ESOP (Employee Stock Ownership Plan)

The ESOP Valuation Requirement – Federal Law, the DOL, and the IRS

ESOP valuations are not discretionary — they are a federal legal requirement under ERISA (the Employee Retirement Income Security Act of 1974) and the Internal Revenue Code. The core obligation is straightforward: shares acquired or held by an ESOP must be valued at Fair Market Value, as defined under IRC Section 401(a)(28)(C), and that valuation must be performed by an independent qualified appraiser on an annual basis.

The Department of Labor’s Role

The DOL is the primary federal regulator of ESOPs and has issued substantial guidance on what it expects from ESOP valuations. Under ERISA Section 3(18), an adequate consideration determination requires that the ESOP trustee rely on a valuation that reflects all relevant factors and is prepared by a person who is independent of all parties to the transaction. The DOL’s enforcement posture has intensified in recent years, with a particular focus on:

• Whether the appraiser is truly independent and free of conflicts of interest
• Whether the valuation methodology adequately reflects current economic conditions and company-specific risk
• Whether the trustee meaningfully engaged with and critically evaluated the appraisal — rather than simply rubber-stamping it
• Whether selling shareholders received no more than Fair Market Value in the initial ESOP sale transaction

IRS Valuation Guidance

The IRS applies the Fair Market Value standard to ESOP share valuations — the same standard used across estate and gift tax contexts. Fair Market Value is defined as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of the relevant facts. Revenue Ruling 59-60 remains foundational guidance, setting out the eight factors appraisers must consider when valuing closely-held business interests — including earnings capacity, asset values, dividend-paying capacity, goodwill, and comparable company data.

For S-Corporation ESOPs, the IRS scrutinizes the tax benefit inherent in S-Corp ESOP structures carefully, and the valuation must properly reflect the economic reality of pass-through tax treatment in the context of a hypothetical sale.

InteleK’s deep knowledge of the ERISA and IRS landscape, combined with tried and proven valuation processes, allows us to deliver highly defensible conclusions of value that stand up to federal scrutiny.

When ESOP Valuations Are Required

ESOP valuations under ERISA and the IRC are required in several distinct contexts:

Initial ESOP Transaction Valuation — When a company first establishes an ESOP and the trustee acquires shares from the selling shareholder(s), an independent appraisal is required to establish that the ESOP paid no more than Fair Market Value for the shares. This is the highest-stakes valuation in the ESOP lifecycle — it sets the transaction price, defines the DOL’s “adequate consideration” threshold, and forms the baseline for all future annual valuations.

Annual ESOP Valuation Updates — ERISA requires that ESOP shares be valued at Fair Market Value at least annually, as of a date no more than twelve months before any distribution, diversification election, or plan transaction. The annual valuation drives participant account balances, distribution amounts, repurchase obligation projections, and contribution levels.

Repurchase Obligation Studies — As ESOP participants reach retirement age or leave the company, the plan’s repurchase obligation — the cash required to buy back vested shares — can represent a significant and growing liability. A repurchase obligation study projects future buyback demands and helps plan sponsors and trustees manage liquidity, plan design, and corporate finance strategy.

Subsequent Transactions — Partial Sales, Secondary Purchases, and Mergers — When an ESOP acquires additional shares, a selling shareholder effects a secondary transaction, or a company with an ESOP is involved in a merger or acquisition, an updated independent appraisal is required to ensure each transaction occurs at Fair Market Value.

S-Corporation Election Valuations — When a C-Corporation ESOP company elects S-Corporation status (or vice versa), an updated valuation is required to reflect the change in tax attributes and their effect on the value of the shares held by the plan.

The Fair Market Value Standard Applied to ESOP Companies

Unlike portfolio fund valuations governed by ASC 820’s exit-price framework, ESOP valuations apply the Fair Market Value standard — defined under the hypothetical willing buyer / willing seller construct. This distinction matters: an ESOP trustee does not need to determine what the company would sell for in a forced liquidation or at a specific measurement date exit price. Instead, the appraiser must determine what a hypothetical, informed, uncoerced buyer would pay for the subject interest in the context of a negotiated transaction.

