Will your business survive losing you?

/in , /by Al Statz

Most entrepreneurs are a rare breed — full of optimism and confidence. But that faith and certainty can also make them feel invincible. Every business downturn will be the last, every new year will be another record, and every good leader retires happily with their family.

Unfortunately, none of us are invincible. And if you’re like many business owners, a significant portion of your wealth — and your family’s income — is derived from your business.

Consider taking these practical steps to minimize the effects of your death or incapacity on your family, employees and business:

Partnerships

If you have partners, update your buy-sell agreement to be sure it reflects your current business situation. I’ve seen many business owners set these agreements up when they start or purchase their company, only to let them sit for 15 years, unchanged as partners come and go and as business and market conditions change.

Many business partners fund their buy-sell agreements with life insurance. Insurance proceeds can be used to purchase your ownership interest from your estate. Your family is made whole and the business isn’t burdened with debt.

Get an updated estimate of value every 2 to 3 years, then adjust your buy-sell agreement and  amount of life insurance accordingly. If you don’t, both your family and your business could be mired in litigation and/or face financial difficulty. As valuation experts, we’re often involved in settling disputes over value.

Consider this scenario.  The fair market value of a company is $10 million, but it is insured for just $4 million. Two 50/50 partners have $2 million of life insurance on the other partner.  If a partner dies, there will only be $2 million to pay the departed partner’s estate, leaving a $3 million gap.  That’s a significant liability for the company to bear, and paying down that debt could mean forgoing growth investments for years to come, negatively affect the company’s ability to compete and reducing the chances of the departing partner’s estate getting paid.

Sole Owners

If you can, build up a management team that can carry on without you. Hire and groom your eventual successor. The better key employees are able to operate the business without you do, the better off your company (and family and partners) will be in the event of your death, illness (or even a business sale).

Even if you don’t have a partner, life insurance can still be a good tool. Proceeds can sustain your family for a while, buying them time to sell the business or establish new leadership. It can also provide the business with the extra equity necessary to hire a transitional CEO or increase management salaries after you’re gone.

Beyond life insurance, you should have a written contingency plan in place to transition business leadership and ownership if you die or become incapacitated.

Contingency Letter

Many business owners have life and disability insurance and a trust, will, power of attorney, medical directive and related documents in place, but few have prepared a letter of guidance to their spouse and family on what to do with their company if something happens to them. We have a Sample Contingency Letter that we share with clients that don’t already have something like this in place.

Whether your plan involves a family member or key employees stepping into your leadership shoes, whether it involves a sale of the company or transfer to existing partners or employees, you’ll want to sit down and talk through your plan with everyone involved, including your spouse, partners and leaders, attorney and CPA.

 

Sorry for the morbidity here, but all of us business owners need to put our entrepreneurial optimism aside once in a while to plan for the worst. There may be nothing worse than losing a loved one, than when that tragedy is compounded by the stress and conflict that results when survivors are left with a distressed business and no clear plan for moving ahead.

For advice on contingency planning or selling a business, contact Al Statz, founder and CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com.

Buy-Sell Agreement Valuation Resources

/in , /by Al Statz

Every business with two or more shareholders should have a buy-sell agreement. A buy-sell agreement is a legally binding contract that restricts and governs how shares are priced and transferred between shareholders or partners of closely-held businesses when certain trigger events occur. Arguably, valuation is the most important (and argued over) aspect of buy-sell transactions.

A good one-third of our business valuation work relates to internal equity transactions, and because this is an area of our practice that we are extremely involved in and passionate about, we’ve authored many articles about buy-sell agreements over the years. This post is a compendium of those articles, for easy reference:

Exit Strategies Group’s Buy-Sell Agreement Valuation Articles

  1. Choices of Pricing Methodologies in Buy-Sell Agreements
  2. Pros and Cons of Price Formulas in Buy-Sell Agreements
  3. Hidden Problems with the Price Formula in Your Buy-Sell Agreement, and Solutions
  4. How a Covenant not to Compete Affects Value in Buy-Sell Agreements
  5. Does My Buy-Sell Agreement Establish Value for Estate Purposes?
  6. Funding Your Buy-Sell Transactions
  7. Four Questions Your Buy-Sell Agreement Should Answer
  8. The Dismal D’s of Buy-Sell Agreements (shareholder departure, disinterest, divorce, death, disability, etc.)
  9. Buy-Sell Agreement Categories (as defined by the relationship between the parties to the agreement, i.e., the individual owners and their business entity.)
  10. Your Buy-Sell Agreement: In good shape? Needs a tune up? Or disaster waiting to happen?
  11. Your Buy-Sell Agreement – Keep It Current Before It Costs You Money and Grief!
  12. One Business Appraiser that All Parties Know and Trust

Finally, a summary of Exit Strategies Group’s services relating to buy-sell agreements.

