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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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