Updated: Nov 30, 2020
A business can be one of the most valuable assets that owners may possess during his/her lifetime. Provisions within an operating agreement, such as the buy-sell agreement once setup correctly can cover the major life situations such as, but not limited to – death, shareholder disputes, disability, retirement, and divorce.
Imagine what a nightmare or headache it can be when turns out your business lawyer tells you that you need a business valuation because your business is failing due to a shareholder’s poor performance. Or how long should a disabled business partner be able to share profits if he or she is not working? Often times these common situations may end with an unfavorable outcome such as a damaged business, broken relationships or irreparable friendships. However, with a little foresight and proactive financial planning can greatly improve the chances of a more favorable outcome during unforeseen circumstances.
Let’s take a look at a case, whereby the agreement called for annual updates and agreement of value by all the partners1. The partners did not update the value as agreed and the founding member who planned on retiring was trapped finding ambiguity in the valuation pricing terms agreed upon many years before and spent time and money invested in a process that was not maintained and could’ve been avoided in the beginning.
From a valuation and pricing perspective, the key elements that all buy-sell agreements (or provisions) should have or include:
1. The Standard of Value and Level of Value – appraisers should be well aware of this.
2. The “As of’ Date – The trigger date e.g. most recent month, most recent fiscal year-end or quarter end.
3. Appraiser Qualifications and Appraisal Standards – make sure whomever does the valuation/pricing work has been trained to do the work, and understands all the nuances and completes the work following the appropriate standards based on their certifications. – listing of the firm name (as long as they have certified professionals on staff).
4. The Funding Mechanism - Just as important as the price determination, is how the transfer will be financed. The goal is ensuring the company, or the paying party, can actually afford to make the payments without putting the whole transfer transaction at risk.
5. Other adjustments to be considered include for example how should key person insurance cash value and proceeds be handled among others.
The goal would be to discuss these items up front during draft or revising of a buy-sell agreement, so that it is clear for all parties involved for a smooth transition and to be prepared for any unforeseen circumstances.
About Trustee Capital LLC:
Trustee Capital LLC, is a certified business valuation and analytics consulting firm specialized in business valuations and custom analytics solutions. The firm’s mission is to deliver independent expert opinions for business valuations to the business, legal, and professional communities and to optimize value for business leaders through the provision of insightful analytics services. The valuation services provided are: valuations for estate and gift tax, business interests, equity valuation (Control/Minority Interests), valuations for transactional support & business financing, financial litigation & forensics, Employee Stock Ownership Plans (ESOPs) valuations, fairness opinions, personal injury, commercial damages and lost profits calculations. Visit https://www.trusteecap.com to learn more.
1See Namerow v. PediatriCare Associates, LLC, 2018 N.J. Super Unpub. LEXIS 2633 (November 29, 2018).
2Mercer, Z. Christopher, Buy-Sell Agreements for Closely Held and Family Business Owners, (August 2010), Chapter 14