MCLE Workshop for Attorneys

Our team also developed a free workshop for attorneys titled, “Avoiding Landmines in Buy-Sell Agreements: A Valuation Expert’s Perspective.” This program qualifies for 1.0 hour of MCLE credit and has been attended by over 250 attorneys so far. Contact Joe Orlando for further information.

Exit Strategies Group provides business valuation and consulting services to business owners and attorneys, to help them create, fix and administer buy-sell agreements (BSA’s). Feel free to check out these articles, and don’t hesitate to reach out to one of our senior appraisers with a related question or potential need.

Al Statz is the founder and President of Exit Strategies Group, Inc. For further information on this subject or to discuss an M&A, exit planning or business valuation question or need, Email Al or call him at 707-781-8580. 

“Closing of the Books” to Allocate Income on S-Corp Ownership Change

/in /by Al Statz

As brokers and appraisers of closely-held and family-owned businesses, we work with a lot of S-Corporations. When S-Corp shares transfer subject to a buy-sell agreement, the valuation date, trigger date and transaction date rarely fall conveniently at the end of a year.  That’s no problem for valuation experts. We can determine value as of any date. But what’s the fairest way to allocate taxable income among S-Corporation shareholders in a year in which ownership changes?

The answer, according to Santa Rosa California-based CPA Dan Prince, is to allocate income among the S-Corporation’s shareholders on a per-share basis in the pre-change period and in the post-change period as if the  books were closed on the date of the ownership change. The shareholders agree to make what’s called a “Closing of the Books” election.

Let’s look at a simple example.

Greg and Matt each own 50% of an S-Corp’s shares at the beginning of the year, and on September 30 they both sell 1/3 of their shares to Bud, at which point they each own 1/3 of the shares outstanding. As part of their purchase and sale agreement, they agree to make a closing-of-the-books election.  Assume the Corp has pre-change income of $200,000 and post change income of $100,000, for a total of $300,000 for the year.

Under the Closing of the Books method, the allocation of the year’s income is calculated as follows:

  1. Greg: 50% x $200,000 + 33.333% x $100,000 = $133,333.
  2. Matt: 50% x $200,000 + 33.333% x $100,000 = $133,333.
  3. Bud: 33.333% x $100,000 = $33,333.

The Closing of the Books method is in contrast to the general rule where annual income is simply prorated on a per share per day owned in the change year.  Under this general “proration method”, here’s the income allocation calculation:

  1. Greg: $300,000 x (50% x 3/4 + 33.333% x 1/4) = $137,500.
  2. Matt: $300,000 x (50% x 3/4 + 33.333% x 1/4) = $137,500.
  3. Bud: $300,000 x 33.333% x 1/4 = $25,000.

In practice there’s more to this, but you get the idea.

Business valuation plays an important role in a buy-in, buy-out, buy-sell, redemption, MBO, ESOP or other equity transactions in privately-held businesses.  When you  transfer stock or LLC interests during a tax year, Exit Strategies Group can provide a business valuation but we are not CPA’s. Be sure to consult with your CPA and business attorney for tax and legal advice.

Al Statz is founder and President of Exit Strategies Group, Inc., a business valuation and M&A brokerage firm with offices in California and Portland, Oregon. For further information on this subject or to discuss a valuation or M&A question or need, confidentially, contact Al at 707-781-8580 or alstatz@exitstrategiesgroup.com.

