Control vs. Minority Interests and Marketability Discounts for ESOPs

1. Control vs. Minority Interests and Marketability Discountsfor ESOPs Ohio Employee Ownership Center Akron/Fairlawn Hilton Fairlawn, Ohio April 16, 2004 Richard A. Schlueter

2. COMSTOCK VALUATION ADVISORS Levels of Value

3. COMSTOCK VALUATION ADVISORS Characteristics of Control

4. COMSTOCK VALUATION ADVISORS Size of the block of stock 100% - Absolute control 80% - Consolidation for tax purposes 50%/50% - No Control but veto power Large minority - Effective control Large minority - No control Swing Vote Small minority Factors Impacting Control/Minority Interest Discounts

5. COMSTOCK VALUATION ADVISORS Company�s industry Nature/magnitude of discretionary expenses Quality of existing management Business opportunities not currently being exploited Potential synergies Cost savings Factors Impacting Control/MinorityInterest Discounts

6. COMSTOCK VALUATION ADVISORS How Control Premiums Relate toValuation Methodologies Market Approach Guideline Companies�������� Minority M & A Transactions��������.. Control Income Approach Discounted Cash Flow�������. Depends Capitalization of Income������. Depends Asset Approach Adjusted Net Assets��������. Control

7. COMSTOCK VALUATION ADVISORS Equity Control Premiums (Mergerstat Review)

8. COMSTOCK VALUATION ADVISORS When Can ESOP Pay a Control Price? DOL Proposed Regulations ESOP can only pay control price if it has control �in form and in substance.� ESOP purchases greater than 50 percent of the voting stock. A control premium can be paid to the extent that a willing buyer would pay a premium, although it may not be reasonable for an ESOP to pay a �strategic� control premium. ESOP initially buys a minority stake but also obtains an option for control. Proposed Regulations state that if there is a written, binding agreement that allows the ESOP to gain control in a reasonable period of time, a control price can be paid. Multi-step transactions ESOP already owns a large minority interest in the company that it acquired in one or a series of minority interest transactions. It then has the opportunity to purchase enough stock for the ESOP to gain control. Can the ESOP pay a control price in the second transaction?

9. COMSTOCK VALUATION ADVISORS Impact of Leveraged ESOP on Control Premiums Traditional Market Equity Approach

10. COMSTOCK VALUATION ADVISORS Impact of Leveraged ESOP on Control Premiums Market Capital Approach

11. COMSTOCK VALUATION ADVISORS Impact of Leveraged ESOP on Control Premiums Control premiums may be better measured on the basis of the firm�s capital value (including both debt and equity) in leveraged ESOP transactions. Alternatively, control premiums computed based upon the firm�s equity value may need to be adjusted to reflect the impact of adding debt to the firm�s capital structure.

12. COMSTOCK VALUATION ADVISORS Should an ESOP-Owned Company Pay a Premium to Acquire Another Company? Control ESOP Example

13. COMSTOCK VALUATION ADVISORS Should an ESOP-Owned Company Pay a Premium to Acquire Another Company? Minority ESOP Example

14. COMSTOCK VALUATION ADVISORS Should an ESOP-Owned Company Pay a Premium to Acquire Another Company? If the ESOP owns control and acquisition is made at fair market value on a controlling interest basis and the ESOP is being valued on a controlling interest basis, then share value should not be dilutive to the ESOP. If the ESOP owns a minority interest or owns a controlling interest but is being valued on a minority interest basis, the value after the transaction could be dilutive to the ESOP unless the control premium can be rationalized on the basis of cash flow enhancements.

15. COMSTOCK VALUATION ADVISORS Marketability The ability to convert an asset to cash at minimal cost. Discount for Lack of Marketability An amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability. Empirical Data Restricted stock studies Pre-IPO studies Discount for Lack of Marketability

16. COMSTOCK VALUATION ADVISORS Factors Affecting the Discount for Lack of Marketability

17. COMSTOCK VALUATION ADVISORS Summary of Restricted Stock Studies

18. COMSTOCK VALUATION ADVISORS Robert W. Baird Pre-IPO Studies

19. COMSTOCK VALUATION ADVISORS Marketability Discount Public companies do not suffer discounts for lack of marketability as they may be readily converted into cash. Some public companies that have limited trading activity may be subject to a blockage discount if the block of stock owned by the ESOP is large enough to have an adverse impact on the stock price if sold in the open market within a short period of time.

20. COMSTOCK VALUATION ADVISORS ESOP Specific Marketability Issues Level of control by ESOP (Controlling vs. Minority Interest) ESOPs can gain liquidity in one of two ways: A sale of all of its stock as is often observed in M & A transactions. Participant can put shares back to company upon termination. Studies on marketability discounts have limited use in the context of ESOP valuations because the participants� put right under ERISA creates a market for the stock. DOL Proposed Regulations requires consideration of: Extent to which put rights are enforceable Ability of company to meet repurchase obligation Other factors to consider: Past practices in repurchases by the company Form and timing of payments

21. COMSTOCK VALUATION ADVISORS ESOP Marketability Discounts Discounts for controlling interest ESOPs are typically zero to 10 percent. Discounts for minority interest ESOPs are more often found to be greater than zero but are typically in the range of zero to 15 percent. Occasionally we have observed discounts greater than 15 percent for minority interest ESOPs.