A: When appraisers do a valuation, they are, among other things, trying to assess your future EBITDA, generally for the next five years. They will look both at your past five years and your forecast for the next five years and then decide which is the more reliable predictor. If they use prior earnings, it is usually because the company has had a fairly steady pattern from year to year. They generally prefer to do that because prior earnings are not just estimates. But in many companies, there is reason to think the next five years will be different. There may be new growth opportunities, new costs, market and competition changes, etc. In that case the appraisers would rely more on the forecast, but they will add a larger adjustment (often called the company risk factor) based on how uncertain the forecast is as opposed to using prior earnings.
It is a good idea to provide a stress-tested forecast. Tell the appraiser what your base case scenario is and then indicate a few other possible results if certain identified things happen and how likely they are to happen. Bottom-up forecasting can help get a more accurate number and get more buy-in to the forecast from more people. Appraisals necessarily involve uncertainty and appraisers are well aware of that, but the more you can help them understand the issues in your business, the more accurate the appraisal will be.
Appraisers will discount your future earnings expectations based on the “weighted average cost of capital.” This asks two questions:
These are then given a weight (such as 25% for debt and 75% for equity) that the appraiser thinks are the best fit for the company’s hypothetical cost of capital to finance its business from the perspective of a potential buyer. This number often ranges between 12% and 21%.
Say the rate is 20%. The investor is then saying (for the next year), the value of the projected $1 million in earnings is only $800,000. For the next year, the discount is compounded by the same rate because the farther out you go, the less certain things are. That means that by year five, the earnings for that year are heavily discounted. The sum total of all future discounted earnings is the enterprise value using the discounted cash flow approach to valuation.
A simple way to think about this is as follows: Say someone said you could purchase the rights to $1 million that would not be paid until 2029. You wouldn’t want to pay $1 million because you could be using that money now to make more money. How much you think you could make, plus how much having the money now is worth to you now just for other uses, is your own discount rate.
A: Guidance from the IRS’s Employee Plans Compliance Resolution System (EPCRS) had said that plan sponsors have to try to recoup inadvertent overpayments from participants, although they provided some leeway. Understandably, employers are often reluctant to do that. It is difficult to do and can create a lot of ill will that can come back to erode confidence in the ESOP or other retirement plan.
SECURE 2.0, passed in late 2022, changed this. The new law, which took effect immediately even though regulations have not yet been issued, states that employers do not have to seek recovery of overpayments and cannot seek them from the participant’s beneficiary, including a spouse, surviving spouse, or the participant’s estate. If a company does seek repayment, it cannot charge interest. It also cannot wait longer than three years. Unless the amounts overpaid are substantial, it probably does not make sense to go after them. If they are, and it seems important to try to get them back, be prepared for a difficult process.
Within the plan, you can and should restate the share value. You will need to create an effective, clear communication efforts to help people understand why the error happened and the consequences. If possible, you can and should make up the difference by contributing part or all the amount of the overpayment to employee accounts so that they are made at least more whole. Your trustee may even require this because the overpayment to former employees means the next valuation will be affected by the unproductive expenditure.
It would be prudent to bring together a summit of your attorney, plan administrator, appraiser, and trustee to discuss your options and understand their consequences.