2011 ESOP ASSOCIATION TRI-CHAPTER REGIONAL CONFERENCE

1. March 28-29, 2011Pinehurst Resort, NC Fiduciaries & Valuations Caryn McNeill, Smith Anderson Marshall Bartlett, Independence Trust Ryan Stewart, Willamette Management Associates 2011 ESOP ASSOCIATION TRI-CHAPTER REGIONAL CONFERENCE

2. OVERVIEW 2

3. Overview 3 Legal Requirements When stock must be valued Roles and responsibilities of those involved Applicable fiduciary standards Valuation Process How to select a valuation firm The process the valuation firm follows How to review a valuation report

4. LEGAL REQUIREMENTS Caryn McNeill, Smith Anderson 4

5. Legal Requirements 5 When must stock be valued? Transactions – “as of the date of the transaction”1 General plan administration = “as of the most recent valuation date under the plan,” so, typically, annually   1 Treas. Reg. 54.4975-11(d)(5) (“In the case of a transaction between a plan and a disqualified person, value must be determined as of the date of the transaction. For all other purposes …, value must be determined as of the most recent valuation date under the plan.”)

6. Legal Requirements 6 Roles & Responsibilities Who is responsible for determining value in the case of an annual valuation? Code suggests “Independent Appraiser”2 (incorrect) But ERISA (in addition to requiring the involvement of an independent appraiser) also requires a fiduciary3 2 Treas. Reg. 54.4975-11(d)(5) (“An independent appraisal will not in itself be a good faith determination of value in the case of a transaction between a plan and a disqualified person. However, in other cases, a determination of [fmv] based on at least an annual appraisal independently arrived at by a person who customarily makes such appraisals and who is independent of any party to a transaction … will be deemed to be a good faith determination of value.”) See also Code section 401(a)(28) (valuations of nonpublicly traded stock must be by “independent appraiser.” 3ERISA 3(18)(B) – Definition of “Adequate Consideration” “The [fmv] of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations promulgated by the Secretary.”

7. Legal Requirements 7 Roles & Responsibilities Whose valuation is it? The fiduciary’s Confidentiality of reports

8. Legal Requirements 8 Fiduciary Standards/Statutory Requirements ERISA § 408(e) (prohibited transaction exemption requires “adequate consideration”) ERISA § 3(18)(B) (“adequate consideration” is FMV as determined in good faith; see slide 6)

9. Legal Requirements Fiduciary Standards/Statutory Requirements ERISA § 404(a)(1) (fiduciary must act solely in the interest of plan participants and all actions must be in accordance with the documents and instruments governing the plan to the extent they are consistent with ERISA) 9

10. Legal Requirements 10 Fiduciary Standards/Regulatory Requirements Prop. DOL Regs. § 2510.3-18 (intended to provide standards to guide plan fiduciaries in determining FMV of employer stock) Two-part test: FMV determination must be accurate and reflected in written documentation that satisfies the content requirements of § 2510.3-18(b)(2) FMV must be product of valuation process and determination made in good faith

11. Legal Requirements Fiduciary Standards/Regulatory Requirements First requirement to meet FMV part of test: Traditional “willing-buyer/willing-seller” definition of FMV Sound principles of valuation Range of valuations 11

12. Legal Requirements Fiduciary Standards/Regulatory Requirements Second requirement to meet FMV part of test: Content requirements for valuation report include Summary of valuation firm’s qualifications Statement of value and methods used All factors taken into account Purpose of the valuation Significance attached to valuation methods Effective date Detailed information about the business and its history, value and outlook, as well as marketability of its securities and whether a control premium would apply if the sale were made to a third party 12

13. Legal Requirements 13 Fiduciary Standards/Regulatory Requirements Two requirements to meet good faith part of test: FMV must be determined by application of sound business principles and prudent investigation of the circumstances prevailing at the time of the valuation The fiduciary must be independent of all parties to the transaction (other than the plan) or rely on the report of an appraiser who is independent of all parties (other than the plan)