Four Questions Your Buy-Sell Agreement Should Answer

/in /by Al Statz

A buy-sell agreement is a common contract between shareholders that both restricts ownership and facilitates the transfer of shares in a closely-held company. The other shareholders or the company become the buyers (marketplace) for what would otherwise be highly illiquid stock. Every buy-sell agreement should answer four fundamental questions:

1. Who is the purchaser?

Generally, buy-sell agreements take one of three approaches to determining who the purchaser will be: Redemption, Cross-Purchase or Hybrid.

In a redemption agreement, the company buys back an owner’s shares. When there are several owners of the company, this may be the best method. In a cross-purchase agreement, the remaining owners purchase a departing shareholder’s interest. This type of agreement is often considered best when there are only two or three shareholders. The cross-purchase method becomes unwieldy when there are several owners and the agreement is funded by life insurance. Insurance policies will have to be purchased by each owner to cover every other owner, which quickly multiplies the number of policies needed. A hybrid agreement is a combination of the above two methods. Upon an owner’s withdrawal, the stock may be first offered to the other shareholders of the company. If they do not wish to buy some or all of the stock, the corporation then buys the shares.

2. What are the buy-sell trigger events?

A buy-sell agreement should be tailored so that a buy-sell is triggered if a company owner dies, becomes disabled, retires, gets divorced, becomes insolvent, has a falling out with the other shareholders or disassociates with the company for any reason. You, your partners and your attorney decide what triggers are appropriate and how shares will be valued and bought out in each case.

3. How will shares be valued?

One of three approaches is generally used to value a departing shareholder’s interest:
(a) Agreed Upon Price – Since the agreement is usually executed years before it is triggered, an agreed upon price is rarely used. The owners must make extraordinary efforts to update the value on a regular basis. In practice, the price is rarely updated.
(b) Valuation Formula – Somewhat common with very small businesses, as an attempted cost-savings measure. Can work when a business has stable management, sales, profitability and operations, and industry and economic conditions are static.
(c) Independent Valuation – This is the most accurate, robust and fair approach. An appraiser can deal with dynamic economic conditions, an emerging industry, complex capital structures, and changed business circumstances.

4. How will the buyout be financed and paid?

Often installment payments are made from the business’s operating cash flows over time, and sometimes life insurance proceeds upon an owner’s death are used. The approach taken should ensure that the business won’t be crippled with a large payout, and that heirs will have money when they need it. A lump-sum payment is available if life insurance is involved. However, if the corporation is to buy out owners during their lifetime, scheduled note payments may be necessary. If an owner retirement triggers a buy-sell, life insurance cash values can serve as a down payment. There is no assurance that a company or purchasing shareholders will have sufficient funds in the future to satisfy note payments. Getting this right requires thoughtful and early planning.

A buy-sell agreement is an important part of a closely-held business owner’s succession plan. There are many more questions to be carefully considered and answered. Exit Strategies provides business valuation and consulting services to owners and attorneys when creating and carrying out buy-sell agreements. We do not provide legal services but can connect clients with attorneys who have deep buy-sell knowledge and experience. Contact Al Statz at 707-781-8580 with any questions or to discuss a current need.

Does My Buy-Sell Agreement Establish Value for Estate Purposes?

/in , , /by Al Statz

Al StatzBuy-sell agreements that contain a clause that values stock at less than fair market value can be disregarded for tax purposes. It is important to consider the requirements of Internal Revenue Code (IRC) Section 2703 when developing an estate plan involving business interests in which 50% or more of the stock is family owned.

Section 2703(a) states that a shareholder agreement (entered into after October 8, 1990) that allows for the acquisition or transfer of property at a price that is less than fair market value will be ignored for estate and gift tax purposes. With respect to buy-sell agreements, Section 2703 provides that such agreements will set the value of shares for estate tax purposes if the agreement is binding in life as well as at death and results in the shares being transferred at fair market value.

Also, the buy-sell agreement must meet these requirements:

  1. It is a bona fide business arrangement.
  2. It is not a device to transfer property to members of the decedent’s family for less than full and adequate consideration.
  3. Its terms are comparable to similar arrangements entered into by persons in an arms­-length transaction.

A buy-sell agreement is deemed to meet the three requirements if more than 50% of the business enterprise is owned by individuals who are not members of the transferor’s family.

