Businesses with more than one owner should always have a buy-sell agreement to handle both expected and unexpected ownership changes. When creating or updating your company’s buy-sell agreement, be sure you’re prepared for the valuation issues that will come into play.
Triggering Events that Activate a Buy-Sell Agreement
Emotions tend to run high when owners face a “triggering event” that activates the buy-sell. These triggering events include the death of an owner, the divorce of married owners or a dispute between owners.
The departing owner becomes the seller who wants to maximize buyout proceeds. The buyers are 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. A requirement for a formal valuation by a qualified business valuation professional is always 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.
Buy-Sell Agreement Protocols
At a minimum, the buy-sell agreement needs to prescribe various valuation protocols to follow when the agreement is triggered, including:
- How will the value be defined?
- Who will value the business?
- Will valuation discounts apply?
- Who will pay appraisal fees?
- What’s the timeline 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.
Developing a Buy-Sell Agreement
Business owners tend to put planning issues on the back burner, especially when they’re young and healthy and owner relations are strong. However, the more details that you put in place today, including a well-crafted buy-sell agreement with the right valuation components, the easier it will be to resolve buyout issues when they arise. LBMC’s business valuation team would be happy to help.