Prepare for valuation issues in your buy-sell agreement

Every business with more than one owner needs a buy-sell agreement to handle both expected and unexpected ownership changes. When creating or updating yours, be sure you’re prepared for the valuation issues that will come into play. Issues, what issues?

Emotions tend to run high when owners face a “triggering event” that activates the buy-sell. Such events include the death of an owner, the divorce of married owners or an owner dispute. The departing owner (or his or her estate) suddenly is in the position of a seller who wants to maximize buyout proceeds. The buyer’s role is played by either the other owners or the business itself — and it’s in the buyer’s financial interest to pay as little as possible.

A comprehensive buy-sell agreement takes away the guesswork and helps ensure that all parties are treated equitably. Some owners decide to have the business valued annually to minimize surprises when a buyout occurs. This is often preferable to using a static valuation formula in the buy-sell agreement, because the value of the interest is likely to change as the business grows and market conditions evolve. What are our protocols?

At minimum, the buy-sell agreement needs to prescribe various valuation protocols to follow when the agreement is triggered, including:

• How “value” will be defined.
• Who will value the business?
• Whether valuation discounts will apply.
• Who will pay appraisal fees?
• What the timeline will be for the valuation process.

It’s also important to discuss the appropriate “as of” date for valuing the business interest. The loss of a key person could affect the value of a business interest, so timing may be critical. Are we ready? Business owners tend to put planning issues on the back burner — especially when they’re young and healthy and owner relations are strong.  Additionally, once the appropriate documents are put in place, business owners may have a tendency to put it in a drawer out of sight. The agreement should be considered a “living document” and the valuation formulas should be tested periodically to make sure that the original criteria are still a good basis for the agreement. It is much easier to discuss the issues when it is an exercise and not an actual triggering event.

So try and be prepared for the unexpected, the more details that you put in place today, including a well-crafted buy-sell agreement with the right valuation components (and some occasional testing) the easier it will be to resolve issues when they arise.