EDITORIAL FEATURE
Buy-Sell Agreement For Small Business Owners By Jeffrey D. Jones, ASA, CBA, CBI
O
ne of the critical documents a business owner should have whenever there is more than one partner/ shareholder in a small business is a Buy-Sell Agreement. Over the years, we have had the opportunity to read many Buy-Sell Agreements. Virtually all of the Agreements have three things in common: a. They are generally written under the implicit assumption that the other guy is going to die first b. The valuation procedures are unclear, unworkable or grossly unfair to at least one of the parties c. The mandated periodic valuations by the shareholders are rarely kept current In my capacity as a business appraiser and business broker, I have discussed the valuation problem inherent in Buy-Sell Agreements with numerous attorneys. The following business issues and suggestions may be helpful, when you are called upon to prepare a Buy-Sell Agreement for your company or a client. A Buy/Sell Agreement should cover the four D’s of Shareholder/Partner involvement which are: 1. Death (who wants to deal with the spouse or family)
2. Divorce (Do you want the spouse as a partner?) 3. Disability (What happens when a Partner/Shareholder can no longer work for an extended period of time. 4. Dissolution (What to do when a Partner/Shareholder wants out). The valuation results may vary greatly depending upon the use of the appraisal. Furthermore, the standard of value to be used when valuing less than 100% contract becomes an important issue. Are minority ownership interests to be valued based on Fair Market Value (which may require a large discount from company value) or Fair Value (usually meaning pro rata of company value)? These issues should be spelled out in the Agreement. The company should consider paying for Key Man Insurance to insure that the funds will be available to buyout departing Partners/ Shareholders. The mandate for the Key Man Insurance and procedures for determining value should be included in the Agreement. Determining the market value of a company and/or a partial ownership interest is an important element of any Buy-Sell Agreement. Many agreements use Book Value as a basis of valuation, while others use a formula or "Rule Of Thumb" method. Book Value may be
SMALL BUSINESS TODAY MAGAZINE APRIL 2012 | PG 18
representative of the company's tax basis in its tangible assets, but it is rarely representative of the company’s Fair Market Value. One or more of the parties to a Buy/Sell agreement is bound to be treated unfairly when Book Value or a fixed formula method is used to determine value. Formulas and "Rules Of Thumb" methods are usually mathematical computations that often do not take into consideration the unique aspects of the subject company. These methods do not specify the procedures to be used in the computation nor fully state which assets are being included or excluded. A few of the agreements we have read state that the company's accountant should conduct the appraisal. This presents a major conflict of interest for the company's account because he will have difficulty being independent when required to represent all parties. Furthermore, the accountant may not be trained or qualified to conduct the appraisal, which would likely result in a faulty value. Left to chance, the courts are likely to rule on the strict interpretation of the agreement, regardless as to the fairness for the parties. Some agreements call for each side to a dispute to hire an appraiser and if they can not agree, then a third appraiser is hired to either www.SBTMagazine.net