Buried in the Corporate Archives …

A lot of our valuation work is done for the purpose of internal share transfers of private businesses, or buy-sell transactions. In doing this work, we often see that owners have overlooked or neglected to keep important documents up to date. One such document is the buy-sell agreement, which articulates important legal, tax, valuation and financing issues that are important to ensuring smooth share transfers and business continuity.

I recently evaluated a holding company with a fair market value of approximately $40 million dollars. Two shareholders each owned a 50% interest in the company, a C Corporation, and one wanted to sell their stake to the other. The client said during our initial conversations that there was no buy-sell agreement in place, so we proceeded with developing a Fair Market Value opinion of a 50% interest. Just to be safe I requested a copy of “any agreements governing  or restricting the sale of shares”, as I always do.

Guess what? Just as I was wrapping up the valuation, the client came across a type-written copy of the corporate buy-sell agreement executed in 1982. The owners and officers had been unaware of its existence. Hence, it hadn’t been updated and they certainly weren’t aware of its terms and provisions. As I reviewed the agreement, I found that it prescribed that any transfer of company shares would be at book value. In this case, book value was less than $1 million dollars.

TAKE NOTE: A buy-sell agreement is a legally enforceable contract. In the 2011 New Jersey Appellate Court case of Estate of Cohen v. Booth Computers, the partnership (buy-sell) agreement stated that value would be “net book value, plus $50,000, on the most recent financial statement.” When Cohen passed away this formula generated a value of $178k. Cohen’s heirs had the business appraised for $11.5 million. The Court upheld the $178k value based on the terms of the partnership agreement!

For my client, this was a nightmare waiting to happen. In my case, imagine what would have happened had my clients not had a great relationship — the seller could have received less than $1 million for a $40-million-dollar asset! Fortunately, the owners were committed to a fair deal and they agreed to set aside the buy-sell agreement.

To assure that your company shares will transfer for an appropriate price when your buy-sell agreement is triggered or to put a buy-sell agreement in place, contact a business appraiser who is experienced in valuing company shares for buy-sell transactions. When you bring in a seasoned business valuation expert early on to interpret the pricing mechanism and other terms of your existing buy-sell agreement, they can recommend changes that will ensure that the agreement operates as the shareholders intended. And the sooner the better. It’s an easy discussion while the shareholders interests are still aligned. Later on, when shareholders becomes buyers and sellers, their interests diverge and making any changes to these agreements become far more difficult in most cases.

For further information on buy-sell agreement business valuation or to discuss a current need, please contact Jerry Matecun, CBA, at jerry@exitstrategiesgroup.com, or call (949) 287-8397.