SecProbe.io

CORRESP
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filename1.htm

  DLA
  Piper Rudnick Gray Cary US LLP

  1200 Nineteenth Street, N.W.

  Washington, D.C. 20036-2412

  T 202.861.3900

  F 202.223.2085

  W www.dlapiper.com

  Nancy A. Spangler

  nancy.spangler@dlapiper.com

  T 703.773.4021  F
  703.773.5021

August
1, 2005

VIA EDGAR
AND HAND DELIVERY

United States Securities
and Exchange Commission

450 Fifth Street, N.W.

Judiciary Plaza

Washington, D.C.  20549-0305

Attn:  Larry Spirgel, Assistant Director

Re:                               Eschelon
Telecom, Inc.

Amendment No. 4 to Form S-1

Filed July 20, 2005

File No. 333-124703

Dear Mr. Spirgel:

This letter is submitted
on behalf of Eschelon Telecom, Inc. (“Eschelon”
or the “Company”) in response to the
comments set forth in your letter to Richard A. Smith, President and Chief
Executive Officer, dated July 29, 2005, regarding Amendment No. 4 to the
Company’s Registration Statement on Form S-1 (File No. 333-124703).

Our
responses to the Staff’s comments are set forth below.  In light of the Staff’s comments and in
response to the Company’s conversations with the Staff, the Company has
reconsidered its prior determinations using a variety of methods, including the
income approach, and reassessed the value of its common stock for purposes of
the April option grants (the “April 2005 Grants”)
on the basis set forth below.

Income
Approach.  In response to the Staff’s correspondence and
conversations with the Staff, the Company has considered the results of a
valuation of the common stock using the income approach.  As more fully described in the AICPA Practice
Aid titled “Valuation of Privately Held Company Equity
Securities Issued as Compensation” cited in our prior responses, the
income approach obtains its conceptual support from its basic assumption that
value emanates from expectations of future income and cash flows.  The income approach simulates, in the absence of observable market transactions
(emphasis added), how market participants would formulate their decisions
to buy or sell securities.  The income

Serving clients globally

approach seeks to convert future economic benefits into a present value and is
in accordance with the FASB’s Conceptual Framework, as well as finance
literature that attributes value to the rational expectation of future economic
benefits.  According to the AICPA, the
method most commonly used to apply the income approach to value a minority
interest in privately issued securities is the discounted cash flow (“DCF”)
method.

The
Company has performed a DCF calculation using its internal five year free cash
flow forecast, which resulted in a price per share for the April 2005 Grants of
$18.84 per share.  Given that the income
approach to valuation yields a price in excess of the expected range for the
Company’s public offering, the Company believes that this valuation result must
be viewed as having very limited utility.
Indeed, the AICPA notes that the income approach is intended to simulate
value in the absence of observable market transactions.  The Company’s public offering is perhaps the
ultimate example of a market transaction.

Company’s Historical Approach.  For the reasons set forth
below in response to the Staff’s comments and as more particularly described in
our prior responses to the Staff’s several letters, while the Company believes
that its process for determining the fair value of its common stock at the time
of the April 2005 Grants has merit, in response to the Staff’s comments, the
Company reassessed the appropriateness of the 40% to 50% discount for lack of
marketability used by Apex in its analysis.
Applying a 15% to 25% discount for lack of marketability (which the
Company believes to be a conservative discount and consistent with the discount
historically accepted by the Staff in similar circumstances) to the valuation
in the March 2, 2005 Lehman presentation cited in the Staff’s letter, the value
of the common stock in April 2005 would have been $14.75 to $16.85 per share,
with a mid-point of $15.80 per share.
The Company views this approach with skepticism as it results in a
valuation for the April 2005 Grants which is well within the expected offering
range established three months later and is only twenty cents less than the
mid-point of the offering range, representing a discount for lack of
marketability of less than 1%.

Proposed Compensation Charge.  Based upon its analysis of the foregoing, and
the shortcomings inherent in each, the Company has reconsidered its prior
determinations and reassessed the value of its common stock for purposes of the
April 2005 Grants using the expected range of the common stock in the public
offering.  The Company does not believe
it appropriate, however, to use a fair value per share for option grants made
in April that is based upon an expected public offering range (1) determined in
July and (2) that by definition assumes the existence of a public market (i.e.,
the range is only relevant for successful offerings).  The Company believes that a discount of 15%
to 25% should be applied for the reasons set forth in response to Comment No. 4(a)
below among others, which results in an average of $12.80 per share.

