Considerations When Preparing a Buy-Sell Agreement

Like insurance, a buy-sell agreement can protect a business owner and his or her family from unforeseen problems, such as an untimely death, disability, divorce or a business partnership gone wrong. Most companies buy insurance, but not many take the time to properly prepare a buy-sell agreement. And if it’s not a quality, forward-thinking document, many business owners find that it may not cover all the bases.

We can trace most buy-sell agreement problems back to one issue:  Valuation. Failing to carefully consider valuation-related issues can create extra complications for shareholders or their families at a time when they can least afford to address them. Once an agreement is in place, owners need to periodically revisit their buy-sell agreement to be sure it still makes sense. Is it still relevant to the business and the needs of the owners? If not, the agreement becomes outdated and may become unenforceable.

The following list highlights some of the main valuation points to consider when drawing up a buy-sell agreement or revisiting your existing agreement. Review these issues and consult with a valuation expert and/or attorney to save some undue future stress and avoid leaving money on the table.

Valuation Issues

• Does this agreement specify an “as of” valuation date for each triggering event? (For example, the date of death of a shareholder.)
• How does the agreement specify valuation? What formula or method is to be used and are all of the terms explicitly defined? As an example, what makes up “cash flow” or does “income” mean before or after tax?
• Did an outside valuation analyst provide the method, and is the method reasonable? Courts generally prefer professional outside appraisals because owners may use unrealistic expectations to influence their value estimates.
• Does this agreement provide guidelines for how to adjust for non-operating items and non-recurring events?
• Is the method the agreement specifies a generally recognized valuation method, so that it is defendable in court?
• Will the method provided in the buy-sell agreement be accepted for estate tax or marital dissolution purposes?
• Does the agreement specify and define the standard of value, such as fair market value, intrinsic value or fair value?
• Does the agreement specify the appropriate value basis for each shareholder’s interest, such as minority-non-marketable or controlling marketable?

Payment Issues

• Does the agreement state whether the seller receives the value in a lump sum or installments?
• If an event requires purchase of a shareholder’s interest, does the agreement specify whether the company or the individual shareholders are the actual buyer(s)?
• If the buy-sell agreement is funded by life insurance, does the same value apply if an event other than a shareholder’s death triggers the agreement? 

Revisiting the Agreement

• Are all current shareholders and their correct ownership percentages listed in the agreement?
• Have the company’s operations changed? For example, has it added a new line of business or eliminated one? If so, does the fair market value listed in the agreement make sense?
• Have shareholders followed the agreement when a triggering event occurred in the past?
• If not, should the agreement be modified?
• Do changes to individual shareholders’ personal situations warrant changes to the buy-sell agreement? (For example, changes in the shareholders’ estates or marital statuses.)

Conflict Resolution

• In hiring a valuation analyst to value the interest, does the agreement specify how shareholders will select an outside appraiser? 
• Does it list the required analyst qualifications?
• Does it specify who will pay for the independent appraiser’s work under each triggering event?
• If shareholders can’t resolve their dispute, does the agreement specify an alternative means for settling the disagreement, such as arbitration or mediation?
• If a case must go to court, does the agreement specify the appropriate venue for cases involving multistate or multinational entities?

In Summary

Addressing valuation issues when writing a buy-sell agreement can prevent future problems. Whether drafting a company’s buy-sell agreement for the first time or revisiting an existing one, consider this list to help ensure the agreement will provide the desired outcome.

For assistance in developing or revising a buy-sell agreement, contact us at 913-648-0185 or [email protected].