By Dean ‘Mac’ Nichols, Attorney
When is the last time you viewed your company’s buy-sell agreement (BSA)? If you can’t remember, or if your business doesn’t have a BSA in place, then now is the time to take action.
BSAs are designed to dictate what happens when an owner retires, dies, becomes disabled, or leaves the company. A BSA will describe the potential arrangements of an owner’s buyout, which includes purchase pricing, funding, and payment terms. Ideally, this document will alleviate what could become at best an emotional negotiation and at worst a lawsuit, minimizing the possibility that shares could be sold outside the company or left to a spouse or children, which may create an unworkable partnership.
One of the critical aspects of a BSA is the valuation provision. This describes how shares of the company will be valued and what mechanism will be used to determine price. There are two common valuation mechanisms. The first is a simple formula such as book value or a multiple of earnings. The other is an appraisal. This would require a professional appraisal to determine value. If a valuation professional is used, then the BSA should also include some additional components:
• Standard of Value—Fair market value is typically the standard of value used, but the specific circumstances for a company may call for another standard, such as fair value. The distinction between these two standards deals with discounts as discussed below.
• Valuation Date—The value of a company and its shares may be affected by this variable. It’s important to consider whether your company wants the valuation date to be the same data as the triggering event, or if you want the date to be independent of any event and to occur according to a schedule dictated in the BSA.
• Discounts—Will the valuation assess the business as a whole, or only the specific owner’s interest in the business? Because of discounts for minority interest and marketability, a portion of the entire business value will differ greatly from the value of a minority owner’s interest.
• Appraisers—How many valuation professionals do you want to hire? What should their qualifications be? Does the company pay for the valuation, is it paid by the departing shareholder, or is it divided between the owners? Hiring a single appraiser is the most cost-efficient option, but some may want one appraiser hired by the company and another by the departing owner.
Another important provision to consider in your BSA is whether it should contain a covenant not to compete for any departing owner. This protects the company from a departing owner using the buyout proceeds to immediately open a competing business.
It’s in the best interest of your business to create and regularly update your BSA. This creates a definitive roadmap that can prevent disputes or indecision. By creating a BSA, all owners are able to collectively agree upon expectations and reduce uncertainty if/when one owner leaves the company.
If you and your company are interested in crafting or updating your buy-sell agreement and would like to discuss the benefits and coverages of a BSA, contact us today.