14. VALUATION PROCESSHow to select a valuation firm Marshall Bartlett, Independence Trust 14

15. Valuation Process 15 How to select a valuation firm Who is responsible? Trustee May involve other parties (committee, etc.) Consult with professionals if needed

16. Valuation Process 16 Considerations when selecting a valuation firm Experience with ESOP valuation Methods Credentials Experience with companies similar to target (industry, proximity) Involved with ESOP organizations Independent from company Ability to focus on a specific project. References Documentation

17. Valuation Process 17 Experience - methods How long has the valuation firm been doing ESOP valuations? What approaches does the firm use for ESOP valuations? Income approach Market approach Asset approach Take me through the valuation process. Interviews management Detailed Tell me what is included in the final report.

18. Valuation Process 18 Experience – credentials Who will be performing the valuation on our firm? Who will be signing the fairness opinion and final report? Does the valuation firm utilize a team approach? Who would be involved in the project? What credentials do the individuals performing the valuation have? ASA - Accredited Senior Appraiser in Business Valuation American Institute of Certified Public Accountants – CPA/ABV – Accredited in Business Valuation CFA Institute – CFA – Chartered Financial Analyst Institute of Business Appraisers – CBA – Certified Business Appraiser

19. Valuation Process 19 Experience – with target company How many ESOP valuations have been done on companies in the industry by your firm? What industries does your firm typically work with on ESOP valuations? Where are the ESOP companies located that valuations have been performed on? Need to understand region where business is located.

20. Valuation Process 20 Experience – involvement in ESOP organizations Is the valuation firm a member of any ESOP organizations? TEA – The ESOP Association National Center for Employee Ownership (NCEO) What does the valuation firm do in these memberships? Attend or speak at conferences Involved in advisory board matters

21. Valuation Process 21 Ability to focus on a specific project How many valuations does the firm perform on an annual basis? How many of those are ESOP? How many valuations does the primary valuator typically do in a year? Is the firm independent and without any conflicts of interest? Audit or tax work would constitute a conflict of interest.

22. Valuation Process 22 References Ask for references from the valuation firm. Ask other professionals for their experience with the valuation firm. Lawyers Trustees Other ESOP companies Can you provide me with a sample valuation report?  

23. Valuation Process 23 Documentation List of firms that were seriously considered. Completed checklists for each company interviewed. What questions were asked What answers were provided A memo documenting the decision and reasons why. Minutes from a committee meeting.  

24. Valuation Process 24 Engagement Letter Ensure letter is addressed to trustee. Note the scope of the report is appropriate. Note fees are acceptable. Indemnification.    

25. VALUATION PROCESSThe process the valuation firm follows Ryan Stewart, Willamette Management Associates 25

26. Valuation Process The process the valuation firm follows: Due Diligence Valuation Analysis Valuation Report 26

27. Valuation Process 27 Due Diligence (Update Valuations) Obtain and review most recent financial data (financial statements, tax returns, projections, strategic plans, etc.) Review current economic trends and industry trends relative to the observed trends of the subject company Conduct management interviews and/or site visit Analyze financial statements

28. Valuation Process 28 Due Diligence (Update Valuations) Make necessary normalization adjustments Extraordinary or Non-recurring items – litigation settlements, proceeds from insurance claims, gains or losses from the sale of assets or business segments, etc. Compare subject company financial performance to industry benchmarks Determine causes of significant variances in performance relative to benchmarks – may require follow-up discussions with management How would the due diligence process be different in an ESOP installation transaction?

