1. Control vs. Minority Interests and Marketability Discounts for ESOPs Ohio Employee Ownership Center Akron/Fairlawn Hilton Fairlawn, Ohio April 16, 2004 Richard A. Schlueter C OM S TOCK V ALUATION A DVISORS  Newport on the Levee  1 Levee Way, Suite 3109  Newport, KY 41071  859-957-2300  C A V

2. C OM S TOCK V ALUATION A DVISORS Levels of Value Controlling Interest Value Buyer of a Company’s Equity or Control Equity Shareholder Non-Marketable Minority Interest Value Non-Controlling Shareholder of a Private Company Marketable Minority Interest Value Price Quoted in the Wall Street Journal Discount for Lack of Marketability Discount for Lack of Control Control Premium

3. C OM S TOCK V ALUATION A DVISORS Characteristics of Control  Change management or directors  Declare & pay dividends  Set operational and strategic policy  Acquire, lease or liquidate assets  Liquidate, dissolve, sell or recapitalize  Set compensation  Sell or acquire treasury shares  Do an IPO  Change the articles of incorporation/bylaws  Decide what products to offer  Decide what markets to enter  Select vendors, suppliers and subcontractors

4. C OM S TOCK V ALUATION A DVISORS  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. C OM S TOCK V ALUATION A DVISORS  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/Minority Interest Discounts

6. C OM S TOCK V ALUATION A DVISORS How Control Premiums Relate to Valuation 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. C OM S TOCK V ALUATION A DVISORS Equity Control Premiums (Mergerstat Review)

8. C OM S TOCK V ALUATION A DVISORS 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. C OM S TOCK V ALUATION A DVISORS Impact of Leveraged ESOP on Control Premiums Traditional Market Equity Approach

10. C OM S TOCK V ALUATION A DVISORS Impact of Leveraged ESOP on Control Premiums Market Capital Approach

11. C OM S TOCK V ALUATION A DVISORS 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. C OM S TOCK V ALUATION A DVISORS Should an ESOP-Owned Company Pay a Premium to Acquire Another Company? Control ESOP Example

13. C OM S TOCK V ALUATION A DVISORS Should an ESOP-Owned Company Pay a Premium to Acquire Another Company? Minority ESOP Example

14. C OM S TOCK V ALUATION A DVISORS 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. C OM S TOCK V ALUATION A DVISORS  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. C OM S TOCK V ALUATION A DVISORS Factors Affecting the Discount for Lack of Marketability  Dividends/Distributions  Potential Buyers  Size of Interest  Prospect of Sale/IPO  Access to Information  Restrictive Transfer Provisions  Put Rights  Built-in Capital Gains  Size of the Company  Redemption Policy  Company Management  Nature of the Business  Financial Condition of the Company

17. C OM S TOCK V ALUATION A DVISORS Summary of Restricted Stock Studies

18. C OM S TOCK V ALUATION A DVISORS Robert W. Baird Pre-IPO Studies

19. C OM S TOCK V ALUATION A DVISORS 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. C OM S TOCK V ALUATION A DVISORS 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. C OM S TOCK V ALUATION A DVISORS 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.