Understanding ESOP Valuations: Key Differences and Why Michigan Is Paying Attention

Employee Stock Ownership Plans (ESOPs) have a relatively short but impactful history in the United States. Their roots trace back to 1921, when a stock bonus plan was added to the tax code to give employees a way to invest in their employer’s stock.

The modern ESOP emerged in 1956 during the ownership transition of Peninsula Newspapers in San Francisco. The founders wanted their employees, not a corporate competitor, to take over the company. Selling to a large newspaper chain likely meant layoffs, reduced quality, and the loss of the brand’s identity. But the employees lacked the money and collateral to buy it. Louis Kelso, an economist and lawyer, proposed using the company’s profit-sharing plan as collateral for a loan, with repayments coming from ongoing contributions. After gaining IRS approval, the first official ESOP was launched. Over the next two decades, it delivered millions in benefits before the company was eventually acquired.

Today, many Michigan business owners are facing similar crossroads. They want to protect their life’s work, keep jobs local, and reward loyal employees while also finding a viable path to retirement.

What Is an ESOP?

The IRS defines an ESOP as a “qualified defined contribution plan that is a stock bonus plan or a stock bonus/money purchase plan” under Section 401(a) of the Internal Revenue Code. In plain terms, it’s a retirement plan that invests primarily in company stock, making employees owners.

For employees, this can mean building significant retirement wealth. For owners, it offers a tax-advantaged succession strategy that preserves the company’s mission, culture, and independence.

Why Michigan Is Paying Attention

According to 2022 data from the National Center for Employee Ownership (NCEO), there are over 6,500 active ESOPs nationwide with nearly 11 million participants, about 6.5% of the U.S. labor force. More than half of these companies operate in manufacturing, construction, or professional services, which are also core to Michigan’s economy.

Michigan ranks tenth nationally with 214 ESOP-owned companies and nearly 300,000 participants. And according to a 2021 Project Equity study, more than half of the state’s private businesses are owned by people nearing retirement. Without strong succession plans, many could close or be sold to out-of-state buyers, taking jobs and community stability with them. ESOPs can keep those businesses locally owned and thriving.

Three Factors That Make ESOP Valuations Unique

Fairness

An ESOP valuation must meet the Department of Labor’s (DOL) “adequate consideration” standard—meaning fair market value (FMV) supported by a thorough, independent analysis. Think of it like a home appraisal: the value has to be based on data, not optimism.

Overstating value, by using overly rosy projections, wrong multiples, or unjustified premiums, can lead to legal trouble. In 2017, First Bankers Trust Services, Inc. (FBTS) settled with the DOL over allegations that it failed to do proper due diligence in three ESOP deals. The result: millions in overpayments and a $15.75 million repayment, plus mandatory reforms.

Why this matters in Michigan: Business owners here need to know that getting an ESOP valuation wrong can create legal and financial consequences for everyone involved.

Control

When an ESOP buys a controlling interest, a “control premium” may be applied. This reflects the added value of making strategic decisions, appointing board members, and directing the company’s future. In minority-interest valuations, the opposite often happens: a discount is applied for lack of control.

Control premiums must be justified. In Fish v. GreatBanc Trust Co., participants claimed the ESOP overpaid for stock. The court upheld the valuation, noting the premium was supported by the facts and still within FMV.

Why this matters in Michigan: Any premium must be backed by clear reasoning, especially in industries like manufacturing and construction where control can directly impact long-term strategy.

Process

An ESOP valuation must be overseen by an independent trustee whose sole fiduciary duty is to plan participants. The trustee ensures the ESOP does not overpay, while the valuation firm must stay objective. When done right, the process is transparent, defensible, and conflict-free.

Plain English: This means there’s a built-in system of checks and balances to protect employees and owners alike.

Michigan’s ESOP Opportunity

Michigan has the right mix of ESOP-friendly industries and aging business owners to see strong growth in employee ownership. Local organizations like the Michigan Center for Employee Ownership and the Small Business Association of Michigan (SBAM) are increasing awareness, offering education on succession planning, valuation, and ESOP advisory services. Partnerships with national nonprofits like the NCEO are making ESOPs more accessible for small- and middle-market companies across the state.

For owners seeking to preserve their legacy and for employees eager to share in future success, ESOPs can be a compelling solution.

Reach out to Breneman Advisors to begin your ESOP valuation process and explore your transition options.

FAQ about ESOP Valuations in Michigan

Q1. What is an ESOP?
An Employee Stock Ownership Plan (ESOP) is a qualified retirement plan that invests mainly in company stock. It gives employees ownership while providing owners with a tax-advantaged succession option.

Q2. Why are ESOPs important in Michigan right now?
Michigan ranks tenth in the nation for ESOP-owned companies, with nearly 300,000 participants. Many local businesses are owned by people nearing retirement, making ESOPs a way to keep companies locally owned, protect jobs, and sustain communities.

Q3. What makes ESOP valuations different from other business valuations?
Three factors make ESOP valuations unique:

• Fairness: must meet Department of Labor standards for fair market value.

• Control: premiums or discounts may apply depending on ownership level.

• Process: requires an independent trustee and objective valuation to protect participants.

Q4. What risks exist if an ESOP valuation is done incorrectly?
If a valuation is overstated or poorly justified, it can lead to legal challenges, financial losses, and Department of Labor enforcement actions against trustees and companies.

Q5. How do control premiums affect ESOP valuations?
When an ESOP acquires a controlling interest, a control premium may be added to reflect decision-making power and strategic influence. In minority-interest cases, a discount is often applied instead.

Q6. Who oversees the ESOP valuation process?
An independent trustee oversees the process with fiduciary responsibility to plan participants. The trustee ensures the ESOP pays fair market value and that the valuation firm remains objective.

Q7. What opportunities do ESOPs create for Michigan business owners?
ESOPs allow owners to retire while preserving their company’s mission, culture, and independence. They also reward employees with ownership and help keep businesses rooted in Michigan’s economy.