Posted by Jonathan Patterson, CPA, CVA
Many businesses upon formation or soon thereafter put in place a buy-sell agreement to protect the business in the event an owner leaves the company (voluntarily or involuntarily). Examples of such events include: retirement, selling shares to someone else, going through a divorce, or death. The buy-sell agreement sets the selling price and terms for a buyout in such an event. It is the protection that is put in place so that all owners know the defined terms of the exit. Yet, as is common with many agreements, they are executed and left unchanged for multiple years. Over time, a business changes and evolves and that original document may no longer holds the same merits it once did.
What is your solution? Revisiting your buy-sell agreement annually is the first step The second is to have the calculation performed for you by a qualified individual to do so. The first time this process is started, it can be EYE-OPENING! This will be especially so if your buy-sell agreement has not been touched for so long that you have to dig it out of the bottom of a drawer and wipe the dust off. The original calculation method might not truly represent the value of the business or a fair buy-out for the exiting owner.
Upon realizing that your buy-sell no longer fits, you should re-evaluate the following key components:
- Appraiser Qualifications – who should be performing the valuation work? Examples of appraisal designations are CPA/ABV, CVA, CFA.
- Valuation Date – the effective date that the formula or valuation for the buy-sell agreement is to take place
- Standard of Value – many buy-sell agreements call for book value of the company, but book value (which is not a standard of value) can be dramatically different than Fair Value or Fair Market Value
- Basis of Value – the means by which the buy-sell agreement sets the value of the entity. Generally, buy-sell agreements fall into three different categories:
- Fixed price agreements
- Formula price agreements
- Appraisal / valuation price agreements
- Funding Mechanism – how the buy-sell will be funded, e.g., life insurance, a promissory note, or perhaps external financing
The discussion of any changes to your agreement should be done with the legal, tax, and valuation advice of experienced advisers.