 A business owner’s estate plan and succession plan can be interrelated in other ways as well.  Exit Strategies does not provide tax counsel, but we connect owners with competent tax professionals.  Our accredited business valuation experts appraise privately held businesses and fractional interests for buy-sell, tax, exit planning and many other purposes.  Contact Al Statz at 707-781-8580 with any questions or to discuss a current need. 

Hidden Problems with the Price Formula in Your Buy-Sell Agreement, and Solutions

/in /by Al Statz

It is tempting to select a formula approach to pricing shares when business partners come and go. After all, a formula is easy for everyone to understand, and in theory at least, inexpensive to apply. If you’re satisfied with getting to a price, any price, then congratulations – job done. But the goal is to arrive at a price that is fair to all concerned. This article discusses some of the unforeseen problems with buy-sell pricing formulas that we as valuation experts encounter frequently.

As a quick introduction, buy-sell agreements usually employ one of three basic approaches to pricing shares upon buy-sell trigger events (when a shareholder retires, dies, becomes disabled, etc.):

  1. Fixed Price: Shareholders agree on a price per share and agree to periodically revisit that price.
  2. Formula: Shareholders agree on a formula to calculate share price. Examples include: book value; adjusted book value; 4 times trailing 3 years average EBITDA, etc.
  3. Independent Valuation: Shareholders agree on a professional business appraiser to determine fair market value (or another appropriate standard of value).

The pricing method prescribed in your company’s operating agreement, by-laws, or shareholder, buy-sell or stock restriction agreement, as the case may be, is important to the success of your next buy-sell transaction. So, what are these hidden problems with the formula method?

Businesses evolve, and formulas are static

No single formula will consistently produce a fair market value result year in and year out. It is common, for example, for companies to move from a project-based model to a recurring revenue model over time. The latter sell for higher multiples, yet the multiple stated in the buy-sell agreement still reflects the old business model. In this scenario, the buyer wins and the seller loses. Formulas don’t capture changes in the business, and eventually become irrelevant. Shareholders usually have every intention of updating pricing formulas, but in practice buy-sell agreements get filed away and forgotten about, and their formulas become stale. As years go by and shareholders’ interests diverge (some become buyers and some become sellers), renegotiating a formula to bring it in line with market value becomes increasingly difficult.

Value is forward looking, and formulas aren’t

One of the central tenets of valuation is that the value of an operating business is based on expected future financial returns, considering risk and market conditions at a point in time. Valuation is therefore a forward-looking concept. Past performance may be a strong indicator of what to expect going forward, or it may not. Let’s say a manufacturing company has invested heavily in new product development for the past three years or has just added significant equipment to increase production capacity. A multiple of earnings formula would grossly under-value the shares in this case. In our work testing buy-sell formulas and providing benchmark valuations, we find that prices determined by formulas often bear little resemblance to fair market value.

Formulas are seldom 100% replicable

I’ve seen three reasonable financial experts apply the same price formula to a company and arrive at three different answers because there were at least three ways to interpret the formula. Rarely do we see pricing formulas that are totally unambiguous. When the formula was created, no one was sweating the details. Years later, when buyers and sellers emerge, a formula that leaves room for interpretation will almost certainly result in a dispute. While seemingly straightforward, a pricing formula that is not designed by a seasoned valuation professional is very likely not 100% replicable.

Formulas can create the wrong incentives

An earnings formula creates a disincentive for a managing shareholder to invest in operations toward the end of his or her reign. If he or she expects to be paid a multiple of EBIT, they might hold back from making investments that fuel growth or allow the company to remain competitive. The exiting shareholder receive more per share, while reducing future cash flows, which reduces actual value. Conversely, an unscrupulous controlling shareholder who knows that other shareholders are nearing retirement, could overspend for a few years to reduce EBITDA and therefore the buyout price. It does happen.

Bottom line; pricing formulas often yield results that are not true economic values. They produce winners and losers, which leads to hard feelings, disputes, and sometimes litigation, which becomes shockingly expensive, time-consuming and disruptive; and destroys shareholder value for all concerned.

All of the above shortcomings can be overcome by having a valuation-based buy-sell agreement and appointing a qualified and experienced business appraiser. However, if you insist on using a formula, I recommend that you at least hire a valuation expert to do a benchmark valuation of your company and design a formula that is more accurate, more replicable, and more robust. Then have that appraiser update the valuation and test and revisit the formula every three years or so.