For closely-held companies — the universe in which virtually all ESOP companies operate — this requires the appraiser to build a thorough, documented analysis of:

• The company’s historical and projected financial performance
• The economic and industry outlook
• The nature, history, and competitive position of the business
• The company’s capital structure, debt obligations, and working capital profile
• Comparable public company trading multiples and comparable M&A transactions
• Discounts for lack of control and lack of marketability, where applicable

Valuation Approaches for ESOP Companies

InteleK applies the valuation approaches most appropriate to the ESOP company’s industry, stage, and financial profile:

Market Approach — Guideline Public Company and Transaction Methods

The Market Approach values the company by reference to pricing multiples observed in the market for comparable businesses. For ESOP valuations, this typically involves:

• Guideline Public Company Method — Selecting a peer group of publicly traded companies in the same or closely related industry and deriving valuation multiples (EV/Revenue, EV/EBITDA, EV/EBIT) from their current trading prices, then applying those multiples to the subject company’s financial metrics with appropriate adjustments for size, growth, profitability, and risk.
• Guideline Transaction Method — Analyzing acquisition prices paid in comparable M&A transactions for private and public companies, providing a control-level value benchmark. Particularly relevant when the ESOP owns a majority or controlling interest.

Income Approach — Discounted Cash Flow

The Income Approach projects the company’s future free cash flows and discounts them to present value using a risk-adjusted discount rate. For ESOP valuations, the DCF is especially important when the company’s financial trajectory — driven by post-transaction debt service, management incentive plans, or capital reinvestment programs — diverges meaningfully from historical performance. The discount rate reflects the company’s specific risk profile, including size premium, industry risk, and company-specific factors.

Asset Approach

For holding companies, investment entities, or businesses where the going-concern value approximates net asset value, the Asset Approach — typically the Adjusted Net Asset Value method — may be the most appropriate method or a meaningful cross-check.

Weighting and Reconciliation

Consistent with Revenue Ruling 59-60 and DOL guidance, InteleK’s ESOP valuations do not mechanically average methodologies. Each approach is evaluated for relevance and reliability given the specific facts, and the final value conclusion is a reasoned reconciliation — with every weighting decision documented and defensible.

Discounts — Control, Minority, and Marketability in ESOP Valuations

One of the most consequential and scrutinized aspects of any ESOP valuation is the application — or non-application — of valuation discounts. The appropriate level of discounts depends on the specific facts of the ESOP transaction and the interest being valued.

Control vs. Minority Interest

When an ESOP owns a controlling interest (typically more than 50% of voting shares), the valuation is generally performed on a controlling interest basis — without a minority discount — because a controlling shareholder commands a premium for the ability to direct management, declare distributions, and determine strategic direction. When the ESOP owns a minority interest, a discount for lack of control (DLOC) may be appropriate, reflecting the minority shareholder’s inability to exercise these prerogatives.

Discount for Lack of Marketability (DLOM)

Shares in privately held ESOP companies cannot be freely traded on a public exchange. The DLOM reflects the reduction in value attributable to the absence of a ready market for the shares. For ESOP valuations, the DOL and IRS scrutinize DLOM applications carefully — requiring that the discount be substantiated by empirical studies, company-specific analysis, and well-established valuation literature rather than simply applied as a formula or rule of thumb.

The DOL’s Scrutiny of Discounts

Discounts can be among the most material adjustments in an ESOP valuation — and they are among the most frequently challenged in DOL enforcement actions and litigation. The DOL has consistently emphasized that discounts must reflect the actual economic circumstances of the specific ESOP and company, not generic industry benchmarks. InteleK’s appraisers apply discounts that are rigorously researched, customized to the case facts, and supported by the best available empirical evidence — providing the strongest possible defense against challenge.

The 2026 ESOP Regulatory Landscape

ESOP valuations operate in an evolving regulatory environment, and 2026 brings several developments that plan sponsors, trustees, and advisors must understand:

DOL Enforcement Priorities

The DOL’s Employee Benefits Security Administration (EBSA) has continued to prioritize ESOP transactions in its enforcement program, with particular focus on initial transaction valuations where the selling shareholder receives proceeds and the ESOP trustee’s independence and adequacy of consideration are most directly tested. Enforcement actions have resulted in significant monetary recoveries and personal liability findings against trustees and appraisers who failed to meet ERISA’s standards.

