Many business owners are aware that buy-sell agreements are agreements by and between shareholders and sometimes the company itself. One purpose of a buy-sell agreement is to establish the procedures by which the stock of one owner may be purchased by another or by the company following death or other adverse conditions (a triggering event). Triggering events could include owner death, shareholder dispute or an owner wanting out of the business.
However, a periodic review of buy-sell agreements is often more important than most business owners realize. When the procedures established are not understood it can result in an unforeseen and unintended transaction price. Don’t underestimate the time and money that can be lost by not reviewing your buy-sell agreement periodically. A routine review of the agreement can help business owners ensure their document takes into account dynamic changes in personal circumstances or changes in the business itself.
Ask yourself these questions: What transaction price (value) would result from triggering your buy-sell agreement? How would the procedures outlined in the agreement be interpreted and applied?
The procedures in a buy-sell agreement to establish value or the transaction price can usually be placed in one of three categories:
• Fixed price. The price is fixed in the agreement typically with a clause that the price will be updated annually. Whether or not the price is updated, the last price established will be the one applied at a triggering event.
• Formula price. The formula is specified in the Agreement typically as a multiple of earnings or cash flow. As the company, industry and economy change and grow, the formula once representative of value may no longer be representative.
• Appraiser method. There are many varieties of the appraiser method calling for one, two or three appraisers. Typically the appraiser(s) is selected at the time of the triggering event. Whether the parties must select a mutually agreed-upon appraiser or each select their own appraiser, there can be a great deal of uncertainty regarding the appraisal process and the resulting work product.
Before triggering the buy-sell agreement, the parties to the agreement have similar interests in mind, including the ongoing operations of the business. Once a triggering event occurs, the parties to the agreement typically now have opposing interests in mind. The buying party wants the lowest price and the selling party the highest. The time to understand the procedures outlined in your buy-sell agreement is before a triggering event occurs. Before a triggering event, appropriate changes can be made to clarify the procedures and even revise the procedures to make sure they best reflect the intent of the parties.
If your buy-sell agreement stipulates that an appraisal will set the transaction price, interpretation of this provision is left to the appraiser. The appraiser could use a variety of different standards of value: fair market value, fair value, control marketable value, minority marketable, pro-rata share of control value, etc. Leaving the interpretation up to the appraiser could result in the pro-rata value of your interest being reduced by combined discounts of up to 40 percent! Don’t leave the interpretation to the appraiser. Have your buy-sell agreement reviewed today by an experienced business appraiser! IBI