.
It’s also quite explicitly not a formula for valuing a private company. One of the biggest drawbacks of the Biden DOL’s draft rule was that it was largely outcome-based and prescriptive – it failed to recognize the most basic covenant of business valuation: that it is not an exact science where a specific process or methodology should apply for every business. Business valuation requires judgements, and those are best left to experts. An overly outcome-driven standard would have made virtually any valuation vulnerable to second-guessing after the fact, significantly increasing litigation risk and making ESOP transactions less attractive as a business succession strategy. Like any privately held asset, such as a house, different appraisers would necessarily arrive at a range of values. We have long argued for, and have finally secured through the Retire Through Ownership Act, a process-based system where trustees may in good faith use an independent expert.
We've also received questions about whether the new law addresses specific transaction structures or financing tools that have been the subject of recent litigation and investigation. How matters such as control premiums (or discounts) or finance tools such as warrants or stock appreciation rights (SARS) are addressed in an appraisal fall inside the areas of judgement contemplated by 59-60. All of these issues would fall under the rubric of Fair Market Value as determined in good faith, and now an ESOP trustee may rely upon a professional independent appraiser to do so.
The law establishes a valuation process rather than prescribing answers to individual valuation questions. Because warrants can be dilutive, for example, their impact remains something the independent valuation expert would consider as part of the overall analysis.
That is ultimately why The ESOP Association fought so hard for this legislation. The goal was never to make valuation less rigorous or to reduce the responsibilities of ESOP fiduciaries. It was to replace uncertainty with a clear, workable process that protects employee owners, gives fiduciaries and their advisors greater confidence, and gives business owners considering an ESOP a more predictable path forward.
That is good for trustees. It is good for professional advisors. It is good for business owners considering an ESOP. Most importantly, it is good for the employee owners whose retirement security depends on getting that answer right.