Accordingly,
with respect to the April 1, 2005 grants, the Company will record a $10.09 per
share compensation expense and with respect to the April 29, 2005 grants, the Company will record a $6.03 per share
compensation expense.  This results in an
aggregate

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compensation expense of $2,078,650 which will be recognized over
the applicable two or four year vesting period.

Once we
have received the concurrence of the Staff with using this approach, the
Company intends to file Amendment No. 5 to the Registration Statement to
reflect the updated disclosure.

While we have set forth
responses to the Staff’s comments below, the Company believes that its use of
the foregoing method to determine the fair value of its common stock as of
April 1 and April 29, 2005 and commensurate compensation expense, will resolve
the Staff’s underlying concerns raised by such comments.

Certain responses set
forth below reflect discussions between Eschelon representatives, its
independent auditors and legal counsel, and representatives of the underwriters
and their legal counsel.  However,
Eschelon has reviewed and approved all of the responses set forth below.  The supplemental information referred to in
this letter will be forwarded separately to Ms. Kathryn Jacobson at the
SEC.  For your convenience, we have set
forth below each of your numbered comments, followed by the response of
Eschelon.

Notes to Consolidated
Financial Statements

8. Capital Stock, page
F-24

1.                                      Please
provide additional information as to how you objectively determined the 40% to
50% marketability discount, given that the options were issued one week prior
to the filing of the Form S-1 and approximately two months after the Lehman
Brothers IPO study was provided.  In this
regard, we note the valuation report indicates that this marketability discount
was based on various pre-IPO pricing studies comparing the price of the common
stock transactions prior to the IPO and the price immediately following the
public offering.  Were the companies
included within the study comparable to Eschelon’s circumstances, such that the
Form S-1 for the initial public offering of equity securities was filed one
week after the options were issued?  Did
your analysis consider the average time period between the filing date of the
original Form S-1 for an initial public offering of common stock and the date
that the equity securities begin trading, as well as the percentage of initial
public offerings of equity securities which are ultimately never completed?

Eschelon
Response:  The Company understands from a telephone conversation with
the Staff that this comment relates specifically to the determination of fair
value of the Company’s common stock on April 1 and April 29, 2005.  As set forth in the Company’s
prior responses, in determining the fair value of the common stock at the time
of those grants, the Company relied upon a variety of factors, including at the
time, a valuation analysis prepared by Apex Financial Services, Inc. (“Apex”) as of December 31, 2004 that

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was delivered to the Company in March 2005 (the “December
Report”).  On June 17, 2005,
Apex delivered a subsequent valuation analysis as of April 29, 2005 (the “April Report”).

The
Board relied upon the expertise of Apex and its own experience to arrive at a
fair value for the common stock that it believed to be reasonable.  The Board
did not specifically study the underlying reports and studies referenced in the
Apex reports with respect to lack of marketability.

The
process of determining the value of the stock of a company which is not yet
public is necessarily complex and subjective, lending itself to hindsight
analysis based upon subsequent events.
We are advised that the Board, at the time of the relevant issuances,
made its best judgment of the value of the Company’s common stock.  Subsequent to the grant dates, as set forth
in the Company’s prior response letter, the Board retrospectively assessed its
fair value determination.  At that point,
the Board had received the April Report, reassessed fair value and with respect
to the April 29, 2005 grant recorded a compensation charge based upon the
mid-point of the range of the valuation set forth in the April Report.

2.                                      Please
provide copies of the March 2, 2005 Lehman Brothers
pre-IPO valuation analysis since this document serves as one of the primary
reports considered in developing the market value as of April 29,
2005.  We note that it was based upon a
discounted cash flow analysis and a comparative earnings multiple analysis.

Eschelon Response:  The March 2, 2005 Lehman Brothers pre-IPO
presentation has been supplementally provided to the Staff.

3.                                      Please
provide additional insight into how the discount for lack of control (DLOC) was
developed.  More specifically, the
valuation report indicates that the discount for lack of control was developed
based on control premiums paid for control of similar telecommunications firms
and various Eschelon-specific factors.
Please tell us the following:

a.                                      Tell
us why you believe it is appropriate to take the inverse of a control premium
and call it a lack of control discount for the purpose of valuing your common
stock.

