Importance of Valuations in Buy/Sell Agreements

If you own a business jointly with others, we recommend you establish an owner buy/sell agreement which governs what happens in situations, such as disability, death of an owner or an owner wants to dispose of their ownership interest. The owners agree on how to proceed when certain events occur.
 
Smith Schafer is frequently asked to help with buy/sell agreements relative to a valuation of the entity at the time of an event. Business owners may think it is more efficient and proactive to include a stated formula in the buy/sell agreement for determining the value of the business when an event occurs, but in reality, having a stated formula may restrict how events are handled and negatively impact the owners.
 
When an event occurs, such as the death of an owner, the heir(s) and the remaining owner(s) will want the heirs to receive and the business and/or remaining owners will want to pay a fair price for the interest owned by the deceased owner. A formula established based on circumstances at the time of inception of the buy/sell agreement, may not be appropriate and fair to all parties at the time of an event. The value should be determined based on current facts and circumstances.
 
Once a buy/sell agreement is put into place, it is easy to feel comfortable that there is a plan, but as time goes by and the business evolves, the buy/sell agreement may become outdated. When an event occurs, the language in the buy/sell may no longer represent the wishes of the owners and may create stress and dishonoring if the partners believe they are being treated unfairly and decide to challenge the agreement (i.e. bring a lawsuit). Relative to valuation, a formula or process that was appropriate at the time of inception – or even subsequent revisions – of the buy/sell agreement may not be appropriate at the time of the event. 
 
Smith Schafer believes the best way to handle valuation related items in a buy/sell agreement is to either have language:

1. at the time of an event, a valuation expert will be consulted (including description of who is responsible for payment to the expert) or
2. a valuation will be prepared annually by an expert. Then the buy/sell agreement would be updated annually with either the most recent value or a description of the method to use to estimate the value at the time of an event (within the next year). In this case, there should be additional language covering the situation if the annual valuation is not done, stating a valuation will be prepared if an event occurs.

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Questions?

At Smith Schafer, business valuation services support these plans and more. We take a comprehensive view of all you have invested in your business — and what you have created. We can help you get a baseline value that helps you implement your strategic plan to build additional value.