| p>Buy-sell agreements exist in many, if not most, | | | | provide valuation opinions. If the values are within |
| closely held businesses having substantial size and/or | | | | 10% or 15% or 20% (pick-a-percent), the price for |
| value. And they exist between corporate joint | | | | the buy-sell agreement will be the average of the |
| venture partners in many thousands of enterprises. | | | | two. If they are more than pick-a-percent apart, the |
| Buy-sell agreements are agreements by and between | | | | price will be determined by the average of the third |
| the shareholders (or equity partners of whatever | | | | appraiser's value and that of the one closest to him |
| legal description) of a privately owned business and, | | | | or her. |
| perhaps, the business itself. They establish the | | | | 2. The buying party shall retain one independent |
| mechanism for the purchase of stock following the | | | | appraiser and the selling party a second. They do not |
| death (or other adverse changes) of one of the | | | | provide appraisals. Rather, it is their job to mutually |
| owners. In the case of corporate joint ventures, | | | | select a third appraiser. Having been one of the |
| they also establish the value for break-ups or for | | | | original two appraisers in several situations, I can tell |
| circumstances calling for one corporate venture | | | | you that this is not as easy as you might think! This |
| partner to buy out the other partner. Buy-sell | | | | third appraiser will provide a valuation of the business |
| agreements (or put agreements in some cases) are | | | | (or interest). The third appraiser's conclusion is the |
| more important than most business owners, | | | | agreed upon transaction value. If you are the third |
| shareholders and boards of directors realize. I've | | | | appraiser, that's an awesome responsibility, one that |
| often said that buy-sell agreements are written under | | | | I've undertaken on several occasions. |
| the assumption that the other partner is going to die | | | | 3. The buying party shall retain one independent |
| first - and one of the partners is right! Seeing two | | | | appraiser and the selling party a second. Both will |
| different agreements recently put the topic at the | | | | provide valuation conclusions which, if close enough |
| top of my mind and triggered a couple of memories, | | | | together (pick-a-percent), will be averaged. If the |
| as well. | | | | conclusions are more than pick-a-percent apart, the |
| Never Updated | | | | original two appraisers shall select a third appraiser. |
| The other day I reviewed a buy-sell agreement that | | | | Again, this is not as easy as one might think. The |
| was perfectly fine on the day it was signed by a | | | | third appraiser must then pick one of the two |
| company's two major shareholders - more than ten | | | | appraisals as the more correct valuation, and that will |
| years ago. The agreement states that the parties will | | | | be the transaction price. That's pretty dicey, too, and |
| reset the value each year. Since then, the company | | | | I've done it. |
| has more than tripled in size and value. However, the | | | | And there are probably other variations on this |
| valuation in the buy-sell when it was signed remains in | | | | theme. |
| effect today because it was never updated. This | | | | The Bottom Line |
| creates no significant problems - unless something | | | | You probably don't spend much time at night thinking |
| adverse happens to one of the shareholders. In that | | | | about your (or your clients') buy-sell agreement(s). |
| case, one shareholder would benefit from a bargain | | | | Take my word for it, you shouldn't. You should be |
| purchase price and the other's family would suffer a | | | | thinking about your buy-sell agreement now, in the |
| true economic loss. With this item now in the open, | | | | light of day, and working to get a clear agreement |
| those shareholders are working to update the | | | | that works for you and your fellow shareholders or |
| document as rapidly as possible. | | | | partners. I never practice law, because to do so |
| Formula Pricing | | | | requires a license. So I don't have any legal opinions. I |
| Many business owners want to create a formula to | | | | prefer to think of them as business opinions. |
| establish the pricing if a buy-sell agreement is | | | | |
| triggered. And quite a few agreements have them, | | | | 1. If you are a business owner or shareholder and |
| usually with disastrous long-term results. However, | | | | your buy-sell agreement has not been updated within |
| this is not uncommon because formulas provide an | | | | the last year (or if you don't understand it if it has), |
| (apparently) inexpensive alternative to hiring a | | | | run, don't walk, to your corporate attorney to talk |
| business appraiser. Almost anyone can put a few | | | | through these issues. If you or your attorneys don't |
| numbers into a formula, whether it calls for book | | | | understand the valuation nuances of your buy-sell |
| value at the preceding fiscal year-end or 4.5 times a | | | | agreement, don't hesitate to bring in a qualified |
| 3-4-5 year (pick one) average EBITDA - less debt, of | | | | business appraiser to read the agreement from a |
| course. (I've actually seen the exclusion of debt to | | | | valuation perspective and to tell you what he or she |
| determine equity value omitted as part of the | | | | thinks it means - or if there is legitimate room for |
| formula!) The questions is, will formula results be fair | | | | misunderstanding between appraisers. Find out what |
| for all sides in all circumstances? I won't prove it here | | | | needs to be done, make the necessary decisions, |
| by boring you with multiple examples, but no rigid | | | | and fix the document. It will never be easier than |
| formula can realistically determine the value of a | | | | right now. |
| business over time with changing company, industry, | | | | 2. If you are a trusted adviser to a business owner |
| and economic conditions. That's why many buy-sell | | | | or significant shareholder, I would suggest making |
| agreements use an appraisal process. | | | | contact for the explicit purpose of discussing the |
| Three Appraisers | | | | buy-sell agreement and subjecting it to formal review |
| As mentioned above, I reviewed two buy-sell | | | | and/or revision. |
| agreements recently. The second agreement | | | | 3. If you are an executive or director of a large |
| involved the use of what I call "one-two-three | | | | company with multiple joint ventures involving |
| appraisers, rock!" The drafters of this type of | | | | substantial resources, you can bring great value to |
| agreement seem to believe that if it is good to retain | | | | your company by requesting a review, from legal and |
| one appraiser to value a business, it is better to | | | | valuation viewpoints, of all existing agreements and |
| retain two, or even three. As an appraiser, I suppose | | | | or put arrangements with appraisal-type pricing |
| I should prefer this mechanism. After all, it increases | | | | mechanisms. |
| the odds of our firm being hired. While I don't know | | | | Remember this about buy-sell agreements - someone |
| the genesis of this, many agreements are written | | | | will buy and someone will sell. You just don't know |
| where the valuation mechanism involves multiple | | | | who that will be when you sign the agreement. Your |
| appraisal firms. Variations go like this: | | | | agreement needs to work for you and your family |
| | | | whether you are the buyer or seller. And it needs to |
| 1. The buying party shall retain one independent | | | | work for your partner(s) and their families (or their |
| appraiser, and the selling party another. They will both | | | | shareholders) whether they are the buyers or sellers. |