DETERMINING THE PRICE FOR A BUY-SELL AGREEMENT
Many business owners realize the importance of having buy-sell agreements in place for their closely held businesses, but few realize the problems that can arise if these agreements havenât been properly thought out. Failing to clearly define how the value is to be determined, and how often, can lead to disputes that may undo the benefit of having the agreement in place.
A buy-sell agreement is a powerful tool to help control the future of a business. By contractually determining what happens to the company stock after a triggering event, it can help avoid shareholder disputes and can also solve ownersâ estate planning problems.
But a poorly thought out buy-sell agreement may cause more problems than it solves. Let's take a look at some common issues often overlooked when drafting buy-sell agreements.
There is no single, surefire method of determining the price, nor is the price necessarily the same in all situations. But having a well thought out regularly updated valuation of the business is essential. Owners can set a price in a number of ways:
Many people like having a formula they can generally apply with some degree of certainty. While a formula has the advantage of being objective, it can pose difficulties because it may not capture the many subjective factors involved in arriving at a value. For example, how can upward or downward trends be considered in a formula based on a percentage of just one yearâs revenues? Is net income considered before or after taxes? Failing to look at these questions when you draft your agreement adds to the complexity and expense of applying the formula when the agreement is triggered.
Because so many issues cannot be captured by objective measures, many owners agree to use fair market value for the purchase price. Usually, they select one or more outside appraisers to find the company's fair market value. If you choose this route, address how you will select the appraiser(s) and how many you will engage. If you are using more than one appraisal and they disagree, which result will you use?
AGREEMENT BY PARTIES:
If feasible, given the situation and personalities involved, you may want to have everyone involved sit down periodically and agree to a value. You can use a formula or outside advisors to help determine a price, and the amount you agree on becomes the value used for the buy-sell agreement. But what if the last time everyone agreed to the value was six years ago? Since then, the business may have changed dramatically. You may want to include a stopgap measure that says, for instance, if the parties have not agreed to a value for 18 months or more, then the most recently determined value should be adjusted for the changes.
It would be wonderful if the future just took care of itself. But in the case of buy-sell agreements, the future depends on how you act today. Carefully crafting a buy-sell agreement for your business now will ensure that the future wonât pose problems you are not prepared to face.