Over the years, we have had the opportunity to read many Buy-Sell Agreements.
Virtually all of the Agreements have three things in common:
a. They are generally written under the implicit assumption that the other
guy is going to die first
b. The valuation procedures are unclear, unworkable or grossly unfair to at
least one of the parties
c. The mandated periodic valuations by the shareholders are rarely kept
current
In my capacity as a business appraiser and business broker, I have discussed
the valuation problem inherent in Buy-Sell Agreements with numerous attorneys.
The following business issues and suggestions may be helpful, when you are
called upon to prepare a Buy-Sell Agreement for your company or a client.
A Buy/Sell Agreement should cover the four D's of Shareholder/Partner
involvement which are:
1. Death (who wants to deal with the spouse or family)
2. Divorce (Do you want the spouse as a partner?)
3. Disability (What happens when a Partner/Shareholder can no longer work for
an extended period of time.
4. Dissolution (What to do when a Partner/Shareholder wants out).
The valuation results may vary greatly depending upon the use of the
appraisal. Furthermore, the standard of value to be used when valuing less than
100% contract becomes an important issue. Are minority ownership interests to be
valued based on Fair Market Value (which may require a large discount from
company value) or Fair Value (usually meaning pro rata of company value)? These
issues should be spelled out in the Agreement.
The company should consider paying for Key Man Insurance to insure that the
funds will be available to buy out a departing Partners/Shareholders. The
mandate for the Key Man Insurance and procedures for determining value should be
included in the Agreement.
Determining the market value of a company and/or a partial ownership interest
is an important element of any Buy-Sell Agreement. Many agreements use Book
Value as a basis of valuation, while others use a formula or "Rule Of Thumb"
method. Book Value may be representative of the company's tax basis in its
tangible assets, but it is rarely representative of the company's Fair Market
Value. One or more of the parties to a Buy/Sell agreement is bound to be treated
unfairly when Book Value or a fixed formula method is used to determine value.
Formulas and "Rules Of Thumb" methods are usually mathematical computations
that often do not take into consideration the unique aspects of the subject
company. These methods do not specify the procedures to be used in the
computation nor fully state which assets are being included or excluded.
A few of the agreements we have read state that the company's accountant
should conduct the appraisal. This presents a major conflict of interest for the
company's account, who will have difficulty being independent when required to
represent all parties. Furthermore, the accountant may not be trained or
qualified to conduct the appraisal, which would likely result in a faulty value.
Left to chance, the courts are likely to rule on the strict interpretation of
the agreement, regardless as to the fairness for the parties. Some agreements
call for each side to a dispute to hire an appraiser and if they can not agree,
then a third appraiser is hired to either do another appraisal or render a
decision after having reviewed the first two appraisals. The cost of hiring 2 to
3 appraisers can be very expensive. There are better methods of determining
value.
Several of the attorneys we have met are solving these valuation issues by
putting a provision in the Buy/Sell agreement that a qualified independent
business appraiser shall be hired by the respective parties to determine value.
A provision in the Buy/Sell agreement can set out a procedure wherein the
parties agree to hire an independent qualified business appraiser having
specified appraisal qualifications. The following language is for concept only
and should be rewritten by counsel to insure compliance with applicable laws and
procedures, as well as the intent of the Partners/Shareholders.
Valuation Procedures
Upon the occurrence of an event requiring a determination of value under this
Agreement, the Partners/Shareholders agree to engaged an independent business
appraiser to provide an opinion of the value utilizing standards of value
specified herein on a (minority interest) (controlling interest) (enterprise)
basis as of the date specified in the agreement. In preparing its valuation
opinion, the appraiser will be provided with such access to the books and
records of the Company and its management as is customary in appraisals of this
type in the course of due diligence procedures. The valuation conclusion of the
appraiser will be binding upon the Partners/Shareholders individually, as well
as upon their estates and beneficiaries, and the Company (if it is a party to
the Agreement).
Said appraiser must be acceptable to all parties concerned and have senior
designations from one or more major national business appraisal organizations,
such as the American Society of Appraisers and the Institute of Business
Appraisers). The normal and customary fees and expenses for an appraisal shall
be split equally between the involved parties.
It has been our experience that the procedures stated above are far less
expensive and results in less litigation than most other procedures for
determining value. When the need arises, contact a business appraiser who meets
the above criteria.