The OBBBA of 2025 and Its ESOP Implications

The One Big Beautiful Bill Act of 2025 brought permanent increases to the federal estate and gift tax exemption — making ESOPs even more attractive as a succession planning vehicle for owners whose estates fall below the elevated $15 million threshold but who still seek liquidity, tax efficiency, and a legacy outcome for their employees. The OBBBA’s permanent QBI deduction also enhances the after-tax cash flow profile of S-Corporation ESOP companies, with direct implications for DCF-based valuations.

Section 1042 Tax Deferral — C-Corporation ESOP Sales

Selling shareholders in C-Corporation ESOP transactions may elect under IRC Section 1042 to defer capital gains taxes on the sale proceeds by reinvesting in Qualified Replacement Property (QRP). This powerful tax benefit is contingent on the ESOP owning at least 30% of the company’s outstanding shares immediately after the transaction — and the transaction price being supported by an independent appraisal establishing Fair Market Value. An accurate, defensible valuation is the gating requirement for Section 1042 eligibility.

S-Corporation ESOP Tax Advantages

An S-Corporation wholly or majority owned by an ESOP pays no federal income tax on the ESOP-owned portion of its earnings — a structural tax advantage that significantly enhances the company’s ability to service acquisition debt, build employee wealth, and fund repurchase obligations. The IRS monitors S-Corp ESOP structures closely, and the valuation must properly reflect the economic value of the S-Corp tax attributes to plan participants and the hypothetical buyer.

Repurchase Obligation — The Long-Term Financial Planning Imperative

A repurchase obligation study is the forward-looking financial analysis that every mature ESOP company needs. As participants vest, retire, or terminate employment, the company is legally obligated to repurchase their shares at the then-current appraised Fair Market Value. Without proactive modeling and planning, repurchase obligations can create cash flow strain, dilutive secondary share issuances, or — in worst-case scenarios — plan instability.

InteleK’s repurchase obligation analyses project:

• The value and volume of shares expected to be redeemed over a multi-year horizon
• The cash flow demands on the company under multiple valuation and demographic scenarios
• The interaction between repurchase obligations, new ESOP contributions, and corporate debt service
• Strategic options for managing repurchase liability, including plan design modifications, financing strategies, and recycling of redeemed shares

This analysis is an essential planning tool for CFOs, boards, ESOP trustees, and plan advisors — and it is most valuable when integrated with the annual valuation update.

InteleK’s ESOP Valuation Approach

Our accredited appraisers bring deep ESOP valuation experience — spanning initial transactions, annual updates, repurchase obligation studies, and S-Corporation and C-Corporation structures — to every engagement. Here is what sets our process apart:

Fully Independent and Conflict-Free — InteleK serves exclusively as the independent appraiser. We have no financial interest in the transaction outcome, no relationship with selling shareholders or ESOP lenders, and no advisory role in transaction structuring. Our independence is total — which is exactly what ERISA, the DOL, and the trustee require.

DOL and IRS Compliant from Day One — Every valuation report is structured to satisfy the DOL’s adequate consideration standard, ERISA Section 3(18), and the IRS’s Fair Market Value requirements under Revenue Ruling 59-60. We understand what DOL investigators and IRS examiners look for — because we have navigated that scrutiny across hundreds of engagements.

Full Suite of Valuation Methodologies — We apply Market, Income, and Asset approaches as appropriate, with rigorous analysis of guideline public companies, comparable transactions, and company-specific risk factors. Every methodology applied, and every methodology not applied, is documented and justified.

Discount Analysis That Withstands Challenge — Our DLOC and DLOM analyses are grounded in current empirical research, company-specific data, and the most current professional literature — not generic rules of thumb. We document every discount conclusion with the level of specificity that DOL investigations and ESOP litigation demand.

Repurchase Obligation Integration — We offer integrated repurchase obligation studies alongside annual valuation updates, giving plan sponsors and trustees a complete picture of the plan’s current value and future financial demands in a single, coordinated engagement.

Collaboration With Your ESOP Team — We work alongside your ESOP trustee, legal counsel, plan administrator, CPA, and financial advisors to ensure the valuation integrates seamlessly into the transaction process, annual plan administration, and governance framework. We understand the roles of every party in an ESOP transaction — and we know how to deliver conclusions that every stakeholder can rely on.

Scalable for Initial Transactions and Ongoing Programs — Whether you are completing your first ESOP transaction or managing an established plan’s annual valuation program, our process is designed to deliver consistent, high-quality valuations within your transaction or plan administration timeline.