29. Valuation Process 29 Valuation Analysis Consider all generally accepted approaches to value and select the most appropriate valuation methods to employ in order to estimate the fair market value of the subject company’s stock Income Approach Market Approach Asset Approach

30. Valuation Process 30 Income Approach Discounted Cash Flow Normalized cash flow is projected by company management for a discrete period into the future (generally five years) and converted to present value by the application of an appropriate present value discount rate Appropriate for all companies Direct Capitalization of Cash Flow Normalized cash flow for one period is divided by an appropriate required rate of return Most appropriate for mature companies with demonstrated history of consistent cash flow generation with steady growth

31. Valuation Process 31 Market Approach Guideline Publicly Traded Company Method Select public companies that are operationally similar to the subject company Develop market pricing multiples based on guideline company trading prices and financial fundamentals as of the valuation date Apply multiples to subject company fundamentals to arrive at indications of value

32. Valuation Process 32 Market Approach Guideline Merged and Acquired Company Method Select recent transactions involving acquired companies that are similar to the subject company Develop market pricing multiples based on acquired company transaction values and financial fundamentals as of the valuation date Apply multiples to subject company fundamentals to arrive at indications of value

33. Valuation Process 33 Asset Approach Adjusted Net Asset Value Method All subject company assets are appraised using appropriate appraisal methods and accumulated to arrive at the fair market value of all assets of the subject company The value of all liabilities is estimated and subtracted from the fair market value of total assets to arrive at the adjusted net asset value of the subject company Generally not used for ESOP valuations

34. Valuation Process 34 Valuation Reconciliation Identify and determine causes for variances in indications of value determined from each method Determine appropriate weightings for indications of value Based on the quantity and quality of data employed in each method Add/Deduct – non-operating assets/liabilities, value of SARS and/or warrants, repurchase liability, etc.

35. Valuation Process 35 Valuation Reconciliation Apply appropriate discount for lack of marketability Usually minor (5%-10%) because of put right associated with ESOP shares Magnitude may be based on subject company’s financial ability to repurchase shares subject to the put right Compare current year key assumptions and valuation conclusion to those of prior years and reconcile differences

36. Valuation Process 36 Share draft valuation conclusion with trustee Solicit comments and questions Make necessary adjustments to analysis

37. Valuation Process 37 Valuation Report Components of the Valuation Report Description of purpose and objective of assignment Standard of value – Fair market value Premise of value – going concern Economic analysis Industry analysis Company description Financial statement analysis Description of valuation procedures and conclusions from each valuation method employed Valuation adjustments Valuation Synthesis and conclusion

38. Valuation Process 38 Valuation Report Submit draft report to trustee for review Presentation of draft to trustee Make necessary adjustments and finalize report

39. Valuation Process Concluding Thoughts The ESOP valuation process should be very interactive with the valuation firm, company management and the trustee all working together to test the reasonableness of assumptions and valuation conclusions Any changes in the valuation from one year to the next must be explained Management must take the time to thoroughly understand the ESOP valuation 39

40. VALUATION PROCESSHow to review a valuation report Marshall Bartlett, Independence Trust 40

41. Valuation Process 41 What to look for “and do” when reviewing the valuation report Overall Process Help valuation firm retrieve information to perform valuation. Review draft valuation report. Highlight parts of report that are confusing or need explanation. Prepare questions to discuss with appraiser. Provide feedback to valuation firm. Ensure answers are understandable and acceptable. Finalize valuation report with valuation firm (repeat items above as necessary)

42. Valuation Process 42 General items to look for Date of valuation Length and depth of the report Are all appropriate sections included? Is a fairness opinion included? Overall value, number of shares, and price per share Does the report include company financial reports (Balance Sheet, Income Statement) Which valuation methods were reviewed (income, market, and asset approaches)?  If some were not done, why?

43. Valuation Process 43 Points of interest in discussing with appraiser What changed the value from previous years? Exhibits. What weight was given to each approach? Why? Financial projections. Company specific risk in WACC (build up method). Why was this risk chosen? Marketability discount. Why? Control premium. Why? Debt analysis and Repurchase Obligation.

44. Valuation Process 44 Documentation Chronology memo. (annual valuation versus transactions) Questions asked of valuation firm. Answers provided by valuation firm. File with final valuation report.

45. Questions & Answers