If you would like to have your buy-sell agreement objectively reviewed from valuation, economic, fairness and practical business perspectives, please give us a call. Al Statz, ASA, CBA, can be reached at 707-781-8580 or alstatz@exitstrategiesgroup.com.

Pricing Methodologies in Buy-Sell Agreements

/in , /by Jim Leonhard

When it comes to valuing a business for tax filings, M&A transactions, ESOP’s and most other purposes, business appraisers are usually free to use all of the methodologies in their arsenal.  But, when it comes to Buy-Sell Agreements that govern the sale or exchange of interests among closely-held business owners, many of these agreements specify a fixed amount or formula to price equity interests. Recently our firm analyzed the valuation and funding-related provisions used in thirteen buy-sell agreements that we encountered over the past several months.

Here’s a summary of the pricing approach taken in those agreements:

• 6 called for one or more independent valuations to determine share price (46%)
• 6 contained a predetermined price formula (46%)
• 1 used a fixed price (8%)

Despite the small sample, our findings were remarkably similar to a survey by forensics and valuation services firm Dixon Hughes Goodman LLP, which asked attorney’s what their preferred method was for valuations in BSA’s:

• 43% prefer a valuation
• 39% prefer to prescribe a formula
• 17% default to using a fixed price

Using a valuation process in a buy-sell agreement normally produces a value that is most fair to all parties, that stands up to scrutiny, is less likely to result in a dispute, and is less likely to be challenged by tax authorities.  On the other hand, the use of formulas and fixed prices introduces potential landmines that should be avoided under most circumstances.
 
Proper business valuation is one of the keys to making buy-sell transactions occur smoothly and cost-effectively. Jim Leonhard works out of Exit Strategies’ Roseville, California office. For more information feel free to Email Jim or call him at 916-800-2716. 

Funding Your Buy-Sell Transactions

/in , /by Al Statz

Al StatzA properly structured Buy-Sell Agreement (BSA) ensures a market for owners’ equity when they leave the business, restricts the transfer of shares to unwanted parties, and lays out a set of rules and processes that mitigate the overall risk of uncertainty when a trigger event occurs. However, without having adequate funding mechanism(s) in place, a well-intentioned buy-sell agreement may not satisfy the shareholders needs when a trigger occurs.

In this post I’ll briefly outline the three most common funding sources that we find when reviewing buy-sell agreements for business valuation purposes.

  1. Life insurance is the safest bet in case of the death of a shareholder. The proceeds are paid out promptly, and if any additional payment is required one of the other methods can be used to facilitate full payment. Several tax and administrative issues need to be considered depending on whether the shareholders or the corporation owns the policies. The type of policy — term, variable or whole life — is also a consideration. The premiums for whole life are substantially higher than for term, but it builds cash value that can be used even if a death doesn’t occur. The BSA should be specific in how life insurance proceeds are to be treated for business valuation purposes.
  2. Seller financing is often used in BSA’s. Price and terms of the note should be clearly spelled out: full payment upon a trigger event? Or a down payment, term, and rate? Some agreements adjust the rate annually to reflect market rates, where others leave the rate fixed or pegged to a benchmark rate as of the buy-sell date. What about protection in case of default? My point is that there is no prescribed way. Obviously financing is a negotiation that can be as creative or as simple as the participants deem practical.
  3. Corporate cash or a bank loan that provides funding is another funding. However, cash isn’t always an option for small, closely-held firms that lack large cash reserves. Securing a bank loan for buyouts is often challenging, especially when a firm has just lost a key executive.

As a fourth option, we occasionally see clients partner with a private equity group to buy out a departing shareholder. By doing this they can also gain access to new capital to support future growth. This type of funding is usually only available to companies with a few million dollars in annual free cash flow. We know a lot of private equity groups and can make introductions when appropriate.

It’s important to point out that these funding options are not mutually exclusive, and are often used in tandem to fund the buyout of a departing shareholder.  We recommend that not only should a buy-sell agreement and the valuation be updated every year or so, but also that funding options be reevaluated and updated based on the company’s financial position, ownership and current valuation.

