“The independent appraiser that issues a fairness opinion to the [ESOP] trustees must be familiar with how warrants work, has valued them, and has fully taken them into consideration when looking at the underlying transaction,” advises James G. Steiker, chairman and CEO of SES Advisors Inc. Steiker spoke at a recent ASA webinar, Demystifying Warrants: How & Why They Are Used in Leveraged ESOP Transactions.

“Warrants are being negotiated as extensively as purchase prices in many of these transactions,” he says. “It’s an important device and shouldn’t be treated as a side-kicker.” He also addressed several fiduciary issues and concerns surrounding ESOPs with warrants in their structures:

• Is “adequate consideration” fair, inclusive of warrant value?;
• Prudence;
• The magnitude of warrant exercise; other case obligations, including ESOP repurchase obligations (distributions);
• Reasonableness of dilution from warrants and other forms of synthetic equity;
• The need for “S” distributions in a less-than-100% ESOP;
• Has the company adequately analyzed 409(p)?; and
• Does warrant design protect S corp status?

Look for more commentary on ESOPs in 2014 in a future issue of the Business Valuation Update.