Is Revenue Ruling 59-60 “Good Enough” for ESOP Appraisers?

Key Takeaway:

Revenue Ruling 59-60 remains a fundamental guideline in ESOP valuations, but it’s not enough on its own. ESOPs require a broader, more rigorous valuation process that aligns with Department of Labor (DOL) expectations and withstands legal scrutiny. At PCE, we integrate RR 59-60 within a comprehensive framework that meets today’s fiduciary standards.

The Foundation: What Is Revenue Ruling 59-60?

Issued in 1959 by the IRS, Revenue Ruling 59-60 (RR 59-60) provides general guidance on valuing closely held businesses for estate and gift tax purposes. It outlines eight factors that should be considered when determining the fair market value of private company stock:

1. The nature and history of the business
2. The general economic outlook and the specific outlook for the industry
3. The book value and financial condition of the business
4. The earning capacity of the business
5. The dividend-paying capacity
6. The presence of goodwill or other intangibles
7. Past sales of company stock and the size of the block being valued
8. Market prices of publicly traded comparable companies 

These principles provide a solid baseline for valuing a private company. However, additional factors need to be considered when the valuation is used for an Employee Stock Ownership Plan (ESOP).

Why RR 59-60 Is Not Enough for ESOP Valuations

While RR 59-60 is still referenced in nearly every ESOP valuation, it was never designed for this purpose. ESOPs are governed by a different regulatory framework under ERISA (the Employee Retirement Income Security Act of 1974). This means the valuation must not only be technically sound, but also defensible in the event of an audit, legal challenge, or DOL investigation.

Key reasons why RR 59-60 falls short for ESOPs

• It does not account for the adequate consideration provisions of the law: Under ERISA, ESOP trustees have a legal duty to ensure the stock is purchased at no more than fair market value, based on a prudent and documented process which their financial advisor should support.
• It doesn’t adequately address capital structure complexity, or the best way to treat repurchase obligations and/or the ESOP’s put option feature — both common in ESOP work.
• It fails to reflect guidance from the “settlement agreements.” The settlement agreements offered important valuation and financial analysis guidance to trustees and their appraisers. This guidance goes beyond what is mentioned in RR 59-60.
• It is not sufficient in court. Legal precedents (e.g., Donovan v. Cunningham) show that trustees must go beyond basic valuation theory and validate the reliability of financial forecasts, methodologies used, and comparables selected.

Common Valuation Methods and Adjustments Used in ESOP Transactions

In addition to RR 59-60, ESOP appraisers often rely on multiple valuation methods and/or adjustments to reach fair market value:

• Discounted Cash Flow (DCF) method
• Guideline Public Company method
• Guideline Transaction method
• Adjustments for control versus minority interests
• Marketability discounts

Applying these methods and/or adjustments provides a more nuanced and defensible valuation for ESOP trustees and fiduciaries.

While ESOP valuations have unique fiduciary requirements, M&A-based valuations (like purchase price allocation requirements under ASC 805) also offer insight into how appraisers assess fair value in transaction settings.

Frequently Asked Questions

1. Is Revenue Ruling 59-60 helpful guidance in the context of ESOP valuations?
   Yes. RR 59-60 provides the valuation framework accepted by the IRS and is used in virtually all ESOP valuations. However, it should be viewed as a starting point — not the full picture.
2. Can RR 59-60 handle the complexities of ESOP capital structures?
   Not fully. ESOPs often involve phantom stock, stock appreciation rights, seller notes, warrants, and repurchase liabilities. RR 59-60 does not explicitly address these elements, which are critical to determining the true economic value of the ESOP’s stock.
3. How often must an ESOP company be valued?
   ESOP-owned companies must be valued at least annually, or more frequently if certain circumstances occur. 
4. What is the difference between a valuation for 409A purposes and ESOP valuation?
   A 409A valuation supports the fair market value of common stock so that stock options strike prices are reasonable and this is typically for tax purposes. An ESOP valuation supports the fair market value of shares purchased by an ESOP and must meet fiduciary standards under ERISA.

How does PCE’s deep expertise enhance our ESOP transaction advisory work?

We integrate RR 59-60 with best practices from our M&A experts. PCE’s internal fairness opinion committee includes investment bankers and valuation experts who understand deal dynamics from both sides of the table. We have real-world experience closing hundreds y M&A deals. This enables us to provide better insight into seller representations, warranties, and indemnification clauses that protect the purchaser, including the ESOP.

Final Thought

Revenue Ruling 59-60 still matters, but it’s not a one-size-fits-all solution for ESOP valuations. At PCE, we’ve helped hundreds of companies structure ESOP Transactions and also helped trustees appraise hundreds of ESOP formations. When starting your next ESOP Transaction, call us - our experience will allow you to navigate the process with confidence.

For a deeper understanding of what internal trustees should know when overseeing the valuation process, download our guide for internal trustees on ESOP valuations.

Daniel Cooper

Daniel Cooper is a Managing Director at PCE and plays a key role in the firm’s valuation practice. He specializes in ESOP valuations and estate planning, advising clients across industries on financial reporting, tax, and transaction-related valuation matters.

Read Daniel's Full Bio