Important Considerations for Buy-Sell Agreements

By: Chad Flanagan

Your client's business may be the most significant financial asset they own. However, some business owners either don't have a buy-sell agreement, or have one that simply won't work as the shareholders intended or expected; these agreements could be referred to as "ticking time bombs!" As trusted business advisors, our goal is to assist your client in increasing and realizing the value of that asset.

The first factor to consider is what triggering events are covered under the buy-sell agreement. Most agreements include provisions for death, voluntary/involuntary termination and retirement. Consider other events that may occur including divorce, shareholder bankruptcy or disability.

We often find that agreements are not current or funded, and have a price determination that isn't fair or workable. Those situations can result in protracted litigation and, sometimes, the demise of the business. Consulting a valuation professional can help ensure that the pricing provision is fair and clear.

A few important considerations include: 

• Approach to Pricing: The agreement should define the approach to be used for price determination in the event of a transaction. Options include an independent appraisal, valuation formulas such as earnings or revenue multiples, and negotiated pricing. Any agreement that dictates negotiated pricing should contain a provision for independent appraisal in the event that the parties cannot agree.
• Defining Terminology: Avoid vague terms such as "value." Specific terms such as fair market value, fair value, book value, investment value, or some other valuation standard should be used.  
• Level of Value: Ownership interests can be valued as controlling or noncontrolling as well as marketable or non-marketable. If the agreement specifies that the interest should be based on fair market value, a minority interest will likely be subject to discounts for lack of control and marketability rather than on a pro rata basis of the value of the business as a whole. The agreement should outline the application of discounts, or non-application, explicitly. 
• Valuation Date: As the value of a business can vary substantially relatively quickly, it is important that the date of value is expressed in the agreement, whether it is the end of the last fiscal year or some sort of triggering event. 

Buy-sell agreements can be one of the most important documents to prepare for turnover in your client's shareholder group. Consider the importance of the funding, pricing and triggering events as you work with your clients to prepare or update these documents.

For more information, please contact Chad Flanagan.