Eschelon Response:  As set forth in the
response to Comment No. 1, these determinations were made by Apex, not by the
Board.  In reviewing the Apex reports,
the Company believes that because empirical evidence with respect to the value
of a minority interest is not readily available but the value attributable to a
controlling interest is, using the inverse of a control premium is a logical
proxy for such value.  The control
premiums analyzed by Apex included control premiums paid for companies in the
telecommunications industry.

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b.                                      Tell
us what Eschelon-specific factors that you considered in concluding that a
25%-33% discount for lack of control was appropriate.

Eschelon Response:  The 25-33% discount is the result of the
mathematical formula of the inverse of a control premium:

Discount for lack of control =
Control Premium/(1+ Control Premium)

With Control Premium = 30 to 50%.

With respect to Eschelon in
particular, over 88% of the Company’s voting power is controlled by its private
equity investors.  Under Delaware law,
this voting power gives these private equity investors control over all actions
taken by stockholders and the right to elect a majority of the Company’s board
of directors.

c.                                       Tell
us how you concluded that the “transactions of controlling business interests
in the acquisition market” on which the DLOC was based were conducted by
“similar telecommunications firms” (in relation to Eschelon).

Eschelon Response:  The Board relied upon the representations
made by Apex with respect to the specific SIC codes (4813 and 4899) of the
companies involved in such transactions.
The Board did not make an independent study of such transactions.

4.                                      Please
provide the following additional information regarding the correlation of value
indications:

a.                                      Tell
us how management concluded that there was only a 50% probability that Eschelon
would conduct an IPO within the year.  In
this regard, we note that one week later, the Form S-1 for the initial public
offering of common stock was filed.  It
appears Echelon would have been more aware that this document was nearly
complete and would likely be filed within the next week.

Eschelon Response:  In making this
determination, the Board relied upon the experience of its Board members and
advisors.  While the filing of a Form S-1
is a critical milestone in the road to successfully consummating a public
offering, it is by no means a guarantee of success given the vagaries of
industry conditions, stock markets and the uncertainties of the offering
process.  We note in this regard that the Company previously attempted an initial
public offering of its common stock at a time when it was thought that the
markets would support it, but ultimately was forced to abandon the offering due
to external market conditions.  Also,
in the course of the preparation of the registration statement, the Company was
not certain as to when it would make its initial filing.  There were a variety of factors that went
into the timing and only a day or so prior to the filing did the Company and
the underwriters determine to actually file the document.  Further, in April, it was

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unclear given the status of the market whether the Company would be able to
engage in its roadshow in July or whether it would be necessary to postpone
until the fall.  Finally, given the volatility of the markets
and the impact that world events can have on them, there will continue to be
uncertainty with respect to the proposed offering unless and until it is
consummated.

b.                                      Given
the significant disparity in the IPO-Based Valuation and the Series B
Transaction-Based Valuation, tell us why you believe it is appropriate to
weight each of the valuations equally in determining the fair value of the
common stock.  What type of analysis did
you perform to understand the cause of the significant difference in value
between each of the two valuations?
Additionally, we generally do not believe that an underwriter’s estimate
of the ultimate IPO price is a reasonable estimate of fair value due to the
significant estimates and assumptions made very early on in the IPO process and
usually prior to a completion of all due diligence.  In light of this, tell us why you believe it
was appropriate to weight this valuation at 50%.

Eschelon Response:  The Company did not engage in a detailed
analysis to arrive at this conclusion but rather made a reasonable estimate of
the likelihood of an IPO as set forth in the response to Comment 4a.  The Company does not believe that there are
empirical data to rely upon that would result in a more exact weighting.

c.                                       Tell
is why the amounts under “Correlated Value Indications” section of the
valuation report for the Series B Transactions-Based Valuation appear to have
the indicated values backwards from the high end of the range to the low end of
the range.

Eschelon Response:  We have been unable to determine the reasons
Apex used this approach or if perhaps the report contains a typographical error
which was unnoticed prior to the Staff’s comment.  We note, however, that even if you reverse
the order of the indicated values, it still yields a resu