Exit Strategies brings independence and over 100 years of cumulative business valuation and M&A transaction expertise to every engagement. Founder and president Al Statz is available for free confidential consultations. You can reach him via email or by phone at (707) 781-8580.

How a Covenant not to Compete Affects Value in Buy-Sell Agreements

/in , /by Al Statz
When someone sells a privately-held company, the buyer usually insists that the seller sign a covenant not to compete. In fact, in over 20 years of business sales and acquisitions, I have yet to see a purchase agreement without a covenant-not-to-compete (CNTC) provision. Now let’s say that your Company or its shareholders purchase all of a departing 50% shareholder’s interest for fair market value; is it reasonable to expect that the selling shareholder would not compete with the Company? I think so.
Yet, many buy-sell agreements (BSA’s) are silent on the non-compete issue, allowing the departing shareholder to receive full value for their shares AND start, join or back a competing business. I briefly surveyed the last 10 buy-sell agreements that I’ve reviewed for valuation purposes, and found that fully half of them were missing a non-compete provision!
A covenant-not-to-compete provision in a BSA usually restricts the selling shareholder from soliciting customers and employees, and otherwise competing with the Company for a specified length of time within a specified geographic area. A CNTC is considered an intangible asset of the Company and may have significant value. Stated differently, the Company’s shares, post transaction, may have significantly less value without a covenant not to compete from the selling shareholder. CNTC’s have value because they protect the future revenue and profitability of the Company.
How does the absence of a covenant not to compete affect share value?
One common approach to valuing a CNTC is called the differential valuation approach; where the business is valued under two scenarios. The first valuation scenario assumes that a CNTC is in place, and the second scenario assumes that it is not. Another approach involves determining the present value of the potential future economic damages that would occur as a result of competition. In either case, the valuation expert’s job is to determine the net impact on revenue, margins and future cash flows arising from potential competition by the selling shareholder. The difference in company value for each scenario is the value of the CNTC.
To project cash flows, the business appraiser will have in-depth discussions with company management to understand and develop assumptions regarding:
  1. Seller’s business expertise in the industry and general ability to compete
  2. Seller’s intent to compete
  3. Seller’s economic resources
  4. Seller’s contacts and relationships with customers, suppliers, and other business contacts
  5. Seller’s age and health
  6. Seller’s intent to reside in the geographic area
  7. Barriers to entry that would limit the seller’s ability to compete
  8. Probability and timing of seller competing
  9. Probability that competition will harm the company
  10. Potential damage to the company due to the seller’s competition
  11. Ability of the company to prevent a customer from leaving
  12. Buyer’s interest in eliminating competition
  13. Duration and geographic scope of the (typical) CNTC
  14. Enforceability of the CNTC under State law
If valuing a CNTC sounds time consuming, subjective, speculative and expensive, it is.  You could be faced with a situation like this if your buy-sell agreement doesn’t prohibit competition. Or someone could be buying shares at a premium someday.
What does your buy-sell agreement say?
The main objective of a buy-sell agreement is to provide for the orderly and reasonable transfer of shares in the event an owner dies or leaves your Company. Yet many BSA’s don’t accomplish this because terms are ambiguous or incomplete, leading to contentious disputes and litigation when a trigger event occurs. Exit Strategies regularly appraises businesses for buy-sell events, and in doing this work we get to read lots of buy-sell agreements (and other corporate documents governing the transfer of shares), and witness firsthand how they don’t operate as originally intended by the parties.
As a business valuation expert, I recommend that you: a) have a buy-sell agreement, b) understand what it says, c) are convinced that it accurately reflects the intentions of your shareholders, and d) have great legal, tax, financial and valuation advisors to help you get it right. Otherwise you may have a time bomb ticking away in your file cabinet.
If you have any questions regarding non-compete or other buy-sell agreement provisions that affect valuation, Email Al Statz or call him at 707-778-2040.

Your Buy-Sell Agreement: In good shape? Needs a tune up? Or Disaster waiting to happen?

/in , , /by Bob Altieri

An Ounce of Prevention is Worth a Pound of Cure

I can’t tell you how many times I’ve heard from business owners and their spouses that a key person became disabled or died and left an operating closely-held business in turmoil. What, no Buy-Sell Agreement? Ask anyone who has been selling and appraising business for a number of years and they will tell you this sort of thing is common. All businesses with more than one shareholder should have a Buy-Sell Agreement (“BSA”) in place. Even when companies have BSAs, they are poorly written, causing divisive and expensive issues down the road.

