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21 Oct

Buy-Sell Agreements and Business Valuations

Posted in Buy-Sell Agreements on 21.10.10

In my last post, you read about Chris Mercer‘s Buy-Sell Agreement triggers.  In this post, I want to highlight some different buy-out valuation mechanisms.

  1. Fixed price agreements –these type of agreements have a dollar amount for a buyout.  The actual price is stated in the agreement.
  2. Formula agreements –these type of agreement have a formula for determining value.  The formula can be as simple as stating the value is equal to book value on the day of the buyout or as complex as five times EBITDA plus cash and account receivable as of the last day of the month immediately before the buyout.
  3. Shotgun agreements – these type of agreements provide that the exiting shareholder offers the remaining shareholder(s) an offer to buy the shares and then the remaining shareholder(s) have the option to either choose to buy or sell his or her shares.
  4. Process agreements – agreement provides that an appraiser(s) determine the value of the interest at the time of the triggering event.

There are pros and cons to using each of the types of agreements.  If you are drafting an agreement you need to keep in mind what will happen if you have to buy or sell your interest under the agreement.  For example, in a shotgun agreement, will you have the funds to buy out the shares if the remaining shareholder elects to sell rather than buy?  More to the point, if the buy-sell were to be triggered by your disability, would you want to buy the shares?  If you are going to be purchasing life insurance to fund the buyout, it may be important to know what the value of the business really is.  A formula agreement makes it relatively easy to determine the price under the agreement, but the price may not equal the value.

The process agreement provides for the determination of the value when shares transfer hands.  However, care must be used in drafting these type of agreements.  There are a few options. The agreement can provide for each side to pick an appraiser and if the values of each appraiser are with 10% of each other, use the average.  If they are more than 10% apart, a third appraiser is selected by the two original appraisers.  While this methodology is fair, it takes a long time to have the appraisals finished, and can be very expensive.  A simpler alternative for the process agreement is to select an appraiser jointly when the agreement is signed, allow a neutral third party to select one appraiser, or have both sides submit names and agree to an appraiser when the time comes.  By only using a single appraiser, you can cut time and cost from the buy-out process and end up in the same place as using three appraisers.

My next post will address defining the value used in a buy-sell agreement.

©2010 Florida Business Valuation Group

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07 Oct

Buy-Sell Agreements: Triggers

Posted in Buy-Sell Agreements on 07.10.10

In August, Chris Mercer, the author of Buy-Sell Agreements for Closely Held and Family Business Owners, spoke in Ft. Lauderdale. He graciously is allowing me to summarize information from his presentation in this post.

Most business owners do not think of the various events that could cause a buy-sell agreement to be triggered.  Chris lists the 20 “Ds” that shareholders can be addressed in their buy-sell agreements (including events which trigger the buyout provisions):

  • Departure – Trigger event, the shareholder quits his job with the company
  • Discharge – Trigger event, the shareholder is fired
  • Death – Trigger event, the shareholder dies
  • Divorce – Trigger event, the shareholder gets divorced resulting in the transfer of an interest
  • Disability – Trigger event, the shareholder is disabled (should address what constitutes a disability and the length of time before this event triggers a buy-out)
  • Default – Trigger event, a shareholder’s interest is transferred due to personal bankruptcy or other involuntary transfer
  • Disqualification –Possible trigger event, a shareholder loses his license or regulatory approval to work in the business or to hold his or her shares
  • Disaffection – A shareholder becomes dissatisfied with the company and needs to be terminated from employment (Chris indicates that this may seem like a stretch.)
  • Disagreement – Shareholders reach a deadlock, the buy-sell agreement should address how to resolve the deadlock, whether it be a way to break the deadlock or the trigger of the buy-sell provisions
  • Disclosure – Provisions for preserving the assets of the company, including trade secrets, customer lists and other confidential information
  • Dispute resolution – Address the process for settling disputes, whether it be mediation or arbitration, and who will pay for the process
  • Dilution – Can additional shares of stock be issued and will existing shareholders’ interests be protected from dilution?
  • Dividends – Specifying a dividend payment policy can provide minority shareholders with the right to receive cash from the company, when profitable.  It can also provide that the company withhold dividends to pay for capital projects or to repay debt.  In any case, a policy can eliminate disagreements between minority and control shareholders.
  • Distributions – For pass-through entities, profits and losses are taxed at the individual level.  In addition to clarifying the distribution process to protect minority shareholders, a distribution policy can guaranty that enough cash is distributed to pay income taxes on profits.
  • Drag-along rights  – When a controlling shareholder receives an offer to purchase stock, drag-along rights can force the remaining minority shareholders to sell their stock.  (Tag-along rights provide that minority shareholders can force a controlling shareholder to sell the minority shares with the control shares.)
  • Double entities – When separate companies are used for other aspects of operations, such as owning real estate, leasing employees or offshore sales, it may be appropriate to have similar provisions in each of the agreements, and have trigger events coincide with each other.
  • Differential pricing – Since shareholders determine the price for buy-sell agreements, they can decide on different pricing for different events.  For example, upon death or disability, 100% of the price may be paid, whereas on termination with cause, only 75% of the price may be paid.
  • Don’t compete agreements – Non-compete agreements may be separate documents, however, a buy-sell agreement can require a departing shareholder to sign a non-compete agreement or a non-solicitation agreement when his or her shares are purchased.  (Consult an attorney regarding the terms and enforceability.)
  • Donate – The buy-sell agreement may restrict transfer to certain parties such as spouse, lineal descendants, siblings, trusts or charities.
  • Distributions after a trigger event – Buy-sell agreements can address what happens to dividends and distributions after the trigger day, since it can often take months or years to resolve disputes.

There are numerous other provisions that could (or should) be included in a buy-sell agreement depending upon the nature and structure of the company.  Consult your attorney to write your buy-sell agreement.  It is a legal document which will affect your rights should a trigger event happen.

There are online tools if you want to take a stab at looking at your buy-sell agreement such as http://buysellagreementsonline.com/buy-sell-agreement-audit-checklist/.

If you have questions on how the different events affect value or the price you will get under a buy-sell agreement, please contact me.

©2010 Florida Business Valuation Group

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