All multi-owner businesses need a well-written BSA to transfer shares in a fair and efficient manner when a shareholder dies, becomes incapacitated, is involved in a marital dissolution, quits or is fired, retires, or the company enters bankruptcy (aka,”Trigger Events”).

Exit Strategies’ accredited appraisers perform numerous business valuations each year, and because this work requires us to review corporate documents, we can say with some authority that many privately-held companies have problematic Buy-Sell Agreements from business, funding and valuation perspectives. When we come across B-S Agreements (pun intended), most often the owners didn’t want to invest the money to do it properly, or they just didn’t understand how import it was to have a viable BSA in place at the outset. Unfortunately, those who experience costly litigation, internal disputes, business erosion and family problems learn a painful lesson later on.

Shareholders have three choices when deciding on how shares will be priced when one of the aforementioned trigger events occurs:

  1. Fixed Price: Shareholders agree on a set price. Unfortunately, the price is likely years out of date and the shareholders usually have not agreed on a way to update the price.
  2. Price Formula: Shareholders agree on a formula to calculate future pricing. Chances are, no one has calculated it lately and because of changes in the company, economic and industry conditions over time, the formula price may be higher or lower than fair market value at the time of the trigger event. Also, it’s often seen where the shareholders haven’t agreed on ways to make necessary/appropriate adjustments to the formula.
  3. Valuation Process: Shareholders agree on a process employing one or more appraisers to determine the value of shares using guidelines specified in the BSA. There are two types of process BSAa: Multiple Appraiser and Single Appraiser. Multiple appraiser agreements call for the selection of two or more appraisers to develop one, two, or three appraisals whose conclusions form the basis for the final price. If that process sounds time consuming, cumbersome and expensive, IT IS!! It can also be divisive. Single appraiser agreements call for the selection of one appraiser whose valuation sets the final price. The choices are to a) select the appraiser and value upon a trigger event; b) select the single appraiser now and value at the trigger event; or c) select the single appraiser now, value now, and of course value again when a trigger event occurs.

Our Recommendation is to SELECT ONE APPRAISER NOW and VALUE NOW

  • Select Now – If the shareholders creating the buy-sell agreement name the appraiser at the time of the agreement, all parties have a voice and can sign off on the selection. Early on, when everyone’s interests are aligned, this is a relatively easy decision to make. Doing it after a trigger event, when interests have diverged, is very difficult.
  • Value Now – Once selected, the chosen appraiser provides a baseline valuation, which is a fantastic way to put all shareholders on the same (price) page. We often provide a draft report, and give everyone time to provide comments for consideration before the report is finalized.

Why selecting a single appraiser now and appraising now is the best choice for closely-held companies when creating a Buy-Sell Agreement:

  1. The selected appraiser is viewed  as independent by everyone
  2. Because the appraiser must interpret the BSA language related to valuation when conducting the initial appraisal, any issues regarding lack of clarity or inconsistency with the owners’ intentions can be resolved up front
  3. The valuation process is observed by all shareholders at the outset, so they all know what will happen when a trigger event occurs (no surprises)
  4. The concluded value establishes a baseline price (no surprises)
  5. The selected appraiser maintains independence with respect to process and renders future valuations consistent with the BSA terms and prior reports
  6. Subsequent appraisals, either annually or at trigger events, should be less time consuming and less expensive
  7. Parties will likely gain confidence in the process
  8. Parties will always know the current value for the Buy-Sell agreement, which is helpful for personal or estate planning purposes
  9. The initial valuation gives the shareholders a roadmap to increasing value if that is their objective.
  10. The appraiser’s knowledge of the company and industry grows over time, enhancing confidence for all parties
  11. Creates a means of maintaining pricing for other transactions, thereby enhancing “the market” for a company’s shares


Valuation is a key piece of any shareholder buy-sell agreement. If you need help with the business valuation provisions of your buy-sell agreement, or need a valuation for a trigger event, feel free to Email Bob Altieri or call him at 916-905-5706.